By Phil Perry
When negotiating merchant account contracts, it pays to be familiar with the credit card industry’s jargon
Here’s a brief overview of the dynamics of how the system works: Consumers obtain their credit cards from issuing banks. Retailers obtain their merchant accounts, which allow them to accept credit cards, from acquiring banks, which hand off the mechanics of processing transactions to companies called processors. The latter either market directly to retailers or rely on Independent Service Organizations (ISOs) to negotiate contracts with retailers and provide service for the retailers’ accounts.
For the ability to accept credit cards, the retailer pays a merchant services cost that’s comprised of three elements. The first element is the interchange cost, paid to the bank that issues the credit card. This non-negotiable fee consists of two parts: a percentage of the sale amount and a per-item transaction fee. The percentage can range from .05 percent for a debit/check card to as high as 3.25 percent for a World Elite Card. The item fee can range from $.05 to $.22. (American Express is not being included in this outline, as its fee structures are quite different from Visa, MasterCard and Discover).
The second element consists of dues and assessments, also non-negotiable, which are paid to associations such as MasterCard, Visa and Discover. Visa and MasterCard have a set .11 percent interchange cost, with an item fee for Visa of $.0195 and for MasterCard of $.0185. Discover’s interchange cost is .0925 percent, with no item fee.
The third element is the risk management and account management fees of the acquiring bank and its approved processor. Unlike the first two elements, fees in this category—which represent payments made to the acquiring bank, the processor and the ISO—are open to some negotiation, depending on the way the pricing is structured. The oldest structure is tiered pricing, in which three to five tiers of price levels are established as blanket coverage for all three elements of the merchant services cost. This pricing structure is more costly to the merchant, with overall costs that can be as high as 4 percent to 5 percent.
In response, many retailers are taking advantage of an alternative structure, which is referred to as cost-plus or pass-through pricing. In this arrangement, only a small percentage and a transaction fee for processing and risk management are added to the first two elements of the merchant services cost. This can reduce the bottom line costs for accepting cards by anywhere from 5 percent to 45 percent, as compared with the tiered pricing. The result can be a total merchant services cost of less than 3 percent.
With all of this taken into account, it should be noted that for every $100 in fees that a merchant pays for accepting credit cards, approximately $82 to $87 goes to the issuing bank, roughly $5 goes to Visa, MasterCard or Discover for dues and assessments, and between $8 and $13 goes to the authorized processor and acquiring bank. These figures are based on cost-plus or pass-through pricing. If a retailer is on tiered pricing, the authorized processor is receiving more than $8 to $13.