Lesson 3: Pricing Methods (Tricks, Gimmicks & Lies)
Or Should We Say Meat & Potatoes? Pay Attention!!
Let The Pricing Games Begin!
It seems that every industry has a trick up their sleeve concerning the actual cost. Although most of us are quite cynical and cautious when examining the cost of the products and services we purchase, unfortunately we find that there are a lot of traps out there. Merchant processing is no exception! How do you truly compare apples to apples, when processors define fees with different descriptions? For example: monthly fee, customer maintenance fee, customer support fee, and monthly merchant processing fee all mean the same thing. It’s not like you’re comparing a green plaid sofa to a green plaid sofa. We only wish it could be that easy! Now, let’s see if we can take off that slipcover and expose this ugly “green plaid sofa.”
The first thing we will cover is the various pricing schemes. MasterCard, Visa, Discover etc. along with the issuing banks, enjoy the biggest piece of “profit pie” when it comes to processing profits.
The ISOs (independent sales organizations) better known as merchant processors, are fighting tooth and nail to acquire merchant accounts. You basically have hundreds if not thousands of merchant processors fighting over one slice of pie. This would help to explain why tricks are used to squeeze every bit of profit possible.
MasterCard, Visa, and Discover, otherwise known as the card associations, along with the card issuing banks set the interchange rate(s) for the various card types. For example, as we learned in an earlier lesson, a business purchasing card has a higher interchange rate when compared with standard credit. Standard credit has a higher rate than signature debit. In short, the interchange table has hundreds of different categories with various rates applied. You will not only find different rates for different types of cards, but periodically the card associations will issue discounts in an attempt to attract specific industry segments. For example, the fast food industry required a lot of prodding and rate incentives from the card associations In order to convince them. The primary benefit was a predicted increase with the average ticket amount per sale.
The Top of The Food Chain
Let’s start at the top where the real money is made, and then we will work our way down to the big pie fight with ISOs fighting over the last slice. Unfortunately, merchants like you end up with a pie in the face!
The card associations skim the cream right off the top so to speak. In simple terms, they created the game and capture a percentage (or basis points) from every sale processed with their respective credit card brand.
Learning note: 100 basis points equals 1%. 50 basis points equals ½%, and 25 basis points equals a quarter percent.
To avoid confusion, and rather than going back 20 years, let’s just say they are currently obtaining 12 basis points, or $.12 on every dollar. The card issuing bank, profits from the entire interchange rate.
Let Us Slice Your Fees!
Our exclusive FeeNinja Program provides you with a complete professional proposal with fair pricing and reasonable rates that you then take to your existing merchant account provider and ask them to match. It’s really that simple! You keep your existing merchant account exactly how it is but with a much better fee structure!
For sake of conversation let’s say we have a standard reward Visa with an interchange rate of 2.3% + 10 cents. Wells Fargo may call their card “The Covered Wagon Card” while Bank of America promotes their standard reward issued card as “The Freedom Card.” I think you get the picture! So, every time a Bank of America Freedom cardholder makes a purchase, Bank of America acquires 2.3% of that purchase + 10 cents. At 2.3% they can afford to give away a sliver of profit to John Q public in reward perks! So if you add the 2.3% + 10 cents, plus the 12 basis points, a merchant is already up against 2.42% + 10 cents, and we still have a few more hands (ISO, funding bank, etc.) reaching for the cookie jar!
Again, it’s worth pointing out that there are hundreds of interchange rates so at the risk of providing too much information, I’ll give you one more example.
Let’s say that we have a standard business reward MasterCard with an interchange rate of 2.7% + .10 cents. Wells Fargo may call their card “The Business Traveler Card” while Bank of America promotes their standard business issued card as “Business Freedom Card.” Every time a Bank of America “Business Freedom” cardholder makes a purchase, Bank of America acquires 2.7% + .10 cents, of that purchase. It might be Freedom for the cardholder, but you, as the merchant, are now in chains!
“There’s more gold in them there hills”
You would think that the card associations would be excited just to shave 12 basis points off every sale in the world, but you would be wrong. Within the last few years, they decided they wanted a piece of the transaction and monthly fee. The transaction fee was just a shave under two cents. MasterCard called their fee a NABU, while Visa called theirs an APF fee. Visa recently introduced a F.A.N. fee designed to acquire a portion of the monthly fee. The fee can vary based on merchant type. For example, E-commerce merchants will pay more per card swipe than brick-and-mortar merchants.
Can you eliminate the “Middleman?”
So we’ve now covered the top of the food chain and I think you’re ready to learn about the proverbial middleman. First of all, do not fall for the gimmick of eliminating the middleman. Many sales reps will tell you that their processor eliminates the middleman. This is simply not true. A merchant cannot call MasterCard or Visa to obtain a merchant processing account. The system is set up so that a merchant account must go through the ISO channel. As we learned previously, each respective ISO, can negotiate a different “buy rate” from the registered partner or payment platform, such as First Data, Heartland, Chase Bank, Wells Fargo, Global, to name a few. Let us provide a simple example.
Let’s say ISO group “Slimy Sam” negotiated a contract with a six dollar monthly fee per merchant account along with a buy rate of 8 basis points and 3 cents. Using the previously mentioned Bank of America “Freedom Business Card” for illustrative purposes, the ISO must now offer a rate to a prospective merchant above 12 basis points (card associations) 2.7% + 10 cents (Bank of America) and 8 basis points and 3 cents (ISO buy rate) or a total of 3.98% plus 13 cents, before posting one cent of profit!
This would explain why the ISO channel will resort to any trick in the book, in order to capture more profit. We are confident that you now have a clearer picture of the cost structure associated with processing. Now we will attempt to explain the different pricing schemes used by the ISO channel to squeeze more profit. This section will cover:
- Tiered or bucket pricing
- Interchange or cost plus pricing
- Enhanced bill back
- Bundled or flat pricing
The industry trend is moving more towards cost-plus or interchange pricing. However FeeSlicers believes it’s important for you to understand the most popular pricing formulas. It might be important to clarify that although cost-plus is the most transparent effective way to price an account, you can have an extremely competitive tiered or bucket pricing, bundled rate, etc. In short, it still comes down to understanding the pricing and receiving the proper pricing within each formula.
Tiered or Bucket Pricing Formula:
If right now you were to stop reading this and searched online for a merchant processor you would be inundated with statements such as:
Industry’s lowest rates! Rates as low as 1.4% plus $.19! We guarantee the lowest rates in the industry! We eliminate the middleman get a rate as low as 1.2%! Now we already know from the information provided, that this cannot be true.
Tiered or bucket pricing gets its name based on the fact that each card processed, will fall into three or four buckets. Traditionally, the buckets are referred to as:
- Qualified: lowest advertised rate, standard debit and credit
- Mid-Qualified: low level reward cards, reward debit cards
- Non-Qualified: highest rate, high-end reward cards, business cards, etc.
In most cases, merchants presented with tiered or bucket pricing are not given all the facts. They are only given the lowest qualified rate, and they assume that the advertised rate is what their rate will be for all cards. It’s not until they get their first statement that they realize that other cards are going through at much higher rates. So the game played is to basically shine the spotlight on the lowest rate, while failing to bring up the other rates associated with the bucket pricing. Let’s go through an example.
Betty, owner of Betty’s Boutique, received a merchant agreement with the following bucket pricing.
- Qualified rate: 1.29% + 20 cents
- Mid-Qualified rate: 2.65% + 20 cents
- Non-Qualified rate: 3.65% + 20 cents
With this formula, ANY card the merchant accepts with an interchange rate UNDER 1.29% will fall into that first bucket of 1.29%. Any card accepted between 1.29% and 2.65% will fall into the mid-qualified bucket of 2.65%. Any card above 2.65%, will be assessed the nonqualified charge of 3.65%! As you can see, it’s easy to fall for the gimmick of seeing an extremely low qualified rate because in many cases the processor knows that most of the cards will not even fall into that bucket. Most of the cards will be above the 1.29%, so this is just a gimmick. The educated merchant will ask what is your non-qualified rate or “worst-case scenario” rate if you accept a business card, corporate card, or high-end reward card. Again, it is worth repeating that you can have a competitive bucket pricing formula but it’s rare to find one.
Interchange Pricing Formula:
As mentioned, there are hundreds of different interchange rate categories. It is common to have an interchange rate along with an interchange transaction fee. Let’s go back to the Bank of America standard reward card, “The Freedom Card.”
Betty, owner of Betty’s Boutique, received a merchant agreement with the following “cost plus” pricing.
Interchange plus 30 basis points + 10 cents.
With this formula, let’s pretend Betty had 100 sales in a particular monthly statement period. Let’s also assume that every single card was different and had a different interchange rate attached. Let’s examine two of those cards to understand how the pricing formula works. As fate would have it, Betty processed two of her 100 sales with the Wells Fargo covered wagon standard reward card and the business freedom reward card by Bank of America. The interchange rate is 2.3% + 10 cents. The “cost-plus” markup is 30 basis points + 10 cents. Each of the hair ribbons that she sold them was $50 each. The total cost for Betty (not including monthly fees or other ancillary fees which we will discuss soon) would be $2.80.
2.3% (interchange rate) + 30 basis points (ISO markup) + 10 cents (interchange transaction fee) + 10 cents (ISO markup) = 2.60% + 20 cents or $2.80 on $100 dollar purchase.
The interchange pass through pricing formula simply applies processing fees by adding a small percentage or “basis points” on top of the actual interchange (wholesale) rate for every transaction. As you can see, this type of pricing is quite transparent, because the ISO profit is clearly displayed. As with any plan, you must still be aware of what the markup is. For example interchange or cost +1.5% would not be a very competitive rate, but it would be transparent.
Enhanced BillBack is another intentionally deceitful pricing model used in the merchant service industry. You are charged a flat percentage rate and transaction fee on all sales at the time they are accepted regardless of the card type. Then you are billed again at the end of the month for all of the rewards, business, and corporate cards that downgraded to the higher percentage, the “billback.”
In an effort to truly complicate the process even further the enhanced billback fees are billed a month behind the flat rate fees. This makes it virtually impossible for you to determine what you are truly paying for your credit card processing. Seems legitimate, right? Unfortunately, this a well-known pricing model and is employed by many.
For example, Slimy Sam walks into your store and is offering you an incredible deal on merchant processing. He explains his program and tells you that he has been given special authorization to offer you credit card processing for a flat rate of 2%! Feeling like you just hit the lottery, you are ready to begin filling out the paperwork. Before you start you take a quick look at the schedule A that includes the fees and rates, you verify it says 2% on all cards. Perfect! Just as Slimy Sam said.
A month passes by and you receive your first merchant account statement. Being the responsible business owner that you are you take a look at the fees and determine your effective rate. You locate the total processing fees and divide that number by the total sales volume. For example if your fees are $3500 and the total processing volume was $82,500 you take $3500/$82,500 which = 0.0424 or 4.24%. Now wait a second, Slimy Sam promised 2%! Welcome to Enhanced BillBack, where the merchant account rep can sell you one thing and provide another.
As the old saying goes, if the offer sounds too good to be true, kindly show the rep the out of your store and be sure to let him get hit by the door.
Bundled or Flat Pricing:
Bundled or flat pricing is straightforward. Bundled pricing is quite common in the small ticket world. For example coffee shops, small sandwich shops etc. as a matter of fact, square has gained quite a bit attraction with their pricing formula for processing on the little square piece attached to your smart phone.
Remember, there are hundreds of different interchange categories, so the school of thought with bundled pricing from the perspective of the ISO, is to have a rate that covers you with most card types. Statistics typically indicate that most people do not pull out high-end reward cards out of their purse or wallet in order to buy a cup of coffee. They will typically use a debit card. Conversely, if they are making a big-ticket purchase like a large TV or new furniture, they will use a high-end reward card to rack up reward points or mileage. Knowing this, an ISO can afford to offer a bundled rate of 2.75% and still make good profit even if the merchant accepts 20% of their sales with a high-end reward card above the 2.75% ceiling.
Betty, the owner of Betty’s Boutique, received a merchant agreement with the following “bundled” pricing.
With this bundled pricing, let’s pretend Betty sold a lot of hair accessories in a particular month, $40,000 worth!
40,000 X 2.85% = $1140.00
Are you hungry for more pie?
At this point, you’ve earned a diploma in pricing 101. What about all of the miscellaneous fees that can appear on a merchant processing statement such as IRS regulatory fee, AVS fee, retrieval fee, batch settlement fee, etc.? Many of these fees are charged directly to the ISO, on a per transaction basis. AVS (address verification system) is a small fee charged to cross reference the database when a card is entered manually versus swiped in person. M.O.T.O (mail order telephone order) merchants or e-commerce merchants will face a potential AVS charge. This can range from $.01-$.05. As with most fees, ISOs will typically charge a little above what they are assessed. If they negotiated a two cent cost on an AVS fee, they may charge their clients four cents. They may be charged a chargeback fee of $15, and charge the clients $25. I think you get the picture!
PCI … Oh my!
We will spare you some of the extreme boring details concerning this topic, but it is necessary for us to give you a layman’s overview of PCI and how it affects you. We have frequently heard stories of security breaches. T.J. Maxx and Target come to mind immediately. The industry decided that there should be a governing body controlling and managing potential fraud. PCI or the Payment Card Industry Data Security Standard (PCI DSS) is a set of requirements designed to ensure that ALL companies that process, store, or transmit credit card information maintain a secure environment. Essentially any merchant that has a Merchant ID (MID). The Payment Card Industry Security Standards Council (PCI SSC) was launched on September 7, 2006 to manage the ongoing evolution of the Payment Card Industry (PCI) security standards with a focus on improving payment account security throughout the transaction process. The PCI DSS is administered and managed by the PCI SSC (www.pcisecuritystandards.org), an independent body that was created by the major payment card brands (Visa, MasterCard, American Express, Discover, and JCB). It is important to note that the payment brands and acquirers are responsible for enforcing compliance, not the PCI council.
Merchants are now required to complete a test annually in order to show that they are compliant. E-commerce merchants, or those merchants processing through a computer or website are also required to have a system scan to ensure that there are no vulnerabilities within the system. Brick-and-mortar merchants are only required to take the PCI exam. We are certainly not trying to downplay the importance or significance of credit card security. It is very important, but a merchant who successfully passes a PCI test is no safer than a person who has yet to take the test. This has basically created a cottage industry for PCI providers. There are many third-party providers who offer PCI testing for the ISO channel. Again, the ISO typically negotiates a fixed rate with the third-party PCI provider and (surprise, surprise) adds a markup to the cost. An example would be PCI provider ABC Company offers its services to XYZ ISO for 4 dollars per merchant account per month. The ISO then charges his/her merchants eight dollars or more per month or a larger sum semiannually or annually. Annual PCI charges can vary from $75-$275 per year. Many merchants ignore the emails or mail concerning this topic and avoid reading the small print on their merchant processing statement that indicates that they must complete the PCI testing by a certain date, or the ISO will assess a $19.95 noncompliance fee. This fee will be assessed monthly, until they show that they are compliant.
Here is a great infographic that shows the difference in fees associated with the different types of pricing methods: