The Scoop on Merchant Services and Credit Card Processing?
I own a pretty successful bike shop in a college town, and I still handle all our books. I can never seem to make sense of how much it's really costing me to accept credit cards. I've switched three times in the past 8 years and every time a new sales rep tells me he can beat my old rate. The last guy's rate was lower than the previous one, but then it jumped up after only 3 months and now it's higher than my original rate, and on top of that it will cost me a boatload if I cancel early! How can I protect myself from the confusing and tricky credit card processing industry and, for that matter, is there any way I can get out of this slimy contract with my current card processing service?
I'm not a merchant and don't sell things directly from AskDaveTaylor, so I don't have to worry about accepting credit cards, but I've heard stories like that before from other business owners and know what you're dealing with. Credit card and merchant processing is definitely confusing and it doesn't surprise me that you've been suckered into a deal that's not so good in the long run.
Since I'm not an expert in merchant services, I bounced your question to Mark Tracy, co-owner of AdvoCharge merchant services of Colorado to get his thoughts on the matter.
Take it away, Mark!
Sorry to hear about this merchant's situation, but it's unfortunately all too common in the credit card industry. Even though credit card processing is essentially a subset of the banking industry, there's very little regulation regarding how processors and their agents can interact with merchants. That said, there are definitely some things you can do to protect yourself.
First, let's step back and look at the industry. At the top of the heap are the card networks, familiar names like Visa and Mastercard. They set the rate that a merchant is charged on every type of card out there -- from debit, to rewards, to corporate cards -- each one has a corresponding rate as well as a corresponding fee that is charged per transaction. As an example, the actual cost on a Visa rewards card currently is 1.65% against the total purchase price and $0.10 per transaction. That rate is for a card-present, swiped transaction, meaning the person is in your store and hands you an actual card that you swipe through your card terminal or point of sale system.
If you have to key in that card number because the terminal couldn't read it, or if you take that transaction over the phone or through your website, the rate jumps to 1.95% and $0.10 per transaction. Visa's thinking is that there is added risk if you don't hold the card in your hand or if the magnetic stripe doesn't read correctly. As a result they charge a higher rate for that implied risk.
That rate and associated fees for all card types is called Interchange. Interchange is the baseline rate that all sectors of the merchant services industry must answer to because Visa and Mastercard control the credit card networks, so it's often referred to as "true cost."
Interchange Plus pricing is one of several different pricing models in common usage, and as its name implies the merchant is charged the Interchange rate on a transaction "plus" an additional fee which typically goes to the processor and its agents. This may be an additional fee against volume, per transaction, or both. In my opinion, Interchange Plus pricing is the only transparent and ultimately honest pricing model because you get a very specific break down of what you are being charged each month. As you mentioned, Bob, it can be very confusing reading processing statements, but with an Interchange model, at least you have all data available if you're willing to dig in.
There are other, shall we say, less savory pricing models out there.
One of the most common is called Tiered pricing. Tiered pricing takes all the various rates included in Interchange and then compresses them down into one of generally 3-4 tiers. There is a "qualifying rate" that is set by the processor. That rate generally is only applicable to the most no-frills credit cards like debit cards and bank-issued credit cards. Then there are other tiers usually labeled something like "mid-qualified" or "non-qualified." These tiers take the qualified rate and add on an additional amount to the base qualified cost; often at a level that is substantially higher even though the corresponding Interchange rate for the cards that fall into these tiers is not be that much higher. These higher tiers may include rewards cards, or corporate cards, or even qualified cards that are not swiped, but instead taken over the phone and keyed in. At that point, those normally lower-tiered cards jump up to a more expensive tier.
Here's an example of an actual tiered pricing model statement with the various tier names circled:
The basic idea, at least on the surface, with tiered pricing is to make it easier for the merchant to understand their rates, and not to be bothered by all the different rates and charges within the Interchange model. The problem is that a processor will never lose money by accepting a card into a particular tier where the actual Interchange fee (true cost) is higher than the rate associated with that tier. In fact, what usually happens is the processor pads the cost on each tier so that they make a pretty healthy profit for all card types accepted into a particular tier.
As a merchant, you can't tell what your real costs are and you can't tell if you are paying fees to Interchange or to your processor. Even worse, many agents will "over-sell" the lowest tier rate and convince the merchant they are getting processing at, say 1.5%, but the reality might be that most of the merchant's cards that they accept fall into a higher tier. In that situation, a merchant might rarely pay the rate promised by the sales agent, and instead might pay a much higher rate associated with a higher tier where most of their accepted cards end up.
There are other pricing models that are truly deceptive, such as enhanced bill-back, where fees are thoroughly buried in the statement and it's not at all transparent what the merchant is paying. One somewhat oversimplified rule of thumb is that if your monthly processing statement has very little information on it, you're likely on either a tiered or even more devious pricing model. The less information means the less you can really tell about what you are paying. I've seen statements that are a lean page or two, whereas an Interchange statement is rarely less than 5-6 pages. That doesn't mean you're necessarily getting a good deal on an Interchange pricing model, but at least you should be able to tell how much you are truly paying and what you're actually paying for, once you dig in a bit.
One more pitch for Interchange, and that's to take advantage of some elements of the newly enacted Durbin Amendment. The Durbin Amendment definitely has its pros and cons and I could probably write a whole article on that alone, but the gist is that it's an amendment aimed at reducing the Interchange rate on debit card transactions. You operate in a college town, so you likely take a lot of debit cards because that's mainly what college students are issued when they get their first credit cards. If you were on a tiered or enhanced bill-back pricing model, you might pay 1.5% and $.25 per transaction for those sales. Doesn't sound too bad, eh?
The new Durbin amendment drops that debit card rate down to just .05% (5 basis points) and $.22 per transaction. If you aren't on Interchange, you might be paying thousands of dollars too much in fees each month. I'll see if Dave will let me write a whole article on the Durbin Amendment to give some more detail. [sounds good to me! --ed]
How can I protect myself from this industry?
As you might have guessed from the previous section, insist on an Interchange Plus pricing model. That's a good starting point for the reasons I've described. One thing about an Interchange Plus model is that rate is no longer your biggest concern -- you're getting the rate that Visa and Mastercard set, so there's nothing you can do about it. You're concern now is the "Plus" part.
The industry average is about 35-45 basis points (.35-.45%) against your total volume and $.10-.20 per transaction. In other words, on a $100 transaction where your customer uses a basic Visa rewards card in person and you swipe the card, the cost is $100 x 1.65% + $.10 = $1.75. That's just for Interchange. Then you add to that the "Plus" part, so let's use 40 basis points and $.15 cents. That would look like this: $100 x .45% + $.15 = $.60 + $1.75 (for Interchange) = $2.35 to accept that $100 sale.
Here's an example of an actual Interchange Plus statement:
If you have an Interchange Plus statement, you can hopefully find a section called "Processing Rate/Fee" or "Discount Rate" -- that's where the basis point charge against your sales volume will be. Then very close by should be a section called "Transaction/Authorization Fee" or "Per Item Fee" and that will be the cost you pay every time you swipe a card.
Since the industry average is between 35-45 basis points and the transaction fee is between $.10-$.20 then if you are above you should start shopping for a new processor, and if you are below, you might be at a good rate, but it's still usually worth shopping now that you are armed with a little more ammunition. In the above example, the merchant is being charged 65 basis points (.65%) and no pennies per transaction -- definitely time to start shopping for a better rate.
Some people say you should try to negotiate with your current processor to get your rate down, but I've always been of the opinion that you shouldn't reward a company that's been taking advantage of you just because they're now willing to drop your rate for fear of losing your business. Better to be with a company that treats you right from the beginning. And above all, make sure your rates are LOCKED! That way you won't experience the rate creep you have seen, Bob, which is something that is all too common.
So to your question about your cancellation fee, that gets a little tricky. I certainly know where the confusion comes from. Most processors have some kind of cancellation fee for small business merchants and they commonly range from $150-$500. You can find processors that offer no cancellation fee and I urge you to continue searching to find one. Now in your case, it sounds like you might be with a processor who used some fine print to trap you into paying a much higher cancellation fee.
Here's an example of one such cancellation policy:
I realize it's pretty fuzzy, so let me point out the relevant parts (and note that I've blocked out the company name: a business that uses a contract like this would definitely try to sue me if I were to name them!). OK, so in the second half of this section starting on the second line it reads:
"MERCHANT agrees to pay "slimy processor" an early termination fee ("EARLY TERMINATION FEE") equal to the greater of $250.00 or $35.00 multiplied by the number of months remaining in the then current term. In addition to all other amounts merchant owes, MERCHANT agrees that the EARLY TERMINATION FEE is not a penalty, but rather is reasonable in light of the financial harm caused by MERCHANT's early termination."
Hey, it's not a penalty, but a reasonable fee in light of the fact that by leaving them, they won't be able to soak you any longer with their horrible rates.
But I digress.
Let's look at how "reasonable" this fee really is.
On the surface, $250 might not seem so bad and it's pretty much in line with most cancellation fees in the industry, but the second part is a killer. This contract was longer than most at 5 years -- most are 1-3 years. So this merchant wanted to leave this processor after 3 months into their contract, which is how long it took before they realized they were being ripped off. What does that look like?
There were 57 months left in their contract, multiplied by $35 comes out to $1,995 to get out of their contract early! And believe it or not, there are far more punishing cancellation fees out there. I really hope you're not tied to one of them.
Some contracts use a multiplier against your average monthly volume to calculate your cancellation fee. I know of one large volume merchant that was going to have to pay $50,000 to get out of their contract early! And they actually paid it because they could save more by leaving to go with a new processor than by continuing to pay the high rate they had.
The sad part in all of this, I'm sorry to say, is that you are likely stuck with the contract you are in - wish I had better news. These contracts go through numerous legal reviews and are usually airtight. If you signed it, you're stuck. That said, it's often worth doing a cost/benefit analysis to see how much it will truly cost you to leave, versus how much you will save by moving to a new processor.
One final consideration is about equipment leasing. If you can avoid it, never lease equipment. You will likely end up paying many times the actual cost of the equipment by the time the lease is up, and you probably won't own it at the end. It's not uncommon to see a merchant pay $49 per month over 5 years for a terminal that only costs $200-250. That's a about a $2700 mark up!
So in a nutshell, here are some things to think about while looking for a new card processor:
- Insist on Interchange Plus pricing
I hope that helps. I do feel for you as this can be a, often intentionally, confusing industry. However, with this info you should be better prepared on the next go-round.
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