Q & A – Choosing The Right Pricing Structure: Tiered Pricing VS. Interchange Plus

The question today comes from an agent asking how to decide which pricing to use for merchants.  Will interchange or tier pricing be the best option for the agent?  How does the size of the business influence this decision?

This is a great question.  Many newer agents and agents making that switch are asking the same question.

Just as in any business, you have your revenue and your expenses.  You must understand that the merchants’ pricing structure will make no difference at all in your expenses.  You have schedule A costs, card brand fees, dues and assessments, per-item fees, and bin sponsorship.  These will not change for you, no matter which pricing you use for merchants.

So, the fundamental question is, “Which pricing will give me more revenue?”  That is totally dependent on how you price the merchant.

• Suppose the merchant is on Interchange plus with 90 basis points and $0.25 transaction fee. That pricing will generate plenty of revenue for you!
• If the merchant is on tiered pricing with blended qualified rate of 1.49% and very low mid- and non-qualified, then you will bring in very low revenue.

The opposite scenario is also true:

• Suppose the merchant is on Interchange plus with 5 basis points and $0.03 transaction fee. That pricing will give low revenue.
• A merchant on tier pricing with a blended qualified rate of 2.5% will bring you high revenue.

Thus, the answer to your question is, “It doesn’t really matter which pricing structure you use.”  The real choice between interchange and tier is simplicity versus transparency.

Most larger merchant accounts want interchange plus.  This preference is not because it’s cheaper, but because it’s more transparent.  The statement shows each category with obvious divisions.  One section is the costs.  Another section is the fees charged on top of the cost.  Interchange plus statements clearly show how much money the merchant makes.

Tier pricing has become less popular; flat-rate pricing is easier.  Why give three rates when you can give one?  Smaller merchants don’t want the complicated statement with fifty different lines anymore.

This brings you to another question, “How should I price each merchant?” 

While Interchange plus pricing is much more complicated for the merchant, it’s simpler for you.  The statement has confusing things for the merchant, but you’ll know exactly how much money you’re going to make.

You’re going to pass through the cost and add “X.”  “X” is the amount you’ll make in interchange pricing.  However, when using tier or flat rate, be careful to understand the underlying costs.

EXAMPLE:

An agent sold a coffee shop on flat-rate pricing at 3.5% across the board.  When the first residual statement arrived, the agent was surprised that money was owing to the processor.  The agent lost money!  How is that possible; 3.5% seems a good amount?

In this case, the coffee shop had a small average ticket size.  The Durbin Amendment regulated debit transactions, so there are per-item costs of $0.22 per item.  There are card brand fees and perhaps a $0.05 transaction fee.  So, now there might be $0.33 of cost.  If a customer spent $2, the agent’s cost would be 15% on that transaction.

Merchants’ Perspective

The smaller merchants want simplicity.  Larger merchants want transparency.

Agents’ Perspective

The place to be careful in choosing pricing is average ticket size.  If the average is below $15, be careful doing flat-rate or tier.  Make sure you have per-item fees in the mix.  If you’re not careful or don’t use a statement analysis tool, that per-item fee will eat your lunch in a hurry!

AGENT:  “I have a client right now whose blended rate is 1.98%.  The customers use a lot of debit cards.  The rates are 1.45%, 2.29%, and 3.5%.  There are two per-item fees – $0.10 and $0.15. The overall effective rate is 1.98%.  And the merchant doesn’t seem too concerned about saving money.”

JAMES:  Blended rate means the merchant has qualified credit cards and qualified check cards or signature debit cards.  In this case, they’re charging $0.25 on every transaction, which is super profitable.  That means that 149 basis points will be all profit on debit transactions.  The cost on most debit is 5 basis points.

Options for that situation:

#1.  If you aim for maximum savings and transparency and for a bigger merchant, go in with interchange plus pricing.  Even if you go as high as 40 basis points and $0.10, you’d still save the merchant a lot of money.

At isoamp.com, you simply upload the statement for us to do an analysis for you.  Get your first couple of statements done free.  We can show you exactly what your profit on that account would look like.

#2.  You can say to the smaller merchant, “I’ll simplify this even further for you.  Instead of having these different rates, why don’t we just do a flat rate of 2.15% and $0.25 (or something similar)?”

You should have a fairly high per-item fee.  Remember, you aren’t passing through the interchange cost.  The only per-item you get is what you charge the merchant.

Given the fact that the merchant doesn’t seem concerned about price, why not just match what they have?  Perhaps the statement you saw was a fluke.  There might be reward and corporate cards run the next month; those are 2.5% or 3%.  If you go in with a flat rate, your profit margin would shrink quickly.

However, if you match what they have, the pricing is going to change if the debit’s not there.  If they’re running more of the rewards cards, it’s going to be mid- and non-qualified.  Now your margin is going to be protected in that case.