Part 2: How to Save Your Merchants Money

Make sure you start by reading Part 1 in this mini-series.

In Part 1 I discussed how Interchange Plus pricing works and how you can calculate your residuals using that cost structure.  On Bundle Rate or Tier Pricing, you still have the transaction fee and the monthly fees.  Nothing is changed there.  The difference is in how the mark-up is achieved.  Interchange Plus Pricing passes the interchange fees through to the merchants, so they can see the true cost.  They also see the basis points of mark-up, so they know exactly how much you are making from the basis points of mark-up.  In short, Interchange Plus pricing is very transparent.

With Tier Pricing, the merchants never see the interchange fees.  Instead, they see bundled rates like the “Qualified Rate,” “Mid-Qualified Rate” and “Non-Qualified Rate.”  Each processor has their own guidelines to determine which transactions end up in which bucket.  The cost and profit for you and the processor are calculated exactly the same; the difference is what the merchant sees.  Bundle rate pricing plans look much simpler, but this simplicity comes at the cost of transparency.

Imagine a retail store which showed the price of every item and, also, how much the store owner paid for that item.  This would be a little more complicated, but it would be very transparent.  You would know when you were getting a good deal and when you were not getting a good deal.  Also, if the retail store owner got a great deal or his costs went down, the savings would be more likely to be passed on to the customers since the customers would know how much the owner paid for that item.

Unlike Interchange plus pricing where the merchant can see how much is paid and how much of the total fees are from real costs versus markup, Tier Pricing hides the true costs by bundling them together with the mark-up for a set percentage.  In the past I have recommended using Tier Pricing on smaller accounts processing less than $20,000 per month in volume when the merchant was already on Tier Pricing.  This just made everything a lot easier.  However, if your goal is to become a #TransactionExpert, then I would recommend using Interchange Plus Pricing on all but the smallest merchant accounts processing less than $5,000 per month in volume.  Let me explain my reasoning.

There are big changes coming in our industry.  EMV / Chip and Pin transactions are already here.  As fraud in the U.S. decreases, there will be increasing pressure on Visa and Mastercard to lower the interchange rates they set for the banks.  The U.S. is currently near the top of the list for highest interchange charges.  We learned from the Durbin Amendment that the government is willing to regulate the fees down when they feel fees are unfair or that Visa and Mastercard are not lowering fees fast enough based on the improvements in fraud protection.  All this means for you and your merchants that you will be able to help them lower their overall costs to process payments over the next few years without changing their fees, as long as they are on interchange plus pricing.

Let’s consider a simple example of bundle rate and interchange plus pricing to show the effects of interchange cost decreases:

Consider an average size retail shop which does less transactions and, thus, has a smaller average ticket size than the pizza shop example in part 1.  The average ticket size for the retail shop is $50.  In this example, let’s say the shop processes $10,000, giving a total interchange costs (as defined in part 1) of $145.  Then we will say the total processing costs are $50.

To identify the difference in cost to the merchant, use two example cost structures:

• First of all, let’s see how much the merchant would pay on Interchange Plus 40 basis points and a $0.10 transaction fee. (See Part 1 for more details.)

$145 of Interchange

$20 of Transaction Fees  ($10,000 / $50 = 200 transactions per month x $0.10)

$10 Monthly Statement Fee

$40 Basis Point Markup ($10,000 x 40 basis points = $40)

$10 Other monthly fees (Free Terminal Insurance / PCI, etc.)

$225 Total Fees on Interchange Plus Pricing

• Now let’s see what the fees look like with Square at 2.75% flat, bundled rate.

$275 Total Fees ($10,000 x 2.75% – considering all their transactions were      swiped.)

So right off the bat, we see that Interchange Plus pricing would save this particular merchant $50 per month over using Square.  Square pricing is much simpler, but is it worth it?  Now if this merchant had a smaller ticket size, the savings wouldn’t be as large and could even be about the same in some cases.

However, here is where the problem actually comes in.  Suppose over the next three years the interchange cost for this merchant drops as a result of EMV compliance, new technology, and new payment types.  To say that interchange fees could drop in this case 1.45% ($145 / $10,000) to 1.15% over the next three years is very realistic – IF this merchant adopts new forms of payment and understands how to correctly process those payments as a result of education and coaching by his or her #TransactionExpert.

In that case, the cost for Interchange Plus Pricing to the merchant would look like this:

$115 of Interchange

$20 of Transaction Fees  ($10,000 / $50 = 200 transactions per month x $0.10)

$10 Monthly Statement Fee

$40  ($10,000 x 40 basis points = $40)

$10 Other monthly fees (Free Terminal Insurance / PCI, etc.)

$195 Total Fees on Interchange Plus Pricing

Notice the merchant is now paying $30 less per month, but your monthly residuals would not be affected at all.  This is because the underlying costs went down, not the mark-up.  Also notice that 100% of this $30 was passed through to the merchant as a monthly savings because the merchant is on Interchange Plus pricing, which passes through the interchange costs to the merchant.

How would lower interchange rates affect merchants on bundle rate pricing like Square?  They would still be paying the exact same thing!  What happens to that $30 in savings? It goes right into Square’s bank account.  If you priced a merchant on flat rate or Tier Pricing, that $30 would become extra margin or profit for you to split with the processor.

While there is nothing wrong with this strategy of making a bet on lower interchange rates to increase your profits, I think that using Interchange Plus pricing and educating the merchant is a much better long term strategy.  Offer your clients true pass-through interchange.  Explain to them that any changes in the industry which reduce the costs of processing payments are going to be automatically passed through to them.  They will receive 100% of the savings associated with improvements on these costs because you are passing their cost through to them rather than bundling the costs in Tiers or Flat Rates.

I have found my interaction with people inside and outside the credit card industry uniquely interesting over the last twelve months.  I have asked just about everyone with whom I have spoken what they think will happen to interchange rates over the next three years.  Most of the executives inside of the industry say things like, “I don’t see a big change coming.”  Many of the lower level employees who actually deal with interchange at these large processing companies and all outsiders looking at our industry (such as payments startups), tell me they are sure the interchange rates will come down.  With the continued improvements in security and fraud protection, as well as a streamlining of the entire financial system, the cost of moving money from consumers to businesses seems very probable to go down naturally over time.

If you want to become a #TransactionExpert, let me challenge you to do something.  Go to google news and create a news alert for yourself that emails you daily with new articles written about “Interchange.”  I get this email daily.  Every day there are four or five new articles, many from other countries where Visa and Mastercard are fighting to keep the interchange fees high while businesses and government entities are fighting to get them lowered.  That Visa and Mastercard are fighting a losing battle is clear to me and most outsiders from our niche.  And eventually, most developed countries will probably have interchange rates that are regulated closer to the UK, which is at an average of 0.4% versus the current 1.5% in the U.S. market.

It is time to make more sales by selling Interchange Plus pricing so that your merchants can take advantage of these savings as they materialize over time.  This is a great foot-in-the door and a great tool to increase retention.

I hope this article was a help to you!

James Shepherd

Read previous post:  Part 1:  How to Save Your Merchants Money

Part 1: How to Save Your Merchants Money

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