Thanks to sustained pressure from the European Union, the UK card processing industry is set for its biggest ever shake-up.
The rates that are charged for all sorts of card payment types are being over-hauled, and industry terminology is being banded about, in ever widening circles, as merchants turn to their accountants, cost management consultants, or specialists like CPRAS, to try to understand the impact that these changes are likely to have on their business.
The CPRAS team developed the software that powers pricing for about 3 billion transactions per year, so many business leaders are turning to us for an explanation of how merchant account pricing works. This blog is a written summary of those conversations, and constitutes a thorough overview of card processing charges and how they are determined.
First, some terminology:
The following terms are commonly used in the industry, and will be used throughout this article:
These are the huge global companies which facilitate electronic funds transfers via payment product which they supply to the banks. In the UK, the two principle Schemes are Visa and MasterCard with American Express and Diners being the next largest.
These are the banking organisations which process card payments. In the UK these are limited to: Barclaycard (Barclays), WorldPay (RBS), Cardnet (Lloyds), globalpayments (HSBC), First Data Merchant Solutions and Elavon.
ISO is the acronym for Independent Sales Organisation. These businesses often appear to be card payment processors, but in fact they package the payment processing from the acquirers. The usual business model for an ISO is to agree a wholesale “buy-rate” with an acquirer and then market those services under their own brand with the difference between their sell-rate & their buy-rate as their principal revenue. ISOs also often supply hardware (terminal & EPOS systems), driving further revenue from cost mark-ups and leasing agreements. Examples of UK ISOs are: Payment Sense, Card Save, Pay A Trader, Accept Cards, Handipay.
This is a set of rates which the schemes apply to each transaction type and charge to the acquirers. Each card type and transaction type (and even some industry classifications) has its own interchange rate associated with it. So, for example, Visa charge the acquirers a different rate for processing a business card than a corporate card. Chip and Pin has lower interchange that a swiped payment, and e-commerce and telephone payments also have their own set of rates.
Whilst Interchange can be considered a “scheme fee”, the term actually applies to another charge made by the schemes to the acquirers. Scheme fees are far lower than Interchange and are made up of a percentage of the value of transactions + a PPT (pence per transaction) charge. Scheme fees are not dependent on card type, transaction type or the industry classification of the merchant. Instead they are determined by the scheme on the basis of the value of business that each acquirer processes with them. The larger acquirers pay lower scheme fees than the smaller ones. WorldPay therefore pay the lowest scheme fees of all the UK acquirers.
This is by far the most common type of pricing system for card payment processing in the UK. In a “blended” pricing, the acquirer groups similar card types together. This makes for simplified quoting and billing to the merchant as the acquirer does not have to list every possible combination of card / transaction type and quote for each in one large table. For example, business cards are often blended together and then priced as a group. In doing this, the acquirer makes assumptions about the value of transactions that will need processing for each card type within the group because this determines the actual amount that they have to pay to the Schemes. If their assumptions are not accurate then the acquirer either takes the loss or the additional margin that results.
This is a transparent pricing system insofar as the acquirer provides the merchant with up to date interchange rate tables and specifies the margin that they will charge to cover their other costs and profit. Billing systems then identify the interchange rate associated with every transaction processed each month, add the agreed margin for that particular card type and calculate the charge accordingly. Billing can therefore be complex and even some of the largest acquirers do not currently have the technology to bill on an interchange+ basis without manual intervention every month. Most acquirers will therefore only offer interchange+ pricing to larger merchants although this is also set to change this year as Visa have mandated that, from 1st April 2015, acquirers offer all new merchants Interchange+ statements if they request them.
This is the same as Interchange+ except that it also identifies the scheme fee element of each charge i.e. Interchange + Scheme Fees + Margin.
Merchant account pricing is often portrayed as being determined by the Schemes. Whilst this is true for American Express & Diners, the bulk of UK transaction are made by Visa / MasterCard cards, and so it is these that we will consider here.
Whilst the Visa’s & MasterCard’s charges (interchange & scheme fees) do make up the main cost of card processing, it is the acquirers who determine the final cost. As well as the direct costs from the schemes, acquirers must consider other factors when negotiating pricing for a merchant account. Most important among these other factor is….
As most consumers are aware, we have certain guarantees when we pay for things by credit card. This can present a risk to the acquirers – who have to make refunds if the retailer can’t.
If I use a credit card to pay a deposit to a travel agent for a holiday I plan to take next year, then the acquirer will pass that money on to the travel agent within a few days. The travel agent will keep my deposit, often for several months, until it is time for me to pay the balance and head to the beach. However, if the travel agent becomes bankrupt before I actually have my holiday, then the acquirer must refund my deposit. In this situation, the acquirer might find itself re-paying thousands of deposits – which it wasn’t even holding! To mitigate this risk, most acquirers either refuse to service high risk industries, or mitigate their risk with a combination of higher rates and insistence on a bond being lodged in their favour.
There are many business sectors to which this kind of risk applies. Season tickets and furniture sales are other prominent examples of where there can be a long period between taking payment and delivery in full of the goods or service that the customers are buying.
This is one reason why major online retailers like Amazon or the supermarkets do not take payment until the day of delivery – it may look like they take payment when we make our order, but the transaction is only fully processed when goods are dispatched. This minimises the risk to the acquirer, and so helps to keep costs down.
The simple rule is that to keep risk premiums down, minimise the delay between claiming payment and delivering goods.
Like anything else, bigger is better when it comes to negotiating merchant account rates. Each merchant account incurs set up and management costs for the acquirer, and these costs are obviously reflected in the rates that the acquirer sets. Larger businesses benefit not only from bulk buying power but also from the fact that set up and management costs are proportionally insignificant.
Smaller enterprises will usually benefit from leveraging the volume of a buying group.
Pricing choices: Blended Vs Interchange++
Each pricing methodology has its own advantages and disadvantages. However, if negotiation the lowest possible rates is the key goal, then an interchange++ pricing structure is almost always best. This is why:
Margin of Error
Whenever a “blend” of rates is created (see above) the acquirer makes assumptions / guesses about the exact proportion of card / transaction types which comprise that blend. Since the acquirers are basically banks not bookmakers, they will not take risks. Therefore, every assumption incorporates a margin of error allowance. This means that of the two possible outcomes…
a) the acquirer has to absorb the loss arising from an inaccurate assumption
b) the acquirer receives an additional margin because either the assumption was correct or overly cautious
Needless to say, only scenario b is ever likely happen.
In other words, merchants pay in full for the margin of error incorporated by the acquirers.
By definition, an interchange+ or Interchange++ pricing is linked to interchange. This does not simply apply to interchange at the time that the pricing is calculated, but rather it is a continuing process i.e. every transaction is charged at the current interchange + scheme fees + the agreed margin.
You may read this and think that, in the context of the recent Visa Debit Interchange changes, it would be wiser not to have your merchant account rates linked to interchange.
This would be wrong.
Firstly, when interchange rises, the acquirers almost universally pass those rises on to all their merchants, regardless of whether they are on a blended or interchange+ pricing. There is a clause in every merchant service agreement which specifically allows them to do this.
Secondly, the Visa cross-border interchange scheme and MasterCard’s promised consumer domestic interchange reductions, mean that linking rates to interchange will definitely be a positive step for all businesses.
The majority of small to medium sized businesses will find it very difficult, if not impossible, to obtain an interchange+ pricing. N.B. at CPRAS we do not consider the globalpayments pricing mechanism to be truly Interchange+ (despite their claims).
However, there are ways to obtain interchange linking without needing to get a full interchange+ pricing. This will be the subject of a later article, but if any reader wants more information in the meantime, please contact the author.