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The Green Sheet Online Edition

October 08, 2007 • Issue 07:10:01

Interchange for dummies

By Steven Feldshuh
Tribul Merchant Services LLC

Interchange is the wholesale price (also called discount rate, fee and variations thereof) charged by Visa U.S.A. and MasterCard Worldwide for authorization and settlement of a credit card transaction. For example, a merchant is charged 3.5% for each credit card transaction made at the merchant's store.

If a customer makes a $10 credit card purchase, 3.5% of $10 is 35 cents. About 80% of that 35 cents (about 28 cents) goes to the issuing bank. The remaining 20% (7 cents) is divided among Visa or Mastercard, the processor and the merchant level salesperson (MLS), if there is one.

So, if the card issuing bank makes 28 cents and Visa gets, say, 3 cents of the remaining 7 cents, then interchange would be 31 cents on that transaction. Did you know?

  • Interchange is the foundation of the entire payment industry's cost structure.
  • Interchange is complex and ever-changing.
  • Understanding interchange and its evolving nature is critical to a true understanding of the merchant bankcard industry.
  • American Express Co., Discover Financial Services LLC, Diners Club Inc. and JCB International Credit Card Co. Ltd. are not part of interchange.
  • Interchange comprises roughly 125 separate categories. Among these, Visa currently has 22 credit, 21 debit, 12 corporate and 19 international categories; MasterCard has 20 credit, 14 debit, nine corporate and eight international categories.

Categorization factors

1. Merchant's industry type: fast food, colleges, warehouses, gas stations, Internet merchants, catalog merchants, for instance

Each transaction must meet one or many factors to qualify for a specific category. Some factors determine if the transaction will be completed, while others determine the rate and transaction fee that will be assessed.

A handful of industries have been assigned a special rate category. In some cases, preferred rates were established to attract merchants to accept credit cards.

These include warehouse clubs and supermarkets. In other cases, categorization rules reflect the unique transaction flow for a particular industry, lodging or car rental, for example, which require authorization at check-in days before a transaction is settled.

As a result of new technologies, such as Mobil Speed passes, rates have been created for gas stations, fast food restaurants and convenience stores. Fast food and gas station transactions are normally completed without a signature and are considered more secure than MO/TO or Internet transactions, mainly due to the limit set on the amount of each transaction.

2. Type of card processed: traditional credit cards, corporate, rewards based, purchasing or check cards

Commercial cards, the marketing departments of Visa and MasterCard have created an endless list of names for virtually the same product. Some examples: purchase, corporate, business, fleet as well as combinations like corporate purchase. The difference between the various commercial cards is defined by the reporting features available to the cardholder.

Commercial cards are designed to help companies maintain control of purchases while reducing the administrative costs associated with authorizing, tracking, paying and reconciling those purchases.

The interchange rate for commercial cards is different than the swiped rate for the average consumer card. It is common for the industry to bundle commercial cards into a nonqualified rate since, in most cases, the interchange cost is higher than the consumers' swiped rate.

In the debit card group, check cards, bank cards and debit cards are often confused with one another; they share some of the same characteristics. However, they are each distinct.

PIN-based debit transactions are routed through a debit network such as Metavante Corp.-owned NYCE Payments Network LLCand First Data Corp.'s STAR network. These transactions are authenticated by the cardholder's PIN number, and the transaction amount is immediately deducted from the cardholder's account.

PIN debit requires a PIN pad for entry of the customer's PIN number. The PIN pad is normally a separate device, but can sometimes be integrated into theterminal/register. Pricing for PIN debit is not governed by Visa/MasterCard interchange, but rather by the interchange of the individual debit networks.

Check cards, offline debit or signature-based debit: These transactions are routed through the Visa/MasterCard authorization and settlement system. Transactions are settled nightly and authorized by the cardholder's signature. Due to the decreased risk factor, these transactions are at a lower rate structure. Keep in mind that the money is not loaned; it is money that is already in one's checking account.

Check card transactions fall into a number of categories. Visa and MasterCard established check card rates that are priced significantly lower than all other consumer credit cards. These new categories provide yet another way for processors to create unique rate offerings.

3. How a card is processed: swiped or keyed-in, present or not present

Determining what a merchant will be charged is based on the method of card entry and what data is entered.

The first and most obvious factor is whether the card is physically present at the POS. Whenever a card is swiped through an electronic terminal or card reader, an indicator is transmitted to Visa or MasterCard, along with the rest of the data. It records the fact that the information was received directly from the card's magnetic stripe. Without this indicator, the transaction is not eligible for any swiped interchange category.

The technology of reading magnetic stripe information has been incorporated into more and more products. Mag-stripe readers can be found in computer keyboards, as attachments to cell phones, or on PDAs to name a few.

Whereas it is relatively easy to capture the information from a magnetic stripe, it is entirely different to properly transmit the information to Visa and MasterCard in a way that will allow the transaction to qualify for a certain rate.

It is possible and, in fact, common for merchants to believe they are qualifying for the best swiped rates, when in fact their transactions are downgrading, which means higher transaction fees for them.

Merchants should be encouraged to test transactions and have their processor verify their qualification levels instead of assuming that a swipe will always qualify for a certain rate.

Key entered versus card not present: Visa and MasterCard both make a distinction between a card that was key entered due to a bad magnetic stripe as opposed to a transaction where the cardholder is not present, such as in MO/TO or Internet orders.

Confirming the fact that interchange is sometimes needlessly confusing, the wholesale rates for key entered and card not present transactions are the same.

To avoid confusion, merchants should follow one simple rule to ensure that they qualify for either the key entered or the card not present rate: Whenever a card is not swiped, enter the information required for Address Verification Service (AVS) as well as an "order number" for every transaction. The order number can be any length, but it must not be used twice in one batch of orders.

Additionally, certain categories have strict qualifications, such as merchant category, merchant actions and transaction size. For most categories, the interchange cost is a combination of a percentage rate and a transaction fee.

Attempting to explain the ever-growing list of interchange categories to a merchant would be impossible. Therefore, most processors bundle the rates into a few categories, such as swiped, keyed and nonqualified (also known as everything else).

Bundling and who it's for

Bundled categories make it easier for merchants and MLSs to understand the different rate types and how they apply to different merchant sizes.

Small-volume merchants have a comparatively small number of card transactions. These merchants usually will not fall into one of the specialized categories, so bundling makes sense for them.

Bundling of rates also may mean that some or all of the transaction fee is eliminated. For a merchant with few downgrades, bundling often provides the same bottom line as if the merchant had been quoted and set up with every available category.

Large-volume merchants: These merchants may have more to gain by having an unbundled rate or an "interchange plus pricing" deal. (For more information on pricing, see "Doing the price thing," by Dee Karawadra, in this issue of The Green Sheet, Oct. 8, 2007, issue 07:10:01.)

Large-volume merchants who trained to process their card transactions correctly and are set up properly can ensure that every transaction qualifies for the best available category.

What is downgrading?

Transactions are downgraded when they don't meet interchange requirements, such as not capturing the correct card information at the POS, settling the transaction after a deadline has lapsed or key-entering rather than swiping a card. A downgraded transaction means higher cost for the merchant.

What is AVS?

In an effort to combat fraud that results from non-face-to-face transactions, Visa and MasterCard created the AVS, which attempts to verify the address and zip code of the credit card customer. Whenever a card is key-entered, the processing system should be set up to prompt the merchant to enter the billing ZIP code (for cardholder's billing address) and the numerical portion of the address of the cardholder.

If this information matches the card issuing bank's records, the system will qualify that transaction for an AVS rate category. (Visa also looks for an invoice number.)

Different rates for specific industries

In the case of categories such as lodging and car rental, data elements like arrival and checkout dates, folio numbers and length of rental are examples of the required information that is sent to Visa or MasterCard along with the credit card data. To qualify for these categories, merchants must use industry-specific software or terminal applications, which prompt for the extra information. They must also properly transmit it to Visa or MasterCard.

Other factors

Transaction qualification is influenced by many factors. Merchants must not only be aware of these factors, but must also understand which factors supersede others. In many cases, the only way to truly know how merchants can minimize interchange costs is to critically examine their bankcard statements.

Going through this analysis with your merchant can be a lengthy process and will require the cooperation of the processor. However, the cost savings to the merchant can make the effort worthwhile For additional reading, Ken Musante has further demystified interchange in "Mastering the interchange game," in this issue of The Green Sheet, Oct. 8, 2007, issue 07:10:01. end of article

Steven Feldshuh is Chief Executive Officer of Tribul Merchant Services LLC. Contact him at steve@tribulonline.com or 866-602-0996, ext. 6236.

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