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The Green Sheet Online Edition

October 08, 2007 • Issue 07:10:01

Mastering the interchange game

By Ken Musante
Humboldt Merchant Services

As ISOs and merchant level salespeople (MLSs), knowledge of interchange can give you an edge over your competitors. Because interchange is dynamic, it is important to stay abreast of the changes and understand their impact on your merchants and prospects.

Most interchange schedules and charts are lengthy and complex, discouraging salespeople from even attempting to understand the process. Instead of ignoring interchange updates, I encourage a different tactic: Utilize your time to understand the basic principles of interchange and the categories that impact your merchants.

Here is a brief review of the facts. Interchange:

  • Is paid by the acquiring bank to the issuing bank on sale transactions (excluding cash advance and ATM transactions)
  • Is reimbursed to the acquiring bank for refunds and chargebacks
  • Compensates issuing banks for free interest loans and credit/fraud losses
  • Represents approximately 14% of issuer gross income (3% to 4% when converted to a percent of outstandings)
  • Is the same for all acquirers, but not for all merchants

As reward cards have continued to dominate the new card market and issuers have gravitated toward higher interchange cards, the range between the lowest-cost transaction and most expensive transaction has widened.

Further complicating the landscape is the tremendous pressure being exerted on interchange from a host of constituents. Merchant groups are suing Visa U.S.A. and MasterCard Worldwide in order to receive interchange concessions.

Simultaneously, issuing banks are clamoring for more interchange and threatening to move volume from one Association to the other if they are ignored.

Cardholders have grown to expect rewards, and issuing banks are expanding their higher income reward portfolios. State and federal agencies have also gotten into the fray in order to provide relief. The card Associations strive to set rates where merchant discounts will be low enough to encourage usage but high enough to compensate issuers.

Examining the impact of the public market on interchange is interesting. Analysts' reports reveal that MasterCard's stock price is adversely impacted because of the perceived litigation risk stemming from interchange related lawsuits.

On the other hand, when MasterCard increases interchange, its stock price increases; investors are disappointed when their interchange is not increased.

These forces seem to operate in opposition to each other, and although corporate governance change at MasterCard has made interchange more transparent, it has not slowed the increases - especially in the reward and business categories.

Making interchange accessible

Both card Associations, however, point to their online postings of the interchange schedules as an attempt to assuage concerns regarding their pricing and increases.

Unfortunately, Visa's schedule is too complex for most merchants to decipher. The company's online rates list the fee program followed by the interchange rate with no explanation of the criteria.

Further, Visa explains near its interchange posting that "merchants do not pay interchange reimbursement fees; merchants pay merchant discount to their financial institution."

MasterCard takes the opposite approach and posts a merchant category guide and glossary of terms that does a better job explaining interchange rates and the associated criteria.

MasterCard goes on to note that "the interchange rate tables are organized by product type. Each interchange rate has a series of requirements, all of which must be satisfied in order for a transaction to qualify for that rate."

Unlike Visa's abbreviated version, MasterCard's guide is 100 pages. With that kind of thickness, there is a greater likelihood that I will read my home loan documents before a merchant reads MasterCard's guide.

I am not criticizing the companies for posting their interchange rates - on the contrary, I support their disclosure. But, if merchants can't read and understand the postings, it defeats the purpose of the guide. The schedule also doesn't assist merchants if it is so large that reading it is intimidating.

Because of the number of categories, it is important to use time efficiently when studying interchange. For example, I tend to only casually glance at the changes to programs surrounding airlines, warehouse and all categories of tier one, two and three. Why? Because Humboldt Merchant Services does not sell to these merchant categories. Further, I know HMS' top three categories for card present and card not present merchants; they are listed in the chart accompanying this article.

 Interchange Chart

Thus when I review a merchant's statement, outside of additional information, I can assume where the majority of transactions may fall. Internally, my staff actually lists the top five categories and make that available to our sales partners along with the actual percentage of volume falling into each category.

That information, while very important to HMS and our business partners, is not essential for this article.

So, keep the chart close at hand. Then you can readily estimate where the majority of a merchant's transactions will fall and which categories your sales partners need to clearly understand.

And when you master the chart, you will know where the transaction will fall in a three/six tier program and what the margins need to be, depending on your revenue requirements.

The information converged in the chart is critically important when a change is made to the interchange schedules. With MasterCard's upcoming Oct. 13, 2007, increase, for example, I know the increase to corporate Data Rate II will be the third most utilized category for MasterCard within HMS' card not present portfolio.

Additionally, such a transaction is already downgrading to nonqualified, so unless HMS increases fees to card not present merchants, the company will experience a basis point deterioration on 4% of volume.

By understanding the top five or so categories for both card present and card not present merchants, you can ignore categories that are not representative in your portfolio. Instead, those merchants who are impacted can be dealt with individually, minimizing sickly long statement messages, while still addressing margin compression.

I suggest you know the interchange costs to each of those categories and where they fall within your tiers. Master the qualifications of those specific categories, and you will understand the interchange for 85% of your portfolio. And if you understand interchange for 85% of your merchants, you will be ahead of 99% of your competitors. end of article

Ken Musante is President of Humboldt Merchant Services. Contact him by e-mail at kmusante@hbms.com or by phone at 707-269-3200.

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