By Michael E. Shatz
Interchange is a topic that defies all notions of liveliness and engaging conversation. If you want to be left alone at a party, just start talking about interchange. But the foundation of the entire payments industry rests on merchants paying that tiny percentage of every electronic transaction to the constituent links in the value chain.
For that fact alone, merchants should educate themselves about the intricacies of interchange, and the additional fees that piggyback it. Merchants who understand what they are being charged - or potentially overcharged - may be able to negotiate more effectively with their processors for better rates.
But who else in the industry could not use a primer on interchange? Certainly ISOs and merchant level salespeople (MLSs) new to payments can benefit from a step-by-step guide to interchange. Even industry veterans could use a refresher course in this all-important topic.
Understanding Credit Card Interchange Fees In Card-Not-Present Environments, a training resource written by Michael E. Shatz and published by The Merchant's Guide LLC, begins with a brief overview of the credit card processing system. Then it dives into interchange.
Interchange, as Shatz describes it, represents only a portion of the entire processing fee merchants pay the various players in the industry.
On top of interchange doled out to cardholders' issuing banks, merchants pay assessment fees to the card brands (Visa Inc. and MasterCard Worldwide), and processor fees to the back-end processors that actually authorize and settle the transactions. These three separate fees are lumped together into what is a called a discount.
As part of the discount, interchange is arguably the most complicated aspect of the equation. According to Shatz, "Between Visa and MasterCard, there are virtually 350 published interchange rates in existence."
These rates fall in to various rate categories defined by the card brands to represent the types of transactions taking place (for example, card present, face to face, in-store transactions versus card not present, e-commerce transactions). Certain categories of transactions are considered financially more risky than others - hence the higher rates, such as in card not present (CNP) transactions.
"Because the card, and in most cases the cardholder, are not present at the point of sale, there is an increased risk that the CNP transaction could be fraudulent," Shatz wrote.
"After all, there is no practical way to check the signature or ask the consumer for some physically corroborating evidence of identity. The Associations [card brands] have therefore legislated a risk premium on CNP transactions [italics Shatz]."
According to Shatz, interchange rates for CNP transactions are broken into active and passive rates. Active rates apply to domestic-based transactions - for U.S. consumer and business-to-business payments - and involve fee structures that merchants might optimize, or improve upon.
Passive rates, however, which comprise international payments, are not subject to change; therefore, merchants cannot get better rates for transactions that fall into the passive category.
Since merchants can optimize active rates, Shatz focused his discussion on them, illustrating the categories most beneficial to merchants and the ones they should avoid. To that end, he touches on downgraded rates, when transactions don't meet interchange requirements, forcing merchants to pay higher fees.
"One of the principal purposes of this document is to instruct merchants how to work with their processor to minimize these downgrades," Shatz wrote.
The e-book gets into the nitty gritty details of interchange - how to apply "simple math" (says the author) to attain a formula for tabulating interchange. Basic interchange is arrived at by adding the percentage of sale, determined by the transaction's rate category, to a per-transaction charge. For instance, multiply a $100 transaction by an interchange rate category percentage of 1.85 to get the percentage of sale, which would be $1.85.
Then add $1.85 to a per-transaction charge (let's say 10 cents) to get a total interchange fee of $1.95. Or, stated differently, that dollar amount represents 1.95 percent of the total sale. This is fairly straightforward and understandable, even for the mathematically challenged.
But then Shatz offers another example that illustrates the value of the e-book. Take a total sale value of $10, and run it through the above formula. Although the total interchange fee is only .285 cents, the resulting interchange cost is 2.85 percent of the total sale, or "approximately 46 percent more" than in the $100 transaction.
"One now begins to understand how the weight of the per-transaction charge grows as the value of the sale declines - it is an inversely proportional relationship," Shatz wrote.
Indeed, it is. As Shatz dovetails from that revelation into comparisons of Visa's and MasterCard's CNP rate categories, discussions of high interchange fees for micropayments (defined as transactions under $5) and the pitfalls of formatting data for transmission, he illustrates why it behooves ISOs and MLSs to educate themselves, and then their merchants, on these topics. As Shatz wrote, the "payment processor is responsible for properly classifying the merchant and obtaining the best possible interchange rates."
In the end, it may mean the difference between satisfied, well-informed merchants who are confident in their choice of processors and uninformed merchants who sign up for processing, then read this e-book (before their processors do), find they aren't getting the best rates and tell the service providers to take a hike.
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