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Taking a Pass at Pass-through Pricing

By Ken Musante

With Visa U.S.A.'s and MasterCard International's restructured interchange programs (effective April 1, 2005*), merchants will see far more transaction downgrades. While this might increase short-term profits, unless acquirers have an alternative for higher volume merchants, these profits might not last.

For several years now, Humboldt Merchant Services (HMS) has offered "pass-through" pricing. With the new interchange rates, and in particular Visa's Traditional Rewards category, HMS is offering this pricing with increasing frequency, especially for T&E merchants because of the 36 basis points separation for Visa's Rewards card over traditional Visa consumer cards.

Although three-tiered pricing is now the predominant pricing method, the industry created the terms "Qualified," "Mid-qualified" and "Non-qualified" to simplify the multitude of interchange tiers and the billing of those tiers to merchants. Nowhere in the card Associations' regulations are these terms identified or defined.

As a result of the card Associations' settlement in the class action lawsuit with Wal-Mart Stores Inc. (see "What Happened: $3 Billion Payout, Lower Fees, 'Honor All Cards' to Change" and "What It Means: Less Revenue, Bolder Merchants," by Patti Murphy, May 12, 2003, issue 03:05:01), the Associations nearly doubled the number of interchange tiers for signature debit.

Many acquirers, HMS included, now price credit and signature debit separately, which creates separate signature debit tiers. When acquirers price signature debit uniquely, six rates result: Qualified, Mid-qualified and Non-qualified for both credit and signature debit.

Though this additional and lower pricing option is helpful, there are still substantial mark-ups above the cost in the Mid-qualified and Non-qualified tiers.

First Annapolis Consulting Inc.'s "2004 Merchant Acquirer Pricing" study illustrates this point. The study reported that for three-tiered pricing, spreads between the Qualified and Mid-qualified tiers range from 20 to 100 basis points, and spreads between Mid-qualified and Non-qualified range from 50 to 120 basis points.

Anecdotally, I am aware of Mid-qualified rates at 150 basis points above the Qualified rate and a like amount for the spread from Mid- to Non-qualified.

True "pass-through" pricing works by "passing through" only the amount of the increase in interchange. Assessments might or might not be included in the markup above interchange.

While some acquirers charge a markup above the increase in interchange, I do not recommend doing this. The beauty of pass-through pricing is its transparency.

By marking up the downgrades, merchants will have to deal with the complexities of the numerous interchange structures and penalty fees associated with downgrades.

Ideally, merchants will see all the interchange tiers on their statements, so only the more sophisticated businesses will be suited for this pricing. In addition to the fixed markup over interchange, pass-through pricing has an authorization or transaction fee with every transaction. Usually other infrequent fees such as chargeback fees are also added.

Finally, because the pass-through pricing is so distinct, we have a separate agreement at HMS that better defines this pricing to merchants.

My hope in sharing this information is to provide an alternative pricing and marketing proposition to lower-margin, higher-volume businesses and/or T&E merchants in the face of new interchange tiers.

Being knowledgeable about pass-through pricing and offering a solution will enhance the ability to meet merchants' needs.

Ken Musante is President of Humboldt Merchant Services. E-mail him at kmusante@hbms.com .

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