Merchant Account Pricing Structures
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Before you read about the different merchant account pricing models, it's important to understand what interchange is and how it is directly responsible for the underlying cost of processing credit cards. If you haven't already done so, read through the interchange fees section of this guide.
Interchange Plus or Pass-Through Pricing
Interchange plus pricing functions just as the name implies. On this model the merchant service provider passes the actual interchange charges to the merchant along with a standard mark up in the form of a percentage referred to as basis points. Interchange plus pricing is transparent because the charge to the merchant is the actual interchange charge plus a fixed mark-up. There's a great article that discusses the difference between interchange plus VS tiered pricing here.
Flat Rate Merchant Account Pricing
The flat rate credit card processing model is the latest and greatest form of merchant account pricing. The biggest distinction and advantage of flat rate pricing is that it's the only pricing model where processing charges from the merchant service provider do not increase along with sales volume.
On a flat rate model the merchant service provider passes actual interchange costs directly to the merchant for every transaction. Unlike all other pricing models, there are no mark-ups of any kind over interchange.
On this model, a merchant service provider makes their money by charging a flat monthly fee. This fee is often referred to as an account maintenance fee or monthly service charge.
When considering flat rate merchant account pricing it's important to make the distinction between actual processing charges that are a result of interchange, and the merchant service provider's charges. It's not possible for interchange to ever be flat because of the different categories and qualifications. The term "flat" only applies to the provider's charges.
Flat rate pricing is very transparent and often the least expensive way to process credit cards.
Enhanced Recover Reduced (ERR)
Enhanced Recover Reduced or ERR is a pricing model that's been around for a while but has been gaining in popularity lately as merchant service providers look for more profitable options to the less expensive flat rate or interchange plus pricing models.
ERR is often referred to as a mixed or blended rate because it's a combination of tiered and interchange plus pricing - with a twist. ERR is a non-transparent form of pricing because it uses a base qualified rate and also a truly hidden charge in the form of the difference between actual interchange and the qualified rate. This hidden charge is the “enhanced” part of the pricing.
With ERR pricing, a merchant service provider will quote three different rates – a qualified debit rate, a qualified credit rate and a non-qualified surcharge. When a merchant processes a qualified transaction they will be charged the qualified rate quote by the provider. Things get a little fuzzier when they process a transaction that doesn't qualify.
In this case, the merchant will be charged the true interchange rate, plus the non-qualified surcharge and the difference between target interchange for the transaction and the qualified rate. That's the "enhanced" part of ERR pricing that makes it look a lot better than it really is.
Tiered Merchant Account Pricing
Tiered merchant account pricing is currently the most popular pricing model. It's been around since the dawn of credit card processing, and it was a lot more cost effective back when the card brands only a few interchange fee categories.
Now that interchange has grown to over five hundred categories between Visa, MasterCard and Discover - the days of a tiered account being cost effective are long gone. The major problem with tiered pricing isn't that it's often more expensive than other pricing models, it's that tiered pricing makes it very difficult to tell what you're truly being charged. Tiered pricing allows merchant service providers to disguise actual processing costs by quoting low qualified rates that make an account appear less expensive than it actually is.
The tiered pricing model functions by reducing interchange down to as few as two or as many as six or more pricing tiers. The first tier of this model is called the qualified rate. The qualified rate is the base rate to which all subsequent tiers are added. The qualified rate is often referred to as a loss leader.
"Loss leader" is the term used in the sales industry to refer to something that lures customers by looking better than it actually is. It looks like a great benefit, but it never really delivers. The qualified rate is a perfect example of a loss leader because it's the rate that merchants focus on, but it's only responsible for a small portion of their actual processing costs.
Tiered pricing is a non-transparent pricing model because the actual interchange charge is disguised by generalized pricing tiers.
Most merchant accounts function on a tiered system where interchange categories rates are divided into three tiers called qualified, mid-qualified, and non-qualified. The qualified discount rate is the lowest obtainable rate, followed by the mid-qualified rate, and then by the non-qualified rate. Merchant service providers advertise their accounts using the qualified discount rate because it's the lowest and most appealing rate. For example, a retail merchant account may have a discount schedule that looks like this:
- Qualified Discount Rate: 1.XX%
- Mid-Qualified Discount Rate: 2.XX%
- Non-Qualified Discount Rate: 3.XX%
When a credit card transaction is raised to the higher mid or non-qualified rate it's said to have "downgraded". There are two very basic reasons why a credit card transaction will be downgraded to a higher qualification rate. The first reason has to do with the type of credit card that is being charged and the second is the method that the merchant uses to charge the card.
The first reason why credit card transactions will downgrade to a higher discount rate has to do directly with the type of credit card that is being charged. The card associations (VISA & MasterCard) have over 100 different qualification rates, called interchange qualifications, for different types of credit cards and each type of card is assigned a different qualification rate. Of course, having merchant accounts with hundreds of different rates would be very confusing so most merchant accounts are setup with three general rates.
When a transaction is processed the true qualification rate of the card being charged is rounded up to the next closest category which either mid or non-qualified depending on how the merchant account is setup by the service provider. Exactly how a credit card will qualify and into which rate category it will fall has a lot to do with the merchant service provider that governs the account. For instance, a corporate credit card may fall into the mid-qualified category when run through a merchant account that is provided by company "A", while the same exact credit card will fall into the non-qualified category when run through a merchant account that is provided by company "B".
Depending on the size of the provider and/or the agreement they have with their acquiring bank, merchant service providers have a certain degree of control over how different types of credit cards qualify under the merchant accounts that they issue and govern. If you will be accepting a lot of corporate credit cards, small business credit cards, or other types of non-personal cards, you should work with your provider to have these types of cards qualified into the best possible category.
The type of credit card that will run through at a qualified rate on almost all merchant accounts is a personal non-reward credit card that is issued by a United States bank. The following is a list of credit cards that are commonly charged at a mid or non-qualified rate.
- Small Business Credit Cards
- Corporate Credit Cards
- Government Credit Cards
- International Credit Cards
- Rewards Credit Cards
- Cash Back Credit Cards
The second reason why a credit card transaction will downgrade to a mid or non-qualified rate has to do with how the credit card is transacted by the merchant. Keying-In - Card-present merchant accounts are setup under the assumption that the merchant will process transactions by physically swiping credit cards through a terminal. This process is called electronic data capture. If a retail merchant keys-in a credit card transaction by entering the credit card number on the keypad of their terminal, the transaction will almost always downgrade to the non-qualified rate. It's very common for a retail business to also have an e-commerce website. Many retail businesses use their card present merchant account to process their online sales as well and they are unaware of the fact that they are paying higher fees for these transactions. In this scenario it often saves money to open a second card-not-present account for the online transactions.
Address Verification Service (AVS) - VISA requires all card-not-present transactions to be processed using AVS. VISA also requires the AVS information to match and be correct in order for transactions to run at the lowest possible rate (qualified). Any merchant that processes credit card transactions when the customer and/or the card is not present (such as an online or mail order business) must use AVS when charging VISA cards to avoiding having all VISA transactions automatically downgrade to the non-qualified rate. In order to use AVS properly the billing address of the credit card being charged must match the billing address on file for that card at the issuing bank.
When taking a credit card order collect the customer's correct billing address and zip code. Once you have this information you must enter it into your terminal, gateway, or processing software, when charging the customer's card. If the AVS information does not match, the terminal or processing equipment will let you know by displaying an "N". Please note that all processing equipment is different and you should verify processing symbols with your merchant service provider. It is recommended that you void transactions that don't show an AVS match and that you contact the customer to obtain the correct billing address. Once you have the correct billing address you may recharge the card and the transaction will fall into the qualified category.
It's not possible to know which qualification rate a credit card transaction will fall under before charging the card.
- Qualified Discount Rate - The qualified discount rate is the lowest possible percentage rate that can be charged for a credit card transaction. To maximize the number of qualified transactions be sure that you are properly charging cards per the guidelines set forth for your specific type of merchant account. These guidelines can be obtained from your merchant service provider.
- Mid-Qualified Discount Rate - The mid-qualified discount rate is the second highest discount rate.
- Non-Qualified Discount Rate - The non-qualified discount rate is the highest possible rate that can be charged for a transaction.
It's very important to keep an eye on exactly how much you are paying in mid and non-qualified fees by reading your merchant account statements every month.
When Fees Are Charged
Merchant service providers typically utilize two different methods for charging processing fees. After you familiarize yourself with the different ways you can contact you merchant provider and request that your fees be charged using the method that you prefer. Some providers have control over when fees are charged and others may not.
Throughout The Month (Real-Time)
The most common way that a merchant service provider charges for processing fees is to deduct the qualified discount rate from a transaction prior to depositing it in to your bank account. At the end of the month the processor will make an additional charge for all mid and non-qualified surcharge fees, as well as any flat dollar amount fees such as transaction fees, batch fees, and statement fees. Many merchants do not like this method because it makes it difficult to keep account balances and books in order.
The second method that a merchant service provider will use to charge for processing fees is to wait until the end of each month and then deduct fees in one lump-sum charge. This method carries more risk to the acquiring bank and some providers are not able to offer this option to their merchants. Third-party processors and larger independent sales offices (ISO) that assume risk for their own merchant accounts are usually able to provide this method of charging fees at their own discretion.
On February 3, 2010 Sam said:What is a Third Party Authorization Fee? For example, each time I swipe the credit card through the machine, the provider will charge me a 2% transaction Fee + 15 cents Authorization Fee?? Is that a true statement??
On February 7, 2010 said:Hello Sam,
There are two types of fees that occur on a per transaction basis. The first is a volume-based fee expressed as a percentage, and the second is a flat fee expressed as a dollar value. Interchange fees typically have both of these fees, but so too does your merchant service provider.
The final percentage and flat fee that you pay on a per-transaction basis is called "merchant discount."
Generally, if you are swiping credit cards, your discount rate should be less than 2%. You may want to shop around a little to see if you can secure a better deal on processing. Specifically look for interchange plus or flat solutions.
On August 26, 2010 Fernando said:Why do merchant accounts hold X% of the payment when processing any payments, and then release those funds after 90 days (average)?
Is this requested by VISA or Mastercard or any other credit entity or is this just something they do to play with your money until it is released?
On August 28, 2010 said:Hello Fernando,
What you are referring to is something called a rolling reserve. A rolling reserve is not typical, and it's not used on all merchant accounts. A reserve is a risk mitigation tool that allows acquirers to accept a merchant that they otherwise would not be able to without the reserve.
The percentage of gross sales held in reserve, and for how long they're held is left to the discretion of the acquirer. If the reserve on your account is hindering your business, try shopping for a new merchant account elsewhere.
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