Payment Gateways: Processing Costs

The purpose of this article is to discuss credit card transaction processing cost as a criterion to be considered during payment gateway selection.

If this is the first time you are reading our “Selecting a Payment Gateway” mini-series, please, start with the Introduction to improve your understanding of this post.

Although processing cost is not the only factor to consider while selecting a processor, it is nevertheless, extremely important. Understanding the processing cost anatomy is not easy. For more information on credit card processing costs, fees and rates, refer to this article.

Processing cost components and transaction pricing strategies

To put it shortly, processing cost consists of base costs (which include interchange fees and assessments) and markups. Within card processing cost it is mostly markup that is negotiable. The three pricing strategies predominant in the industry include: “cost plus” (also called “interchange plus” or “pass through”), tiered (or bundled) pricing and blended rate. Every other pricing strategy, after closer consideration, usually turns out to be a variation of these three.

Blended rate pricing

Blended rate pricing strategy is the easiest to understand; it does not take the differences in card types and transaction costs into account at all. Under blended rate pricing, the processing fee is usually established as an average processing cost plus some fixed markup.  In other words, regardless of the card type, the same price is charged for every transaction.

So if a business has a good variety of cards it is constantly dealing with, under blended rate pricing these differences don’t matter much. But if a merchant knows that some card types are predominant in the transactions processed (for instance, the  business is dealing mostly with debit cards), then this merchant is going to consistently overpay.

Tiered pricing

Tiered pricing, in essence, is an extension of blended rate pricing model, where transactions are assigned to different tiers. These “tiers” or “levels” are defined by ISOs/processors based on transaction qualifications, card types or other factors. The problem with tiered pricing is that the processor’s scheme of transaction qualification may be really difficult to understand. And without understanding it, a merchant would often be unable to predict the cost of a transaction before it settles. At the same time, even with multiple tiers, some averaging of cost still occurs (similarly to blended rate model) and, consequently, there remains a risk of systematic overpayment by a merchant.

Cost plus

Cost (interchange) plus is the most transparent of credit card processing pricing models, because the processor’s markups do not depend on base interchange.  All markups are charged as a fixed rate fee on top of true cost, which comes from an association (Visa, MasterCard, etc) for every transaction.

Merchant Perspective

Naturally, any merchant will look for a processor offering the most cost-efficient pricing model. While considering the processing cost, it’s important to remember that different transactions cost differently. In general, some transactions (as a group) will cost cheaper to process than others. For example, debit cards would cost considerably less to process than reward cards (or credit cards with cash-back option), and swiped credit cards would qualify for a lower rate than keyed cards. A merchant would want the processing fees to be structured based on true cost. Actually, a merchant would wish the final cost to be as close to the true processing cost as possible, with the above-mentioned differences in transaction costs (interchange qualifications) taken into account.

Beside the price that the merchant gets quoted, the merchant also needs to think about the types of cards it processes (debit or reward, keyed or swiped, etc) and fee structure that is offered. Any merchant would definitely want to go with someone whose pricing model reflects the differences in card types.

Example

The health club chosen as an example is going to be dealing with a variety of cards, but might be heavier on the card-not-present side (all membership dues are collected as card-not-present). To optimize the cost it would be best for it to go with a processor providing “cost plus model.

Conclusion

In general, the advice to a merchant who wants to get a transparent and flexible model reflecting card type differences is: go for “interchange plus” pricing. The recommendation is especially relevant for those who are more on the debit cards side.

Reseller Perspective

Traditional types of resellers (such as ISOs) are generally interested in flexible and affordable pricing structure. Software companies acting as resellers might also be interested in the ability of the processor\payment gateway to combine software fees and processing fees.

Example

Usually, software companies tend to charge separate fees for software usage and separate fees for transactions processing services. For instance, a fitness software company wanting to offer merchant services to its customers could charge a certain amount in dollars per month for software (say, $100 per location) plus optional 2.5 % for processing. However, in today’s environment it might be more beneficial from the marketing standpoint (and more profitable) to offer managed processing at 5 % with software included for free.

Conclusion

In general, a reseller should prefer to partner with the processor\payment gateway offering “cost plus” pricing model, as it makes it easier to price and resell, and seems to be more appealing in today’s market.

Those resellers interested in charging their service fees as part of the processing costs should consider processors\payment gateways capable of accommodating this.

Our next installment will be dedicated to ease of integration with different credit card processors\payment gateways.

Payment Gateways: Introduction

Modern market environment constantly calls for new solutions in the area of credit card processing.

For many merchants in today’s market it is extremely important to make the right decisions concerning merchant accounts, merchant services and merchant relationships. Unfortunately, many merchants are stuck with the misconception that when it comes to merchant services the only thing that matters, the only determining factor while making a decision, is the price. Or, to put it simply “whoever offers a better deal in terms of costs is going to be the preferred choice”. While the cost actually is the most important aspect, it is far from being the only one.

Feeling the need for informing the key players of merchant services industry about various aspects of credit card processing, we’ve decided to publish a mini-series of posts intended to help individuals and organizations facing the task of credit card processor\payment gateway selection. Each of these posts will be dedicated to some specific aspect to be considered while selecting a payment gateway.

The series is addressed to the two groups of entities we are going to refer to as merchants and resellers. Merchant’s and reseller’s viewpoints will provide the two key payment gateway selection perspectives. In order to ensure clear understanding of our terminology, it is appropriate to start by defining these two terms.

Payment gateway selection perspectives: merchants and resellers

A merchant is a business that needs to process transactions for itself. Let us consider a health club as an example of a merchant. The reason for choosing a health club as the most illustrative example among potential ones is because a health club has multiple uses for credit cards.

A health club needs to process transactions (a retail “card-present” transaction) at the point of sale (for instance, a member buys a protein shake). On the other hand, any decent health club has a web-site where customers can also make payments and buy things online – so here’s where e-commerce comes into play. And, finally, sometimes club representatives might contact their clients by phone to collect past dues – that is another example of card-not present transaction, beside online payments. As we can see, a health club usually conducts transactions involving several so-called industry types, both card-present and card-not-present (retail, e-commerce, direct marketing, mobile and others).

Alongside merchants, there is an emerging group of entities (people or organizations) functioning as intermediaries between merchants and processors. Here we are going to call this group resellers. Resellers help merchants to get their merchant accounts or contribute to processing of the transactions in some other way. Examples of resellers include software companies, ISOs and, potentially, franchise owners.

Since a health club is chosen as a merchant example, a fitness software company should provide a suitable example of a reseller to refer to. Most club management software packages today have credit card processing as their component. People using the club management software automatically become prospects for the sale of merchant services. This provides the software company with an opportunity to partake in residual revenue. It becomes the link to connect the club with the processor\payment gateway (in technical terms) or the ISO\underwriter (in business terms).

Now that the play-field is defined, it’s time to move to analysis of specific features to be considered during payment gateway selection. The next installment is going to cover the processing costs.