In this article we are going to address the question of how merchants can, potentially, reduce their costs by optimizing the size of merchant services fees they pay. In order to save on merchant services fees you need to know their structure and understand where specific fees come from.
Structure of merchant services fees
Merchant services fees include the following groups:
- interchange fees (or, so-called processing fees)
- flat fees (or base costs)
- subscription fees
Processing fees, in their turn, consist of the interchange itself and per-item fees. As we explained in an article on pricing models, there are three common models being used: blended rate, tiered pricing, and cost plus. These three models, one way or the other, are incorporated in the processing fees with respected markup, charged by the processor.
Flat fees are additional surcharges (not dependant on transaction amount) for various transaction types. Flat fees are charged in addition to processing fees. In some cases, specific transaction types (such as chargebacks) actually carry the cost for the processor from the association, which is passed on to the merchant. In some other cases, the flat fees are just a fixed amount, charged by your processor. Beside chargebacks, the most common types of transactions, on which flat fees are charged (in addition to processing fees) are declines and ACH returns.
Why merchant services fees are charged
In order to effectively negotiate pricing, it is crucial to understand, where the fees are, because, in some cases, merchants actually have excellent deals, given their processing volume, and still think that they are being ripped-off. We encourage you to carefully assess your situation, as you might already have a great deal with your current processor.
Processing fees represent the basis of your processor’s revenue. It is important to understand that average profit margin of a processor amounts to 1% of the total processed transaction volume. On smaller accounts this amount might be insufficient to compensate the costs, associated with support of the customer when handling certain transaction types, requiring some additional efforts from the processor. Examples of such efforts are chargeback resolution, decline recycling, or some settlement-related actions. In order to cover such costs, flat fees are charged on top of processing fees for processing of the more “labor-intensive” transaction types.
Subscription fees also represent a form of additional revenue for the processor. However, their primary purpose is to compensate for low processing volume on behalf of a merchant. The reason is because support of a merchant account requires some effort from the processor, independently of transaction volumes processed. For example, a merchant, processing $1000 a month can consume as many support hours, as the one, processing $1,000,000.
As we can see, on large-size merchants, the basis of the processor revenue is formed by processing fees.
A merchant processes $1,000,000 worth of transactions on a monthly basis, and pays 1% of this amount to the processor as processing fees, while subscription fees amount to $100 only; these subscription fees are really insignificant in comparison to processing fees, representing only about 1% of the processor’s total revenue of about $10,100.
On the other hand, on small-size accounts the processor’s revenue mostly comes from subscription fees.
Every month a merchant processes $10,000 worth of transactions, and pays 1% of this amount to the processor as processing fees, while subscription fees amount to $100. In this case subscription fees represent 50% of the processor’s total revenue of about $200.
Finally, flat fees allow a processor to handle the situations when a merchant has a large percentage of certain “labor-intensive” transaction types that require special efforts.
Before you start pricing negotiations, you need to understand the needs or your business, particularly, which category of the fees you pay generates the most significant share of your processor’s profit. If you see, that the amount you are paying to the processor could be reduced, because some other processors have better deals on respective categories of fees, you can try switching to another processor.
Keep in mind, that you might run into situations when you are approached by a competitor of you current processor, offering reduction in certain types of fees; however, before accepting the offer and switching to a new processor, analyze the potential profitability (for your business) of the deal you are offered, and the cost of the conversion. Make sure that the conversion costs do not exceed your savings (check our article on migrations). Only after these considerations you can make a really balanced decision.