Management & Finance

Credit Card Processing FAQs, Part 2: Pricing Models

Ecommerce merchants depend on credit card payments. But the processing fees associated with those payments are notoriously confusing. This post is the second in a series in which I’ll answer frequent payment-processing questions.

The first installment, “Part 1: Learning the Jargon,” contained an extensive glossary of industry terms as well as explanations of fixed versus percentage fees.  Readers may want to review that glossary as I’ve used those defined terms, below, where each defined term is capitalized.

Among the most-asked questions from merchants involve the various pricing models. That’s what I’ll address in this post.

What are the pricing models for processing and the pros and cons of each?

There are three standard merchant pricing models. Each has advantages and disadvantages. Understanding the models will help you find the best pricing for your business. If your Processor puts you into the wrong model, you would likely pay higher than necessary fees.

Model 1. Flat-rate Pricing. The flat-rate model offers merchants easy-to-understand pricing. You’ll receive one Flat-rate Price for all transactions: card-present (in-store), card-not-present (ecommerce), and manually-entered  (mail and telephone orders). It’s the same price regardless of the type of credit card used and the type of product purchased. Examples of Processors with flat-rate plans are Stripe, Square, and PayPal.

Flat-rate Pricing is controversial, but it’s not necessarily bad. Behind the scenes, the Processor calculates and pays all of the various Interchange fees and Wholesale Fees and then adds a markup. The Processor then bundles all of those into one fee.

If a merchant accepts payment for a low-cost card, such as a basic, non-reward Mastercard, the Processor will benefit as it will pay an Interchange rate of about 1.6 percent and charge the merchant roughly 2.9 percent, typically — resulting in a 1.3 percent profit. However, if the merchant accepts a luxury rewards card, the Interchange rate would be much higher and potentially less than the flat rate — resulting in a loss for the Processor.

The controversy surrounding flat-rate payment Processors is that they allegedly break even (avoiding a loss) on high-cost transactions. It’s hard to know because the Interchange rates are hidden.

The pros of Flat-rate Pricing:

    • Merchants know precisely how much each transaction will cost.
    • Simple monthly statements.
    • Ability to create budgets and forecasts and adjust business practices based on known costs.
    • Process premium rewards cards, corporate cards, and luxury cards for the same fee as basic cards.

The cons of Flat-rate Pricing:

    • Processors add Markup Fees to Wholesale Fees. The markup could be significant or minimal. There’s no way of knowing how much markup is added. Some Processors (a few bad actors) reportedly add excessive markups.
    • Hidden fees. Some Processors add Markup Fees seemingly everywhere. Merchants should look closely at all of the fees, not just the flat-rate percentage. For example, check for exorbitant cancellation fees or ridiculous account setup fees.
    • Too expensive. If its customers pay with basic (non-rewards, non-corporate) credit cards, a merchant could overpay for processing.

Model 2. Tiered Pricing. The Tiered Pricing model segments transactions into tiers (buckets). The Processor then prices each transaction based on its tier. The three common tiers are Qualified, Mid-qualified, and Non-qualified.  Each has a different price. However, many processors add subsets, which results in six or more tiers. Such convoluted tiers are often, but not always, opportunities for Processors to increase profits.

I’ve explained the three tiers in the “Part 1” payments glossary. In short, Qualified Transactions are low-risk, such as card-present and PIN-supported payments. Mid-Qualified Transactions include mail and phone orders as well as rewards and cashback cards. Non-qualified Transactions are card-not-present, luxury cards, and generally all ecommerce transactions.  Qualified Transactions have the lowest processing cost; Non-qualified has the highest.

Tiered Pricing can be controversial because the Processor determines the tiers. The Card Brands (Visa, Mastercard, American Express, Discover) set only the Interchange fees and Card Association Fees. Furthermore, the Processor decides how to classify each transaction. There’s no industry oversight or regulation over how Processors do this. Thus merchants must understand exactly how their Processor will categorize and charge for each type of transaction.

Another controversy has been the marketing tactics of some processors. Some (but not all) offer merchants wonderfully inexpensive pricing while hiding the fact that it’s for Qualified Transactions only. Merchants should demand answers, in writing, to the following questions.

    • Are you quoting me the Qualified price only?
    • What are your other tiers and their prices?
    • Describe the criteria for classifying my transactions?
    • How would my current transactions fall into each tier?
    • Explain your company’s policy for downgrading transactions from Qualified and Mid-Qualified?
    • Can your company add or change tiers and classification policies? Will you notify me of these changes? How far in advance?
    • What would my monthly statement look like? Will the statement disclose how my transactions were classified?
    • Can I dispute your classification of each transaction?

The pros of Tiered Pricing:

    • Reduces processing costs so long as most transactions are Qualified.
    • Monthly statements are easier to follow than Interchange Plus (described below) but more confusing than statements for Flat-rate Pricing.

The cons of Tiered Pricing:

    • Processors could Downgrade transactions to increase fees.
    • Markup Fees are hidden.
    • Processors with many tiers could produce confusing statements.
    • Understanding how a transaction was classified or downgraded could be difficult.
    • Classification criteria could be hidden.

Model 3. Interchange Plus. Interchange Plus offers the most transparent pricing. The Processor simply passes the Interchange and Card Association Fee directly to the merchant with an agreed-upon Markup Fee. “Interchange Plus” refers to the combination of Interchange, Card Association Fees, and Markup.

Unfortunately, many Processors offer the Interchange Plus model only to high-volume merchants. For example, Stripe requires interested merchants to submit a form, disclosing monthly volume. If the volume is too low, Stripe will start with Flat-rate Pricing until a merchant reaches the minimum transaction volume.

The pros of Interchange Plus:

    • Transparent pricing with clearly defined Markup Fees.
    • No hidden fees, typically.

The cons of Interchange Plus:

    • Monthly statements are often long, confusing, and difficult to read because there are hundreds of Interchange fees.
    • Usually offered to merchants with high payment volume.

See “Part 3: Reducing the Cost.”

Mike Eckler

Mike Eckler

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