Where Merchants Can Negotiate Payments Rates

Payments processing is a confusing industry. Intentionally so, as there’s money to be made in chaos. Unfortunately for merchants, this money comes at their expense. Some merchants have had enough of the shenanigans and opt for a higher – but fixed – processing fee because they know it won’t be fiddled with by an unscrupulous payments processor.

We think it very important for every merchant to understand how payments processing works, and where the money goes. Now we write this article knowing that merchants don’t do any self-discovery, so these learnings will go unseen.

Oh well, at least we can say we tried.

There are three parties involved in processing a card payment. You probably know two of them already: you (the merchant) and the customer. But there’s this really nebulous third party that moves the money from the customer’s bank account to your bank account. This is what we’ll try to clarify first.

Open up your wallet and pull out a credit card. You’ll see the logos like Visa, Mastercard, and American Express. But you’ll also see the name of a bank. Maybe it’s Chase, or Bank of America, or something else. This is called the issuing bank, and it’s the customer’s bank who issues the credit card to the customer. In the below sample credit card the issuing bank is USAA.

Then you’ve got the obvious card logos: Visa, Mastercard, American Express, and a few others like Discover. These are the card networks. The companies move money from the customer’s bank account (issuing bank) to your bank account (acquiring bank), which we’ll get to next.

Merchants have bank accounts as well. These are called acquiring banks. Why? In the old days the banks would knock on your door and explain why they should be your bank of record for card transactions. They were acquiring you, the merchant. Over time these banks outsourced the work of acquiring merchants to merchant acquirers, or payments processors in colloquial terms. Acquirers are companies like First Data, Global Payments, et al. It’s now the job of these merchant acquirers to represent your acquiring bank.

Here’s a simplified graphic of the different parties involved.

The money the customer spends on their card first goes through their bank (the issuing bank). Then it goes through the card networks and eventually it hits your bank (acquiring bank).

What matters to you is the $100 the customer spent somehow dwindles into $97 when it reaches your bank account. So what happens?

Well, all of these parties take a cut. Where it gets really complicated is trying to understand how much of a cut each party gets.

When you get a credit card you probably notice that the rewards are different. Some credit cards offer very little rewards, while others, like the American Express Centurion Card, have all sorts of goodies. Each card type has a different fee accordingly, with the AMEX cards generally being more expensive than Visa and Mastercard varieties. There are hundreds of types of cards, all with their own specific fee, and the fees vary depending on the type of merchant you are (some merchants have higher risk, for example). Oh, and the way the card is processed also influences the fee, with an in-store transaction racking up different fees than an online transaction. This makes calculating the amount each party takes intentionally confusing. if you’d like to see a partial list of fees based on card types you can do so here.

These fees are called interchange, and they’re non-negotiable. Interchange is collected by the card networks but get paid to the issuing bank. The networks then take a separate fee which is much smaller by comparison. Technically the network fees, often called assessment fees, are not part of interchange but they’re also non-negotiable, so they are interchange in a defacto sense. (Note: If the US government would grant more bank charters interchange would be less, but incumbent banks make too much money to risk opening up to competition.)

Now we know what interchange is and what it costs. But we haven’t talked about how the merchant banks and their merchant acquiring partners get paid. Their cut is termed the discount rate and it’s made incredibly nebulous to the point where the acquirers are almost single-handedly responsible for giving payments processing the horrible reputation it now has.

Instead of providing clear transparency into their discount fee, most merchant acquirers do one of two things.

1. They make up fees – like the PCI variety – and add them as a separate line item in the monthly processing statement. Merchants have no idea if these fees are real, so they don’t know when to push back
2. They pad existing interchange fees, making it really challenging to see where their margins are coming from. For example, they might take a certain card fee on Visa’s website that should be 1.4% and pad it to 1.45%. Without the merchant going through hundred of card types they’d never know where they were paying higher rates

To simplify this conundrum many merchants will look for processors who offer “interchange plus” pricing. Too often merchants only think they’re paying the “plus” pricing and ignore that they’re also paying interchange. So a merchant will sign up for “interchange plus 1%” and believe they’re only paying 1%.

Uh, no, that’s not how it works.

Merchants should seek to pay as close to interchange as possible. Run through your statement, see what interchange would be based upon your card types, and negotiate with the acquirer from there. Don’t take what the acquirer offers out of the gate because you’re likely getting screwed with fantasy fees or padded interchange. Yes, it takes time to sit down and go through it, but this is why firms like Payment Authorities or Merchant Cost Consulting exist. If you don’t get this under control we’re talking about thousands of dollars a year, and hundreds of thousands if you’re multi-location operator. An extra 0.5% adds up if you’re doing $50M in annual sales (it’s $250,000, by the way) and it’s even crazier when you realize it contributes zero value to your business.

Here’s a quick visual. The blue chart is what you’re required to pay in interchange. The red part is what’s negotiable. The first step is negotiating the red bar to be as small as possible. Most interchange categories fall around 1.8%, and Lightspeed is on record saying that they want to reach 0.6% fees as a processor, so that’s the average we’re using here. (Note: some processors average a lot more than this, with several public acquirers aiming for 1% as their goal, which is truly stomach churning.)

If there’s a silver lining in all this it’s that margins for acquirers are falling. This has spurred a slew of consolidations, but still doesn’t counteract the reality that merchants are increasingly signing up for payments processing directly online or getting it from their software providers via Payfac model. In other words, the internet is sufficiently disrupting payments processing distribution as well.

And why not? When you’re a commoditized middleman, what did you expect to happen?