Merchant Processing 101

Credit Cards – Players

One of the most confusing areas involving credit card processing is deciphering the ins and outs of the industry.   We have put this document together to assist you in understanding the players and the definitions behind them.

Acquiring Bank (Merchant Bank)

An acquirer (or acquiring bank) is a member of a card scheme(s), for example MasterCard and/or Visa, which maintains merchant relationships and receives all bankcard transactions from the merchant.  The Visa/MasterCard acquirer is the entity that is contacted for each authorization request, and then the entity that provides the approval or decline of the credit card.

Merchant Services Provider (MSP)

If the Merchant did not set up their Merchant Account directly with a Merchant Bank, then the Member Service Provider/Independent Sales Organization will be the organization to quote a Discount Rate to the Merchant.  There are several different types of organizations that can provide this service to the Merchant: Merchant Banks, Member Service Providers, Independent Sales Organizations and Processors.
The Merchant Service Provider will quote the Merchant a Discount Rate and setup account information with both the Front-End and Back-End Processors to handle the Merchant’s credit card transactions. The Merchant Service Provider is responsible for all communications and relationships between the Merchant, Card Associations, processors and Merchant Banks.

Front-End Processors handle the up-front authorization of a credit card transaction.  They have connectivity to all of the Card Associations and route transactions to the appropriate network for authorization.  The Front-End Processor is the Merchant’s point of connectivity for authorization and settlement of transactions.  When a Merchant settles or submits a batch, it is sent to the Front-End Processor who then routes the batch to its Back-End Processor.

Back-End Processors receive settlement batches from the Front-End Processor.  Transactions from all Merchants are grouped together by BIN (Bank Identification Number) range and submitted to the appropriate Issuing Bank on a scheduled time frame.

Member Service Providers/Independent Sales Organizations represent a variety of Merchant Banks and are authorized to setup Merchant Accounts on behalf of these banks.  There are literally thousands of these organizations that provide their services both online and in-person.  These organizations can be thought of as extended sales forces for the Merchant Banks.  As such, they typically work with more than one Merchant Bank and can offer a broader range of services (payroll, Funding, ATM’s, check services).

Payment Gateways

Payment Gateways connect the Merchant to the bank or processor who is acting as the front-end connection to the Card Associations.  Payment gateways encrypt sensitive information, such as credit card numbers, to ensure that information passes securely between the customer and the merchant.They are called Gateways because they take many inputs from a variety of different applications and route those inputs to the appropriate bank or processor.  Gateways communicate with the bank or processor using dial-up connections, Internet-based connections and/or privately held leased line connectivity.
Gateways can offer additional value added services such as terminal repair and replacement, free online reports, risk management and fraud control.  Each payment gateway provides connections to standard industry POS equipment (Verifone, Hypercom, Ingenico) along with other integrated software applications.  Many gateways have use of their own proprietary software solutions that is only accessible to their system.

Issuing Bank

Also known as the Issuer, this is the financial institution that physically provides a credit card to an individual or business.  There are many forms of credit cards.
The Issuing Bank shares in the Interchange Fee charged by the Card Associations.  Most of the power in the credit card industry resides with the Issuing Banks.  Some examples of current Issuing Banks include: RBSCharter One Bank, Capital One Bank, Chase Manhattan bank and Citibank.
Credit Cards – Process – How it works – I would like to put this information the 101 document.
http://usa.visa.com/merchants/new_acceptance/how_it_works.html

Credit Cards – Fees & Rates

If someone asked you today how much accepting a credit card transaction was costing your business, chances are you wouldn’t be able to give them a very accurate figure.  Merchants are continuously trying to figure out and understand the various fees that they get charged for accepting credit card transactions.  The industry has created a myriad of different fees that can be imposed upon a Merchant and these fees are hidden behind a variety of different rules and regulations created by the Card Associations.
The only fee most Merchants are familiar with is their quoted Discount Rates.  The Discount Rate is a percentage of each dollar processed, and possibly an additional flat per transaction fee that the Merchant Service Provider charges the Merchant for processing a transaction.  From that Discount Rate, the Merchant Service Provider, Processor, Issuing Bank and Card Associations all take portions for their services.
Turning to the Merchant Services Provider will not always shed light on the fees the Merchant is paying.  As the Merchant experiences problems with transactions, causing them to “downgrade”, the Merchant will pay a higher rate for those transactions depending on the level of failure and risk assessed with the transaction.  That higher rate equates to more monies being collected by the Merchant Services Provider and more being shared amongst the Processor, Issuing Bank and Card Associations.  The Effective Rate is the calculated bundled rate to the Merchant of a transaction after combining the Discount Rate, assessments, downgrades, and other per item transaction fees.

Interchange Fees

Interchange Fees are the fees that the Card Associations charge for processing a transaction.  There are a variety of different Interchange Fees based on how the transaction is sent and the type of Merchant Account.  It is usually stated as a percentage of the total bill, plus a flat per transaction rate. This fee covers the costs and time associated with getting funds to the Merchant Bank and getting the billing information to the Issuing Bank.  The fee is paid by the Merchant Bank to the Issuing Bank, who then pays the Card Association.
Interchange Fees are normally hidden from the Merchants.  With the availability of information on the Internet there are many places publishing current Interchange Fees.  See Visa Interchange Fees and MasterCard Interchange Fees.
Here is an example of the fees associated with a typical Visa CPS/Retail transaction a merchant may process and how these fees are distributed to the various parties involved:

• If we assume a Discount Rate for a Merchant of 2.05% + $0.15 Transaction Fee, then for a $100 Visa charge the amount the Merchant would pay their Merchant Services Provider will be $2.20.
• This is amortized as follows:
• Visa and Issuing Bank split the Interchange Rate of 1.65% + $0.10, or $1.75 (see Interchange Rate documents above)
• Merchant Services Provider and Processor split the .40% + $0.05 mark-up, or $0.45

Because there are dozens of different rates and fees, some processors and Merchant Service Providers have bundled various rates together into “Rate Tiers”.  Tiers are usually more simplistic than Interchange Fees in their naming, such as “Qualified”, “Mid-Qualified” and “Non-Qualified”.  While this may seem simpler to understand, it does not provide a great deal of detail to the Merchant to understand what they are actually paying for and why.  Merchant service providers will even assess different tiers for Visa/MasterCard rates, even breaking the tiers to Credit and Debit cards.   A traditional three tier pricing schedule can now be a four tier, five tier, or even a six tier pricing schedule.

It should be noted that only Visa MasterCard and now Discover actually partake in the Interchange process.  American Express does not participate in Interchange.  American Express is the Issuing Bank, the Merchant Bank and the Card Association, so they handle all aspects of the card transaction and don’t share their fees. 

Discount Rate

The Discount Rate is the fee paid by a Merchant to the Merchant Service Provider to handle the deposit of credit card funds into their Merchant Bank account.  It is negotiated at the time the Merchant selects their Merchant Services Provider and is usually quoted as a percentage or fractions thereof (basis points).  The Discount Rate is the amount the Merchant’s deposit will be discounted.

The Discount Rate includes the Interchange Fee, communication costs (leased lines, 800 services, etc.), split processing fees and other miscellaneous costs as determined by the Merchant Service Provider.  The Merchant Service Provider does have flexibility when determining a Merchant’s Discount Rate based upon the amount of profit the Merchant Service Provider wishes to make on the Merchants Account.
While certain aspects of the Discount Rate will always remain, such as the Interchange Fee, some Gateway solutions can help lower certain costs – i.e. communication costs, split processing fees, etc. – that a Merchant Service Provider must pay and those savings can and should be passed on to the Merchant to help lower the Merchant’s Effective Rate.

A Merchant’s Effective Rate is the true cost of each transaction.  You can figure a Merchant’s Effective Rate by summing together all of the fees and charges assessed to the Merchant and dividing those by the total dollar amount the Merchant processed.  Do the math on your current statement to figure out what your current Effective Rate is.  It is very important to realize the Effective Rate can be significantly more than the discount rate you were quoted.

Authorization Fee

All processors charge a flat fee per transaction for the authorization request.  This fee may be listed as its own line item to the Merchant on their statement or it may be “bundled” into the Merchant’s Discount Rate.  Some Merchant Service Providers will state they are waiving this fee, but usually it is just being “bundled” in the Discount Rate.

Communication Cost

There is always a cost related to moving a transaction from one point to another; this is referred to as the Communication Cost.  Depending on the method being used to move the transaction, the cost for it will be higher or lower.  The most costly form of communication is via a dial-up connection, since the Processor has to maintain toll-free phone circuits and modems for the calls into its network.  There are a variety of connections that can be made using the Internet; these are fairly inexpensive to the processor so they should be cheaper for the Merchant to use.  However, some processors see this as a premium due to the speed the Merchant enjoys using these connections, so they add a premium fee. A third form of communication is a private line between the Merchant and the processor.  With this type of connection, the Merchant is charged a monthly support and maintenance fee for the dedicated line.  Since the Merchant has a separate agreement for this line, there are no communication costs in the Discount Rate.  This is a fairly expensive option and primarily used by very large Merchants processing thousands of transactions per day.  Merchants taking advantage of a Gateway, which uses its own dedicated connection to the Merchant’s processor, can save the Merchant considerable money since the processor is getting paid by the Gateway for the communication cost.

Merchant Service Providers often bury communication costs into their rates to pass them on to their Merchants or they may appear on the customer’s statement as 950, 800 or WATS fees.  If the Merchant isn’t seeing communication costs on their statement, they are being “bundled” in the Discount Rate.

Downgrades (Non-Qualifications)

A large portion of the costs associated with credit card acceptance is the downgrading or non-qualification of transactions.  These are the transactions that do not qualify for the best possible Discount Rate because they don’t meet the data content or transaction-timing regulations set by the Card Associations.

When a transaction is downgraded, the Merchant is charged additional basis points on top of the quoted Discount Rate.  The exact amount is dependent on the data missing from a transaction.  Pin Based debit is the most secure transaction, where as a keyed transaction is a higher risk due to the transaction not capturing the data from the magnetic strip (swiped transaction).

Depending on the type of transaction there can be different reasons for a downgrade.  Some of the reasons that a transaction would downgrade include: not being settled within 2 days of initial authorization, missing/invalid Tran ID or Banknet data, missing or corrupt swiped data from the magnetic stripe read of the card or no AVS – CVV2 attempt on manually keyed transactions.

Chargebacks

On any given credit card transaction the cardholder has up to 60 days from the time it receives its statement referencing the transaction to dispute the charge.  When the cardholder files a complaint with their Issuing Bank stating a charge was not valid, the Issuing Bank issues a retrieval request which is sent to the Merchant.  To respond to a retrieval request, Merchants are charged a fee by their Merchant Service Provider.  This fee runs from $10 to $50 per retrieval request, the average is $15.

If the Merchant does not respond in a timely basis, it can also be charged a timeliness fee and may even lose the transaction completely.
There are a variety of other instances where a chargeback does not require the cardholder to initiate the event.  These are initiated by the processor, Merchant Bank or Issuing Bank.  Even a partial reversal of the original amount of the transaction is considered a chargeback.

American Express

Nearly 40% of all business travelers utilize American Express as their corporate credit card and there remain a percentage of cardholders preferring the Discover card.  Unfortunately, accepting these card types has historically been an expensive endeavor.  Typically, a Merchant pays a third party routing fee to connect to American Express or Discover.  This fee can be as high as $.35 per authorization. The Merchant Service Provider may tell the Merchant that they don’t charge for American Express or Discover transactions, but this is almost never the case. The cost may be buried in the Discount Rate, but since third party processors charge the Merchant Service Provider, you can be assured the charges are passed on to the Merchant.

As discussed earlier, Discover has decided to work more like Visa/Mastercard.  Many banks have already started authorizing Discover transactions.  Over the next few years, all major banks will be able to qualify Discover transactions as they do with Visa/MasterCard transactions.

American Express has seen opportunities in markets they have little share in and have reduced their processing rates.  For instance, American Express lowered their rate in the medical field to capture more market share.  This rate is as low as a rewards card issued by Visa or MasterCard and Discover.

Credits

Most Merchants don’t realize how much issuing credits cost them.  While most Merchant Service Providers charge nothing for credit transactions (except for a communication fee), the Merchant did pay for the original charge the credit is intended to correct.  As an example a clerk goes to key in a transaction for $15, but accidentally adds an extra zero making the transaction $150.  Assuming the Discount rate is 2%, the cost to process this transaction should have been $.30, but instead the Merchant will pay $3, a full 20% of the total $15 ticket they’ll eventually be funded for.
If the error is corrected before the batch process has taken place, the above scenario is negated (Void).  If the transaction happens after the batch process (Credit Return – Refund) then the merchant is responsible for the fees assessed by the mistaken amount processed.

Additional Charges

There are other fees that are charged to a Merchant for processing that don’t tie directly to the transaction itself.  Statement Fees, Monthly Minimums, Annual Fees, Voice Authorization Fees, Termination Fees and Application Fees are common fees many Merchants are faced with.  These fees need to be considered as part of the cost of processing transactions.
There is no hard rule regarding these additional charges. Some Merchant Service Providers charge them and some do not.  Some will decide whether to charge them based on each individual Merchant and or, the amount of the fee may fluctuate with each individual Merchant.  Because there can be such a variance in these fees, it is wise for a Merchant to “shop around” and get rates/quotes from several Merchant Service Providers to compare and ensure that the Merchant is getting the best rate possible for its business.

Credit Cards – Merchant Accounts

Merchant Account is the means by which a Merchant Service Provider identifies the Merchant.  It is made up of a variety of different “numbers” (Merchant ID, Terminal ID, SIC, etc.) and enables the Merchant to accept credit card payments.  The Merchant Account contains information that identifies the Merchant to Issuing Banks and provides information regarding their Merchant Bank and business checking account setup to receive funds from credit card transactions.

Why do I need one?

Because you cannot accept credit card transactions without one a Merchant Account. Using another Merchant’s Merchant Account to accept credit cards is called “factoring”, or money laundering, which is a serious violation of Visa and MasterCard rules.

Application Fee

Most MSPs will request an application fee from a Merchant to setup a new Merchant Account.  This is varies from $25 to $250, but could go higher.  This fee is commonly waived if the Merchant requests it.  It is important to note, account setup fees are different than purchasing licenses to use virtual terminals.  Make sure your MSP is specific about the charges you are being assessed.

Policy Changes

Financial institutions commonly change policies on their accounts, which include Merchant accounts. There are a lot of reasons for these changes, but most often a merger or acquisition preempts the change in policy. These mergers will often redirect the focus of the financial institution.  If you’re Merchant type is no longer of value to financial institutions, your account may be terminated.  Luckily these policies are usually planned ahead of time and affected Merchants are made aware of their need to find a new Merchant Service Provider.

Merchant Identification

When a Merchant’s transactions are settled and received at the Issuing Bank, certain identification regarding that purchase and the Merchant is passed along as well.  Some of this information is used to provide information to the cardholder regarding the details of the transaction on the bill.  If the cardholder is unable to easily identify the Merchant and transaction, then the cardholder may file a dispute, or chargeback with the Issuing Bank.
The more complete and accurate Merchant information you provide in your Merchant account setup, the less likely a cardholder will be to file a dispute against you regarding the transaction.

Types of Merchant Accounts

Part of the Merchant Account process is correctly identifying the specific type of business the Merchant will be conducting with the account.  Make sure that your MID (Merchant Identification) is classified in the appropriate category for your business type.  Not having the appropriate classification can mean serious downgrades on all of your transactions.

Check your Merchant descriptor and verify the contact phone number is correct and the description of the business for the MID is accurate.  The better defined this information is, the less chance you will have of receiving disputes from customers who may have forgotten about their transaction with you.