American Express (AMEX) has a three party system. AMEX approves its own transactions. They issue their own credit cards.
Visa and MasterCard have a four party system. They do not issue any credit cards. Rather, they license their payment brands to Issuers and Acquirers. Issuing banks are the entities that provide you, the consumer, with the credit cards in your pocket. Acquirers are the entities that process the transactions. We are part of the acquiring side. As a registered Independent Sales Organization (ISO) of Visa and MasterCard, we pay them thousands of dollars a year for the privilege of using those brands.
As shown in the Transaction Process above, unlike the three party system, Visa and MasterCard do not approve transactions. The bank that issued your credit card approves the transaction. The issuing bank takes on the risk that you as the consumer will pay them back for the items you purchase. In turn, the issuing bank get paid Interchange.
The cost of interchange depends on the card type that is presented. A debit card, which is tied to your checking account, is a low risk, low cost interchange. If you don’t have money in your checking account, the transaction is declined.
Corporate, government and foreign credit cards are high risk. They have the highest interchange rates. You may ask why. Simply, if someone from a foreign country buys an item here but refuses to pay for it later, perhaps because of a dispute, it is very difficult, sometimes almost impossible to get that money back. Also, people in corporations and government make purchases that are not authorized by higher management. If they quit or are terminated, these entities will often dispute the charges as unauthorized. This makes these three card types high risk.
Interchange is not voodoo or secrative. Interchange is clearly posted and updated on the internet (Visa Interchange rates and MasterCard’s Interchange Rates).
Why is Interchange Important?
According to the Board of Governors of the Federal Reserve System in their June 2009 Report to the Congress on the Profitability of Credit Card Operations of Depository Institutions, there are 565 million general purpose credit cards labeled Visa or MasterCard. There are another 111 million general purpose credit cards provided by American Express and Discover.
The population of the United States approximates 300 million ( 307,047,313). That means every infant, child, adult or infirmed, would possess 2.34 credit cards per person.
Five years ago, the average male, 35 years of age an under, carried less than $20 cash. They used their debit cards. These males are now 40 and have taught their children by using debit cards instead of cash. It is estimated that the vast majority of transactions between $5 and $60 are paid with debit cards.
In our article Debit Card use Surpasses Credit Cards, for the first time in Visa’s history, debit card use surpassed Credit Cards in the fourth quarter 2008. On page 14 of Visa’s Form 8-K, filed on April 29, 2009, U.S. debit card volume was $206 billion, versus a credit card volume of $203 billion. The growth of debit cards was up 5.5%, while credit cards were down 6.9%.
So, what does all this mean? It means the market, specifically consumers, have chosen plastic over cash and checks to pay for their purchases. They have voted on it with over 600 million credit cards issued to a population of 300 million.
Efficiency and Total Costs
Businesses that accept only cash payments do not have costs associated with credit card processing. However, they often lose more money than they would have through credit card processing because of employee skimming and theft. A cash only business is serious temptation to an employee earning minimum wage.
When you take into account your bank charges and fees, trips to the bank to deposit cash and checks, and ancillary overhead such as bookkeeping, ACH rejects and cash management, the cost to a merchant for a grocery store transaction of $54.24 is:
- $0.72 if paid by credit card
- $1.11 if paid by cash
- $1.21 if paid by check
Source: Page 188 of Daniel D. Garcia-Swartz, Robert W. Hahn, and Anne Layne-Farrar, The Move Toward a Cashless Society: A Closer Look at Payment System Economics, Review of Network Economics, Vol. 5, Issue 2.
According to MasterCard, in 2008 their average interchange rate was 1.85%, which is paid to the banks that issued the credit card. On the flip side, issuing banks had credit losses as a percentage of transaction volume of 4%. This indicates that issuing banks lost more money than they made in interchange. As the economy continues to struggle, these issuing banks will continue to see their losses climb.
Bottom line: The merchant gets paid, even if the issuing bank does not.
Three Parts of Merchant Fees
Interchange is paid to the issuing bank. There are approximately 200 Interchange rates, depending on the card type (e.g. debit card, corporate card). This is a variable that changes.
Dues and Assessment. A question often presented is, “How does Visa and MasterCard make money if they don’t issue credit cards?” Visa and MasterCard has Dues and Assessments, which is 11 basis points (.0011) they receive per transaction.
The acquiring bank charges a small fee for the processing of the transaction, ensuring the merchant gets their money, as well as providing monthly statements, 24/7 support and terminal troubleshooting. This fee gets locked into your agreement. For example, let’s use 30 basis points.
For a debit card merchant fees would be:
- Issuing bank: 1.03%
- Dues and Assessments .11% (Assessed by Visa or MasterCard)
- Acquiring Bank: .30%
Your total percentage fees for a $100 transaction would be $100 x (1.03%+.11%+.30%) or $100 x 1.43%, which equals $1.43.
The Dues and Assessment along with the Acquiring Bank fee would not change if you are using Interchange Plus pricing. The only variable that changes is Interchange to the issuing bank.
Interchange is the lubricant to the gears in the transaction process. Interchange rates are based on risk. Debit cards have lower risk, corporate cards have higher risk.
Not accepting credit cards will have your customers buy from your competitors that do accept multiple forms of payment.
Consumers using credit cards buy more than customers with cash. With cash, you can only buy with what you have in your pocket.
Merchants accepting cash only have a higher risk of pilferage by employees. There are some merchants that do NOT accept cash, simply for that reason.
The cost of managing cash and checks, which include bank fees, trips to the bank, etceteras, all have implicit costs attached to them. Consider if you would an office manager that makes $16 per hour. Each day the office manager puts together the cash and checks along with the deposit slips. It takes them 15 minutes a day to accomplish this task. Each day they drive to the bank. It takes another 15 minutes in round trip drive time and dropping off the bank deposit. If your employee does this task three days a week, 30 minutes per day, 50 weeks per year, they are spending 75 hours per year on non-value added work. At $16 per hour, that’s $1,200 per year. What else could they work on if they didn’t need to do these tasks? Even if you still had to make trips to the bank, but could reduce the preparation time from 15 minutes to 5 minutes, that save you $400.
Understanding interchange makes you a more savvy merchant. It helps you understand when you are negotiating your merchant account what fees can be adjusted and which cannot.
If you would like more information concerning Visa MasterCard Interchange or establishing a merchant account, please call us at 877.577.3779.
Jon Perry is the CEO of Merchant Services Inc. He is a speaker, writer and columnist for one the payment industry’s leading magazines. You can connect with Jon on LinkedIn, follow him on Twitter or learn more about him on Facebook Profile or Facebook Business.