October 29, 2008
Most software and ecommerce businesses need to accept credit cards. Over the past four years, as the owner of an ecommerce business TSS Raido, I have learned the hard way how expensive credit card processing can be. There aren’t a lot of resources on the net to help business owners negotiate on an even playing field, this is part of my attempt to fill the void.
Four Simple Rules to Getting Good Pricing
1. Don't Accept Cancellation Charges
The fine print of many credit card processing contracts include a cancellation charge of at least $250 and as much as several thousand dollars. There is no reason for a cancel fee and most salespeople have the authority to waive this fee. Make certain that the fee is waived in writing, either in the contract or as an amendment. If you have a big cancel fee your service provider has no incentive to give you good service.
2. Use Interchange-Plus Pricing
Credit card processors’ largest expenses are the payments they make to Visa and Mastercard. Those payments are set by a complicated formula called Interchange and vary for each transaction (for example, the fee is higher when a rewards card is used). It is set by Visa and Mastercard and cannot be negotiated (Mastercard interchange rates, Visa Interchange Rates).
When you use interchange-plus pricing, you agree to pay the processor their costs (interchange) plus a constant markup. Since the markup never changes you ensure that you avoid any tricky fees.
Most smaller businesses do not have interchange-plus pricing, rather they have tiered pricing, where the processor groups the transactions into groups (with names like “Qualified” and “MidQualified”) and sets a fixed price for that group of transactions.
Large businesses such as Wal-Mart and American Airlines have always negotiated on an interchange plus basis because it results in a better deal. Every credit card processor can provide interchange plus pricing and smaller businesses can benefit from this kind of pricing as much as big ones.
“Traditionally, smaller merchants had pricing blended into three or four categories… This simplified the entire process. In addition, common practice was for acquirers to mark up and charge significantly more for ‘downgraded’ transactions (those that did not qualify for the best rate applicable). These ‘downgrades’ often comprised the majority of the profit acquirers received on merchants, as business owners focused mainly on the ‘qualified’ or best rate. Interchange-Plus does not allow acquirers to increase profit on ‘downgraded’ transactions… I would argue that acquirers only take money out of their own hands by accelerating the practice of Interchange-Plus pricing.”
3. Comparison Shop
Best results are achieved by businesses that comparison-shop between at least 5 credit card processors.
Make sure that you compare the offers on an apples-to-apples basis (interchange-plus pricing makes this easier) and make sure to let each of the prospective service providers know that you are comparison shopping.
If you use an independent gateway, such as Authorize.net, you can expect a per transaction fee of less than $0.10. If you use a gateway owned by your processing network, such as Orbital from Chase Paymentech or Linkpoint from First Data, then the per transaction fee should be less.
Interchange (NOT negotiable)
For a business that accepts credit cards over the net, does address verification and whose customers use a typical mix of cards, the average interchange rate should be about $0.12 per transaction plus 1.93% of volume. So, if your business has $500K in credit card receipts each year and your average transaction size is $50, you will pay $10,850 in interchange fees each year.
You can get a more accurate estimate of what your interchange fees will be using this free credit card processing calculator (disclaimer, it belongs to TransFS, a business that I own).
Processor Markup (negotiable)
The amount that your processor marks up the interchange rate (remember, if you are not on interchange-plus billing this markup will be hidden) varies dramatically. On average, businesses with $500K in credit card processing volume / year pay their processor about 0.90% on their volume, or $4,500 / year, on top of the $10,850 in interchange fees.
Unfortunately for us, the average pricing is lousy!
Without even trying very hard a business that size could negotiate the fees down to $0.10 per transaction and 0.15% (which would save you $2,750 / year in our hypothetical example). If you are an informed and tough negotiator you can get it even lower. Disclaimer- my other business TransFS makes money by automating this negotiation, allowing you to shop for credit card processing with an online interface similar to Orbitz or Priceline.
In total, you should be paying no more than 0.10 (gateway) + 0.12 (interchange) + 1.93% (interchange) + 0.10 (processor) + 0.15% (processor) = 0.32 + 2.08%. If you are paying more than that, you should consider shopping around or renegotiating with your current provider.
Other useful links:
http://discerning.com/topics/services/paymentprocessing.html (very detailed but old)
http://transfs.com/blog (disclaimer – my blog)
TECH cocktail Community Contributed Knowledge
Sean Harper is the co-founder of TSS-Radio, an online seller of satellite radios and accessories and
TransFS, an online comparison-shopping website for small business financial services, including credit card processing. Before starting those businesses he worked in venture capital at Longworth Venture Partners and William Blair Capital Partners. He is also a student at the University of Chicago GSB.
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