Thursday, February 17, 2011

Merchant Accounts and the Credit Card Tax

Merchants that accept credit cards in the USA must pay a fee for each transaction where a credit card is used. To be qualified as a merchant to accept credit cards, one must agree not to offer any special discounts to customers who pay cash. This is so the customers are more likely to use the credit card instead of cash. The problem with this is, the credit card transaction fees must be distributed across all customers because the merchant can't recover the fees per transaction. Therefore each time you purchase something, you are in effect paying a "credit card tax" enforced by the credit card banks.

Any time a merchant refuses to accept a credit card for any reason (short of the card being invalid, stolen, etc.), but will accept cash as an alternative is called "card suppression" and is against the terms of the credit card companies. If a merchant practices this, the merchant risks losing their ability to accept credit card payments.

There are many businesses that will still practice credit card suppression and offer discounts for cash, but they are not supposed to to do this according to their terms of service.

Government entities are allowed to charge a fee to accept a credit card for payment. They will usually charge in the neighborhood of 3% for accepting a credit card.

Fees charged to the merchants for credit card transactions are not the same for every merchant and can vary between credit card companies and credit card types. For instant, if a company is a small business with very little transactions, they could be paying a "blended rate" for all credit card transactions. This is an average rate good across multiple credit card brands and types. A good idea as to what blended rates are is easy to ascertain as they are usually advertise, but be aware that advertised blended rates are usually "qualified rates", which means that it may be rare that a transaction qualifies for that rate and it may be much higher in reality.The blended rate may be multiple tiers so that it has multiple flat qualifying rates.

A typical blended rate for accepting Visa and MasterCard is around 3% - 5% per transaction. American Express is usually higher and will typically be over 4%. Discover is usually higher than Visa or MasterCard.

If a company accepts credit cards, they must have what is called a "merchant account" which is provided by 3rd parties. A merchant account allows one to accept credit cards and bill credit card companies. The merchant account is not exactly like a PayPal account because the merchant is not at the mercy of PayPal when a dispute occurs, but rather they can communicate directly with credit card companies to resolve disputes.

Also, companies that provide merchant accounts will not just give an account to anyone (like PayPal does), one must be a legitimate merchant with good credentials to secure a real merchant account so there is little risk to the merchant account provider. This is also why one would enjoy much lower rates than what PayPal charges.

With a merchant account you may negotiate the fees you pay. The more transactions that your business accrues, the lower your rate may be. You can also set up your account so that you pay a percentage above "interchange" and "assessment" fees imposed by the credit card companies. This is good because the merchant will most likely save money with this sort of account. The merchant will pay different amounts per transaction depending on the brand and type of credit card. If transactions normally occur with low interchange rate cards, the merchant saves even more money.

The type of card will determine the interchange and assessment fees. Interchange rate is usually a percentage, like 2.1%. The assessment fee will be a flat fee around 0.10 - 0.15 cents. A rewards card or business card will typically have more interchange fees than non-reward cards because the credit card company is in effect charging the merchant extra to pay back rewards to the customer. The merchant in turn passes this cost on to the customers to avoid taking the hit. So if you purchase items without using a rewards card, in effect, part of the price of the item goes to pay high credit card interchange fees — part of which go into the pockets of customers who use reward credit cards!

Customer that use reward cards can easily get paid back 1% - 3% of their purchases in merchandise or cold hard cash after they accumulate around $25 or more. For these customers, they are offsetting the "credit card tax" and saving a little bit to boot since merchants will spread their fees across all transaction types.

Flat percentage rates plus transaction fees above interchange and assessment rates is usually called "Interchange Plus" rates. These are not usually advertised and merchant account providers generally don't want merchants to know that it exists because they will make more money with blended rates. It is not uncommon for a merchant to pay a very, very small percentage on top of interchange and assessment fees. For example, a merchant that has around 3 or 4 million dollars of credit card transactions per year may only pay 0.15% + 25 cents in merchant service fees per transaction. For example, if this merchant accepts a regular Visa card for payment of $100, the fees the merchant will pay would be (0.023 + 0.0015)*$100 + $0.10 + $0.25 = $2.66. In this case, the interchange rate is 2.3% and the assessment fee is $0.10. Sometimes the Interchange Plus percentage rate is expressed in "points". So 0.15% might be called 15 points or 15 basis points. 1%  (0.01) is 100 basis points.

In contrast, a merchant may pay a blended rate of 2.70% + $0.30 =  $3.00 for the transaction. This would be typical for a qualified blended rate. But like I mentioned previously, a qualified transaction at this rate may in reality be a rare occasion.

It may be better for a merchant to pay a blended rate if their tickets are low. For example if a merchant pays a blended rate of 2.59% + $0.25 for a $20 item, they would pay $0.77 for the transaction. If they payed an Interchange Plus rate, it could be 2.3% + 0.15% + $0.10 + $0.25 for a $20 item and they would pay $0.81 for the transaction. The blended rate is a better deal for this particular transaction, but if the merchant's transactions are averaging $150 for this type of Visa card, they will pay $4.13 with the blended rate and only $3.82 for Interchange Plus rate. If the company makes $1 million in sales annually of this type with Interchange Plus rates, that is a savings of over $2,200 annually!

Note that online merchants typically pay higher fees to accept credit cards because their risk is higher. This is called a "card not present" transaction. Certain industries, like grocery stores may pay lower merchant fees than an electronic store. Also government entities or corporate entities with special purchasing cards will save the merchant more money since these are usually used to buy big ticket items. Some big ticket transactions may simply just qualify for a lower exchange rate due to the amount of the transaction.

Also, each time a merchant transaction is disputed by a customer, the merchant will be charged anywhere between $25 - $50 per dispute, no matter if the merchant wins the dispute or not. These costs are also passed on to the customer as well as loses incurred from disputes where the merchandise is not returned or returned in unsellable condition. Opened merchandise usually can't be sold as brand new and must be discounted to sell. Merchants can easily lose fraudulent charge backs unless they can prove the customer actually received the merchandise. 100% loss of the cost of the merchandise plus the dispute fees are involved in fraud. Merchants are generally only allowed so many disputes and they may either lose their merchant account or may be penalized with higher rates.

The merchant bears all the risk for fraudulent transactions — not the credit card company nor the merchant service provider. The credit card company only loses when their customer doesn't pay their credit card bill.

If you are doing low dollar and/or low volume sales, PayPal (or Google) may be much better solution for you than a regular merchant account. I have not looked into current PayPal merchant solutions and have never looked at Google merchant solutions. They are definitely worth looking into.

"Bill Me Later" is a better solution than credit/debit cards because there are lower fees and risk for the merchant. A business would have to be doing around $20 million dollars in sales annually to qualify for this the last time I checked into it.


The interchange and assessment fees for Visa and MasterCard can be found here:

October 2010 VISA USA Interchange Rate Sheet (PDF)

April 2010 MasterCard Interchange Rates and Criteria (PDF)

It appears Discover attempts to keep their interchange and assesment fees a secret, but it doesn't work. Here is a website with current Discover interchange rates:

Discover Interchange Rates (HTML)

2 comments:

  1. good job, you could do a good job explaining, baseline budgeting and a budget cut is not a budget cut but a cut in the rate of growth

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