Insights

The Ultimate Guide to Interchange Optimization

Card Fees

Whether you’re a family-run auto shop or a multinational supermarket chain, card processing fees can seriously impact your bottom line. In 2021 alone, interchange fees—just one type of processing fee—amounted to a staggering $31.59 billion in the U.S. for debit and prepaid card transactions, marking a 19.1% increase from the previous year. This growing financial burden highlights the importance of interchange optimization.

If you’ve noticed a chunk of your profits being eaten up by card acceptance fees, you’re likely wondering how much of that can be reduced. Like any successful business venture, a solid strategy is key—and this applies to your payment strategy as well. Understanding what interchange fees are and how much control you have over them is the crucial first step in reclaiming those profits and protecting your bottom line.

What are interchange fees and how do they work?

Every time you make a sale, especially when accepting credit cards, you’re charged an interchange fee. The acquiring bank pays the cardholder’s bank an interchange fee. The merchant then pays the interchange fee back as part of its card processing fees.

As a merchant, understanding interchange fees is essential in interchange optimization, as it will enable you to make better decisions around your payment strategy negotiate better rates, and maximize your savings.

So, how do interchange fees work? It’s a pretty simple process, that typically goes like this:

Step 1: The Sale
Congrats! You’ve made a sale. Your customer swipes, taps, or inserts their card into your machine to complete the purchase. The transaction details are then sent to your payment processor.

Step 2: Forwarding to the Card Network
Your payment processor sends the transaction information to the relevant card network, such as Visa, Mastercard, or Amex.

Step 3: Authorization by the Issuer
The card network forwards the transaction information to your customer’s bank (the issuing bank). The issuing bank runs a quick check to ensure the customer has sufficient funds or credit to complete the transaction. The transaction is then either approved or declined.

Step 4: Deduction of the Interchange Fee
Once the transaction is approved, the issuing bank deducts an interchange fee from the total transaction amount. The remaining funds are then sent back through the card network.

Step 5: Card Network Processing
The card network subtracts any additional fees, such as network processing fees, before forwarding the remaining funds to your payment processor or acquiring bank.

Step 6: Funds Settlement
Your payment processor or acquiring bank deposits the remaining funds into your account. However, the amount you receive is less than the original transaction amount due to the deducted interchange and other processing fees.

 

What’s the difference between payment processing fees and interchange fees?

 It’s easy to mix them up.

On your company accounts or receipts, interchange fees and payment processing fees are often bundled together under a single line item, commonly referred to as the “swipe fee” or “merchant discount rate.” The specific term can vary by region; for example, in Australia, it’s known as the “merchant fee,” and in the UK, it’s referred to as the “merchant service charge.” Regardless of the name, the principle remains the same: you’re charged fees that typically appear as one combined payment, though they are actually a mix of different fees.

Interchange fees are paid by your bank (the acquirer) to your customer’s bank (the issuer) for each card transaction. In contrast, payment processing fees are paid to the payment processor for securely transmitting transaction information between banks and facilitating the entire payment process.

Interchange fees usually constitute the largest portion of the total card processing costs, often making up around 70-80% of the overall fees, with the remaining percentage covering payment processing fees and other potential charges like assessment fees from the card networks.

Check out this article for top tips on how to lower the overall cost of payment processing fees.

How does interchange optimization help merchants save money?

The average interchange fee in the US is approximately 2%, although this can range from 1.3% to 3.5%. If the average payment you accept comes to around $400, you’d expect to be charged $8 per sale and if you plan to make 1000 sales a month, that would cost you a total of $8000 per month, or $96,000 in a single year.

Interchange optimization is a powerful strategy designed to minimize the interchange fees your company incurs with each transaction. By implementing a thoughtful interchange optimization strategy, you can ensure that each transaction is processed in the most cost-effective way possible.

This process involves a deep understanding of how interchange fees are calculated, which factors influence them, and what actions you can take to reduce their impact.

What factors affect interchange fees ?

Factors that impact interchange tend to fall into two categories, the uncontrollable and the controllable. While there’s a lot you can do to limit your exposure on the controllable aspects, the uncontrollable aspects are usually outside of your remit.

The uncontrollable factors include:

The type of card used

Whether the card used is a Visa Traditional, Visa Rewards, Debit, or something else will impact the interchange on that single transaction, in particular, if the payment is made with a credit card rather than a debit card.

Your merchant category code (MCC)

Credit card issuers will assign your business a four-digit number that lets them know what your business does. This number is based on the ISO and SIC codes. When your customer swipes their card, the credit card issuer will register what type of purchase is being processed (e.g. food, assets, entertainment) and how much you need to pay to accept the transaction.

These codes are also used by credit card companies to assign rewards to specific purchases. If you run, for example, a coffee shop that also sells flowers, you might be assigned a less or more favorable code than if you run a flower shop that happens to sell coffee.

Method of entry

The way a payment is processed—whether the purchase is made in-store or through an e-commerce platform, whether it’s a one-time payment or recurring, and whether the card is swiped, dipped, or inserted—all impacts the interchange fee.

Typically, card present payments (like those that take place in many brick and mortar stores) are associated with lower interchange fees than card not present (CNP) payments as there is a lower risk of fraud in the first instance.

Transaction amount

Interchange fees are charged as a percentage of the total transaction, so higher transaction amounts usually incur higher fees.

Average ticket size

Your overall average ticket size along with the typical number of tickets you send through will also play a role in how much you are charged overall.

Here’s what is within your control:

Business processes

Maintaining stable, optimized business processes can have a direct impact on your interchange fees, as improper processes can result in downgrades which can increase your costs as a merchant.

Wait, what’s a downgrade? A downgrade occurs when the transaction is not processed at the lowest possible rate for the item category. Downgraded transactions occur on a case-by-case basis and incur higher fees. If your current processes are throwing a lot of transactions into a downgraded state, these fees can quickly add up.

Three core business processes can result in regular downgrades, these include:

  • Data collection: The information that is sent with a transaction includes identification information to prevent fraud, for example, CVV codes and billing addresses. If you do not collect and send this data accurately, the bank may still process the transaction but could consider the transaction riskier and hike up the interchange fee.
  • Settlement: Late processing can result in higher fees. Ensure you’re batching and settling transactions in a timely manner.
  • Chargebacks: Too many chargebacks could also result in a merchant-wide downgrade.

Six strategies for interchange optimization

Interchange fees can be reduced with a strong strategy. Here are six things to include in your interchange optimization strategy.

  • Get informed:
    Knowledge is power. By reading this you’ve taken a solid first step. Find out how much each network charges and under what conditions here to help you make an informed decision about how you’d like your payments processed.
  • Employ effective technology: You’re not trapped and you’re not alone. Payment technology is designed to help you take home more profit per transaction. At Optimized Payments, for example, our software not only helps you lower your credit card processing fees, it even sifts through historical records to find and recoup unnecessary fees you may have already paid.
  • Settle transactions daily: Avoid those pesky downgrades by settling transactions at the end of each day.
  • Negotiate with card networks and issuers: Your negotiating power may increase if you’re equipped with all the relevant data. Unfortunately, many merchants aren’t able to use it to it’s fullest potential because of how laborius the process of collecting and organizing it is. Our software gathers industry information for you, helping you negotiate for reduced rates and incentives.
  • Leverage level 2 and level 3 data: Wherever possible, ensure you’re gathering and submitting the maximum amount of information available.
  • Check your MCC: Check your MCC to ensure you’re being charged the right amount. Returning to our example of the coffee shop that sells flowers, if that shop has been categorized as selling coffee and if coffee comes with a higher interchange fee than flowers, they have the choice to split their business into several MCCs, ensuring each line item is charged at the most optimal rate.

Interchange fees make up one piece of the payment puzzle and as such they’re only one of many areas your business can optimize and save in. A holistic optimization of your payment strategy could save you millions. And no, that’s not a typo.

While the tips provided above can help you get started, sometimes, it takes fresh eyes, a new outlook, and years of experience to strategically find new areas to save.

At Optimized Payments, we help our clients save and streamline by finding the gaps in your payment strategy and providing actionable insights and support. From improving the number of chargebacks you receive to reducing the overall cost of accepting payments, we’re here to help you maximize profitability and reduce stress.

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