Insights

Pricing in the credit card processing industry is very complex and most merchant statements do not make it any easier to understand. There are so many technical and industry laden terms (Interchange, qualification tiers, downgrades, batch fee, ACH fee, authorization fee, settlement fee, AVS fee, PCI compliance fee, etc.) that even a sophisticated financial manager can get cross-eyed. So how do you really understand your true cost of credit/debit card processing, and then use that knowledge to ensure that your company is getting the best value for merchant services? This article will help you understand and manage the effective cost of different payment cards.

Let’s begin – obtain paper or electronic copies of your most recent monthly merchant statements and start with the following calculations. It is helpful to maintain an Excel spreadsheet with all of this data. This methodology will take a little time to setup but will become easier and routine over time. One output of this exercise can be a dashboard with the following information – the effective cost/rate by card type. This analysis can be done on a monthly or quarterly basis to identify trends and issues with payment processing costs. The chart below shows a hypothetical example of a retailer with $100 million in card sales and an average ticket of $40.

            Effective Cost of Processing by Card Type – March 2009

        

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Calculating Effective Rate for Visa & MasterCard Credit Cards

• Since the cost of accepting and processing Visa and MasterCard (VM) credit transactions is very similar, they are combined together for easier analysis.
  
• Add all fees from interchange categories related to credit card transactions (do not include any interchange categories for debit transactions).
  
• Add fees from assessments and dues. Assessments are not typically broken out separately for credit and debit transactions but they can be easily calculated since they are uniform for all Visa transactions at 0.0925% and for all MasterCard transaction at 0.0950%. Dues are small fees charged per transaction by VM. Some fees from dues include the $0.005 fee per VM authorization and the upcoming $0.0185 Network Access and Brand Usage (NABU) fee from MasterCard.
  
• Add all transaction fees (authorization, settlement, and AVS), batch fees, chargebacks fees, statement fees, reporting fees, annual fees, monthly fees, and other miscellaneous fees. Do not add authorization fees relating to American Express and Discover. All fees in this grouping are levied by the payment processor and a portion of these fees should be allocated to VM signature debit cards based on weighted average of all VM transactions. For instance, if VM credit transactions represented 70% of VM total transactions then 70% of all processor fees should be allocated to VM credit and the other 30% to VM debit.
  
• For companies who have qualified and non-qualified rates – add all fees from discount charges, downgrades, and surcharges.
  
• Divide the sum of all the above fees by net sales (total sales minus refunds/credits). The result is the effective rate or cost for accepting VM credit cards. In the chart above, the effective rate for VM is 1.95%.
  
• Take this rate and multiply it by the average sales ticket for VM transactions. The result is the average cost to process an individual Visa or MasterCard transaction. In the chart above, the average cost to process a single transaction is $0.78 (1.95% x $40).
  

Calculating Effective Rate for Visa & MasterCard Debit Cards

• The process for calculating effective rate for VM debit cards is exactly the same as credit cards.
  
• Remember to allocate a portion of all of the processor fees to debit cards based on the weighted average of all VM transactions.
  

Calculating Effective Rate for American Express Cards

• Most businesses have a direct merchant relationship with American Express (AmEx). Add all discount and other fees from the AmEx statement.
  
• Add the AmEx authorization fees from your payment processor.
  
• Divide the sum of the above fees by net AmEx sales (total sales minus refunds/credits). The result is the effective rate for accepting AmEx cards. In the chart above, the effective rate for AmEx is 3.10% and the average cost to process a transaction is $1.24.
  

Calculating Effective Rate for Discover Cards

• Most large businesses have a direct merchant relationship with Discover. In the last two years, Discover has partnered with merchant acquirers to allow the acquirer to authorize and settle Discover transactions. If the processing relationship is directly with Discover then add all fees from the Discover statement and add the Discover authorization fee from your payment processor.
  
• If the processing relationship is through your payment processor, add all Discover interchange, assessments, and processing fees. For companies who have qualified and non-qualified rates – add all discount charges, downgrades, and surcharges.
  
• Divide the sum of the above fees by net Discover sales (total sales minus refunds/credits). The result is the effective rate for accepting Discover cards. In the chart above, the effective rate for Discover is 1.93% and the average cost to process a transaction is $0.77.
  

Calculating Effective Rate for PIN-Debit Cards

• Add all interchange and switch fees from Electronic Funds Transfer (EFT) networks like Interlink, Star, Pulse, NYCE, etc.
  
• Add the per transaction processing fees related to PIN transactions
  
• Divide the sum of the above fees by net PINed sales (total sales minus refunds/credits). The result is the effective rate for accepting PIN cards. In the chart above, the effective rate for PINed cards is 1.20% and the average cost to process a transaction is $0.48.
  

After the individual card effective rates are calculated, the overall effective rate for all cards can be calculated by taking a weighted average based on sales. Alternatively, you can add ALL the fees and charges of all card types and divide by their net sales volume. Once completed, a dashboard not only provides insight into the average cost for each card type, but it can also identify savings opportunities. For instance, the dashboard above shows that 20% of sales are going through VM signature route and 12% of sales are going through PIN-debit route. In this example, PINed transactions cost $0.16 less than signature transactions and since most debit cards can be routed through either route, a Bank Identification Number (BIN) management strategy can be used to prompt consumers to enter the PIN. This strategy can drive the signature debit sales to less than 10% and increase PINed sales and thus, reduce overall payment costs.

Next, since AmEx transaction cost significantly more, a merchant may decide to stop accepting AmEx cards to reduce payment costs. Obviously, this is a complex decision that involves evaluating payment preferences of your customers, competitive pressures, your company’s profit margins, etc. A dashboard will simply quantify the savings opportunity but other important factors need to be considered.

Another observation is that over 60% of all the payment processing costs come from VM credit sales. Applying a business intelligence (BI) tool or even Excel –based filters, you should be able to drill down and identify the major cost drivers for VM transactions. Click here to read an article on how to analyze interchange and processor fees.

A common mistake when calculating Visa/MC credit effective rate is that some financial professionals underestimate the cost by including AmEx sales but not AmEx fees. AmEx sales are typically authorized and reported on the same statement as Visa and MC sales but they settled directly by AmEx. Since the Visa/MC statement does not include AmEx fees, AmEx sales must be excluded when calculated Visa/MC effective rate.

As a general rule of thumb, the following matrix identifies the savings opportunity based on a company’s overall effective rate if it processes at least $5 million in annual credit/debit card sales. For instance, if annual card sales for a company are $50 million and the overall effective rate to process these sales is 2.65% then there is a high probability that savings can be realized if payment products, pricings, and processes are optimized. Few exceptions to this rule include grocery stores, utilities, and businesses with average sales ticket of less than $10. Grocery stores and utilities have effective rates well below 1.80% due to low interchange rates for these industries. And businesses with small average tickets have their effective rate skewed higher due to the significant role per transaction fees play in the overall effective rate.

In order to manage the overall cost of card payments, it is important to benchmark effective costs by card type. A dashboard will assist identifying current costs and it will prioritize next steps based on trends and issues presented. Small reductions in overall effective rates can yield profound savings when applied to any company with significant card sales. A 10 basis points savings in the retail example above can yield $100,000 in processing fee savings per year. In the current economic environment, any and every savings opportunity is significant. Perhaps, it is time to calculate the effective cost of your card payments.

This article appears in the May 2009 AFP (Association for Financial Professionals) Payments Newsletter.[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]