1.   Agreeing to a Bundled Discount Rate

Many merchants agree to a bundled billing arrangement whereby their payment processor charges a percentage-of-sale “discount” on gross sales.  These agreements may also include a fixed per item fee for each sale.  The percentage-of-sale portion of the fee is loosely based on the Interchange and Assessment fees that processors are required to pay the Card Associations and the card-issuing banks.  The discount rate that the merchant pays their processor is somewhat arbitrary in the fact that it includes fees owed to others plus the processor’s own profit.  The following simplified example demonstrates how the fees included in a bundled discount are distributed to all of the parties involved in the transaction.

Figure 1. The Discount Rate and its Components

In this example, a merchant agrees with its payment processor to pay a discount of 3%, for “Qualified” Visa and MasterCard transactions.  This discount is actually shared between three distinct parties.  The largest part of this percentage, let’s say 2%, goes to the card-issuing bank in the form of Interchange.  In essence, your payment processor passes this portion of the discount to the bank that issued the consumer’s card.  A very small percentage of the discount, the Assessment, let’s say 0.09%, gets passed to the Associations – Visa or MasterCard.  The payment processor keeps the remaining percentage (0.91%) for itself.  This represents the processor’s gross profit.  This diagram can be expressed by the simple mathematical formula:

D = I + A + P

Unfortunately, many merchants billed under this arrangement see only the discount rate, “D” in their processing statements, leaving little opportunity to determine their constituent fees, “I,” “A” and “P.”  This billing plan also makes it hard for the merchant to understand who exactly is being paid.  Historically, Interchange and Assessment rate information was restricted to members of the Associations and affiliated payment processors.  So, it was impossible for merchants to “do the math” and determine their true fee structure.  In the Fall of 2006, however, both Visa and MasterCard decided to publish these rates in an effort to increase transparency into their payment networks.(1)(2)   Although heralded as an epiphany, merchants quickly learned that the Interchange system was fairly complex, and that determining the equitability of their fees would be a challenge.

Despite these challenges, some profound themes have emerged for those willing to take the time and effort to competently understand the implications of bundled discount rates and their constituent fees.  In many cases, percentage discount rates offer relative simplicity at the expense of increased cost.  The absolute pros and cons of agreeing to a bundled rate therefore coincide with the size of the merchant in terms of sales volume.  It is impossible to stipulate where the line should be drawn because the decision involves the determination of how much diligence the merchant is willing to expend.  Suffice it to say, however, that if a merchant is approaching $500,000 in sales, then it is probably worth the time and effort of performing a payment operations audit.  This is especially true if it is a rapidly growing business.  Periodic proficient audits will help merchants quantify the costs of various issues discussed in this document.

(1) Press Release: “Visa USA Posts Interchange Rates on Website,” October 17, 2006, Visa Inc.
(2) Press Release: “MasterCard Interchange Rate Schedule for US Merchants Posted On Mastercardmerchant.com,” October 30, 2006, MasterCard Worldwide