5. Agreeing to Forego Returned Interchange on Refunds

According to the Associations’ public Interchange documentation, when a merchant issues a refund, the Interchange paid by the merchant to the Card-issuing Bank is for the most part reversed.  More simply put, the Card-issuing bank pays back the merchant.   In fact, one need only review the published Interchange rates on the Associations’ websites to get a detailed look at what Interchange they should be receiving as a result of refund activity.

Despite the Associations’ regulations, merchants do not always receive Interchange reversal on refunds.  This is usually because these merchants agree to a bundled discount rate as opposed to an itemized or “Pass-through” rate.  As has been stated, using our basic discount formula, D = I + A + P, these merchants have agreed to be charged in terms of “D” rather than the constituent parts “I + A + P.  Interchange, “I,” or at least a great part of it, is supposed to be returned when a refund is issued.  In this case the only transaction the merchant sees is a discount, “D,” paid on the gross sales value.  There is no ensuing transaction where the merchant sees its Interchange returned on a refund.  This is sometimes referred to as being “discounted on gross.”  This was first reported in the April 06, 2004 issue of Direct Marketing News.  What’s more, the reporting formats many of these merchants receive do not even provide for Interchange reporting per se.  Merchants therefore are not even capable of performing an accounting of the constituent parts of the discount.

So where does this returned Interchange go?  The Card Issuing Bank returns the Interchange to the payment processor.  The processor, in this case, does not forward the returned Interchange to the merchant.  It simply keeps it as an additional fee.  This type of charge is often thought of as a hidden fee.  While this may be true from a visibility standpoint, one must remember that in most cases the merchant agreed to this type of billing when it agreed to a discount rate based on gross sales. This practice is not against the regulations per se, but many consider it to constitute a gray area.

Of course, this aspect of bundled discount billing affects only merchants with meaningful refund levels or high ATVs.  But consider that a Web-based merchant with an average ATV of $80 loses approximately $1.60 per refund!(5)  This topic is covered in more detail in the article, “Hidden Costs of Credit Card Processing,” which can be found in the April 06, 2004 archive of Direct Marketing News.(6)

(5) Based on a published Interchange refund rate of 2.04%
(6) http://www.dmnews.com/Hidden-Costs-of-Credit-Card-Processing/article/83798/