A Real Opportunity for Merchants to Save Money on Credit Card Fees

Historically, information on interchange rates was restricted to members of the Credit Card Associations and affiliated payment processors.  Ironically, Interchange generally represents the bulk of what merchants are required to pay the credit card systems!  According to an extrapolation of data contained in Visa’s SEC registration statements, merchants paid over $100 billion of Interchange in 2006.

In this same year, however, both Visa and MasterCard decided to publish their respective Interchange rates.  For the first time since the inception of the Associations, merchants were encouraged to “do the math” and understand their true fee structure.  This translated into a real opportunity for merchants to save money on Interchange fees.  The following three examples are drawn from real-life scenarios, and are designed to illustrate the profound monetary effects of understanding Interchange principals.

Case 1:  Municipalities, Visa Interchange:

A major Midwest municipality developed a website designed to allow citizens to pay fines, traffic citations, certain taxes, and municipal utility bills with their Visa® and MasterCard® credit cards.  The city obtained a merchant account from its commercial bank, which contracted out such activities to a large payment processor.  Because the city processed citizens’ payments through a Web site, it was classified as an “e-Commerce,” merchant and was assigned the customary online Mastercard and Visa Interchange rates.  Within two years, the city was processing at a rate of $7MM per year, with an average payment value of $183.00.  Sixty percent (60%) of the city’s transactions were made with Visa cards.  Of this percentage, 65% of the payments were made with debit cards which received an Interchange rate of 1.60% + $0.15 per transaction.  The remaining 35% of the payments were made with credit cards which received a rate of 1.85% + $0.10 per transaction.  At the annual rate of $7MM,  the municipality paid total Visa Interchange fees of approximately $123,000 per year.

Because of the high volume of fees flowing through the Web site, the city decided to perform an independent audit of its credit card operations.  The municipality soon found out that they had been eligible for a less expensive Interchange rate from the inception of the Web site.  Under a special program mandated by Visa, the municipality should have received Interchange rates associated with the “Retail 2” program.  This program provided for debit card rates of 0.8% + $0.25 per transaction and credit card rates of 1.43% + $0.05 per transaction.  Applying this fee structure moving forward, The city now paid total Visa Interchange fees at a rate of only $78,000 per year its annual sales of $7,000,000.  This 37% savings was augmented with additional savings from a similar program offered by MasterCard.

The mathematical framework and calculations behind this case can be found in Chapter II of The Merchant’s Guide publication, Understanding Credit Card Interchange Fees In Card Not Present Environments.

Case 2:  Direct Marketing Subscription Merchants:

In April of 2007, Visa mandated a program change affecting direct marketers engaged in subscription and continuity businesses.  Covered by the Merchant Category Code 5968, this rule change provided some opportunities and problems for merchants offering subscription services such as periodicals, music clubs, and social networking sites.  Prior to the change, these merchants were subject to the “Card Not Present” credit card rate of 1.85% + $0.10 per transaction and the CNP debit card rate of 1.60% + $0.15 per transaction.

Under the new program, these merchants were now entitled to the Interchange rates associated with the “Retail 2” program.  Under this program, credit cards received a rate of 1.43% + $0.05 per transaction, while debit cards received a rate of 0.8% + $0.25 per transaction.  This new scheme provided a clear win for merchants processing credit cards, as both components of the new Interchange rates were cheaper.  The net savings for these transactions equaled 0.42% + $0.05 per transaction.  Unfortunately, the case for savings was not as strong for debit cards, where the difference between the old and new rates equaled 0.80% + -$0.10.  So, while the percentage portion of the differential provided a savings, the fixed portion of the fee was more expensive.

As it turns out, this new debit rate becomes more expensive than the old rate for products and services selling under $12.50.  So, merchants selling products over $12.50 enjoyed savings all around.  For merchants selling products under $12.50, the overall savings (or loss) depended on the percentage of debit cards processed by the merchant.  For merchants processing a large debit card percentage, the new program might have resulted in an overall loss.

The mathematical framework and calculations behind this case can be found in Chapter II of The Merchant’s Guide publication, Understanding Credit Card Interchange Fees In Card Not Present Environments.

Case 3:  MasterCard and Real Estate Transactions:

In April of 2007, MasterCard rolled out a new Interchange rate affecting merchants involved in certain real estate transactions.  This lower rate was introduced to provide landlords and other property renters with an incentive to accept rent payments via credit cards.  Prior to the new rate, these merchants were subject to the “Merit 1” Interchange rate with credit card and debit card rates of 1.89% + $0.10 and 1.64% + $0.16 respectively.

The rates for real estate transactions under the new “Merit 1 Real Estate” program were set at 1.1% with no fixed transaction fee for both debit and credit cards.  This represented a savings of 0.79% + $0.10 for each credit card transaction and a savings of 0.54% + $0.16  for each debit card transaction.  Because rents tend to be relatively high, the fixed fee savings tended to be meaningless.  The percentage savings, however, turned out to be significant.  Base on a monthly rent of $1000, a landlord would save between $5.50 and $8.00 per transaction depending on whether a credit or debit card was used.