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The following is a more detailed look at some of the different rate categories that the credit card associations use. As mentioned in the accompanying story, interchange rates are based on risk and the cost of doing business. The higher the risk, the higher the likelihood that the money to pay the charge won’t be collected and the higher the cost for all credit card association members. It is important to note, that while interchange rates generally increase each year, fraud risk, as reported by Visa, has actually declined in recent years- from $.15 per $100 in 1993, to around $.07 per $100 in 2000 (http://usa.visa.com/personal/about_visa/newsroom/visa_security.asp). This leads many ISOs to question whether interchange rates are actually reflective of risk at all.
Unlike a mortgage or auto loan, a credit card charge is unsecured debt — there is nothing the creditor can repossess. Therefore, if the cardholder declares bankruptcy with $10,000 in outstanding charges, the card association members absorb the loss. Similarly, if the card is stolen and an unauthorized user runs up thousands of dollars in fraudulent charges, the card associations absorb the cost.
Therefore, a transaction is riskier and more expensive, if the card is not present. It’s also riskier if the customer doesn’t leave the store with the merchandise. There’s a higher chance of a return and a chargeback if an item is bought through a catalogue or via an infomercial because the consumer is more likely to be dissatisfied when actually receiving the merchandise.
So the best rates – categorized as Merit III for MasterCard and CPS Retail-Credit for Visa — are reserved for traditional retail merchants, like department stores. Supermarkets receive slightly lower rates because the returns are far smaller and the average ticket is larger than for many other retail chains. The larger the average ticket, the less total charges and therefore lower processing cost, for the same overall total. For example, a merchant with an average ticket of $10 would need 1,000 total tickets for $10,000, while the merchant with an average ticket of $100 would need only 100 total tickets. A coffee shop like Starbucks might have an average ticket of $5 (or less), so there would need to be that many more charges to reach $10,000.
The rates escalate from there. Charges need to meet criteria specified in the chart to receive better rates. If a criterion isn’t met, the charge goes to the next higher rate. Additionally, some market segments, like service businesses, have higher historical charge-offs and other expenses, so they incur higher rates.
Again, the general rule-of-thumb is the more costly the transaction (risk is considered as part of the cost), the higher the interchange fee. Key-entered transactions, for example, are more costly to process and are more likely to be in error than transactions involving electronic reads of magnetic stripe cards. Catalogue sales would be one example of key-entered transactions.
Electronic commerce transactions that are encrypted and transmitted daily qualify for the same rate as key-entered transactions.
The rate for standard transactions, which must be cleared within 30 days and which require the issuer to print airline data (for the purchase of airline tickets) on cardholder statements are 2.30 percent plus 10 cents per item.
The associations also charge a small assessment on gross sales, as mentioned in the accompanying story.
Since most Agents and ISOs don’t have true interchange pass through — they have a buy-rate — we will first present the basis points method of calculating effective rates. “What makes calculating rates so difficult is that you are forced to combine different units of measure — percentages (1.49%) and numeric (per item $.20). Too often you see someone just add the two together and say the effective rate is 1.69%. This, of course, is wrong,” said Michael Kopp.
To simplify, many convert the per item fee into basis points (one basis point is 1/100th of one percent or .0001). This is done by dividing the per item rate into the merchant’s average ticket. For example: A $.20 fee on a $75 average ticket, converts to 27 basis points (.27%). Add that to the 1.49% rate and the effective rate is 1.76%.
To show the dramatic difference in the effective rate with the same rates/fees on a low ticket sale, try the same calculation, but with a $15 ticket. A $.20 fee on a $15 average ticket, converts to 133 basis points (1.33%). Add that to the 1.49% rate and the effective rate jumps up to 2.82%.
A more involved explanation follows:
To calculate the effective rate, take the interchange rate, add in the assessment and the per item fee on the average ticket. Take, for example, a merchant who qualifies for Visa’s CPS Retail-Credit Rate (1.38 percent). Then add in the nickel per charge, which is where it can get tricky. A nickel per charge is a higher percentage for smaller tickets than for larger tickets. Five cents is .5 percent of a $10 ticket, but only .05 percent of a $100 ticket. So if the merchant’s average ticket is $10, the rate including the per-item amount and assessment (.084% for Visa) is 1.964%. If the average ticket is $100, the effective rate is 1.514 percent. Because the rate goes up as the amount goes down, some merchants won’t accept charges below a certain amount. (This by the way is not allowed according to Visa/MasterCard rules. Merchants who accept credit cards as a form of payment must accept them for all transaction amounts and may imply no minimums or surcharges — the costs of the items bought must be the same as they would be if the cardholder were paying for them with cash.)
However, this example doesn’t take into account higher rates for non-qualified charges, like keyed entries. This can happen when the customer has the card present, but the magnetic stripe has become demagnetized, so the stripe can’t be read. Other items may not be transmitted the same day, as in the case of a restaurant that is open overnight, or a hotel that has check-ins and check-outs around the clock. The above example also doesn’t take into account additional charges for chargebacks, statements, etc.
To calculate an overall effective rate being charged to a merchant, take all fees and assessments and divide that by the total of all tickets. For example: A merchant with an average ticket of $100 has 100 charges in an average month, a total of $10,000. Half are qualified, using the example above. The charges for those equals $75.70 (1.514 percent times $5,000). The other half are keyed transactions that meet all other qualifications for the Visa CPS Retail Key-Entry rate (1.80 percent, plus the assessment, plus 10 cents — .1 percent of a $100 ticket, a total of 1.984 percent). So multiply the other $5,000 by 1.984 percent, a total of $99.20. Adding together $75.70 and $99.20 results in transaction charges of $174.90 (1.749 percent).
If you want to take this one step further, add in other fees. For this example, use $100 in additional fees. The total is now $274.90 (2.749 percent).
The above is a simplistic example because there are usually a variety of fees as all credit card sales don’t always meet one or more criteria for one of the two rates above. However, the above example provides a good guide because you can use it, along with the accompanying charts, to figure out how to add in additional charges and calculate rates with any number of variables.