As I write this column, we are experiencing our fourth re-pricing in a year. These constant price increases to merchants have escalated churn industry-wide. Churn coupled with increased competition and lower margins have challenged Acquirers, forcing them to look at their portfolios and policies to find ways to drive greater profits. These additional profits on credit card portfolios can be generated through operational policies or pricing policies. This column will focus on the operational policies associated with managing a portfolio's profitability, with next month's column thoroughly addressing pricing policies.
When I use the term operational policies, I am referring to the way an account is managed or funded to increase profitability. Listed below are some of the more common operational policies Acquirers use to increase profitability and manage their portfolios.
Restructuring of Surcharges
Most Acquirers use a three-tiered pricing structure for their merchants (qualified, mid-qualified, non-qualified). Certain Acquirers are moving to a four-tier structure to accommodate new off-line debit rates. This tiered structure enables them to bundle similar interchange levels into separate buckets, which makes understanding the payments world much easier for the sales rep and the merchant. There are no set rules on which interchange levels qualify for which tier. By moving interchange levels to different tiers, an Acquirer can increase or decrease profitability. Certain Acquirers are even known to have only two tiers, creating the opportunity for even greater margin. Downgraded transactions and off-line debit (check card) transactions can account for as much as forty percent of merchants' transactions. This is the most commonly used recurring operational policy change implemented by Acquirers.
When margins were much greater, most Acquirers billed their merchants per item or transaction fees on settled items only-meaning that a merchant would only be charged a per item fee if the transaction was approved and settled. Today, most Acquirers have moved to true transaction billing. The merchant will be charged each and every time a terminal dials out and accesses a processor's host. It is important to note, the Acquirer has costs and other charges as a result of all transactions regardless of whether they are approved or declined. The change from settled-item billing to transaction-based billing has enabled Acquirers to increase margins with minimal concern to the merchant. Ten to fifteen percent of most merchants' transactions are not approved transactions. The average merchant having 100 approved transactions will have an additional 30 to 35 transactions a month (including batches), which equates to more money for the Acquirer with minimal cost.
Daily Discount (Gross Deposit)
Visa and MasterCard remove interchange and fee costs from Acquirers on a daily basis. If a merchant is not billed these fees until the end of the month, the Acquirer is paying the associations prior to payment from the merchant. By deducting discount fees from daily deposits, Acquirers can increase profits as the need to float interchange until the end of the month disappears. Daily deposit will save an Acquirer approximately 0.5 basis points or 0.005% (.00005) on a merchant. Spread out over an entire portfolio, this can be significant. For this reason, most Acquirers set smaller merchants on daily discount. Appropriately, this also limits discount risk (if a merchant goes out of business, the discount dollars owed to the associations are not lost).
Net Deposit (Gross-Gross Deposit)
When a merchant on Daily Discount runs a transaction, his deposit is the price of the sale less the discount rate charged. If the item is subsequently returned and the merchant issues a credit, the Acquirer is refunded interchange from the issuer. However, a merchant who is set up on Net Deposit will have the price of the sale deducted from his next settlement and returned to the issuer, but will not be credited back the discount rate charged by the Acquirer. The transactions are processed, so the merchant is charged the cost of two transaction fees and the original discount rate which is not refunded.
One of the more controversial avenues for increasing profitability is delaying merchants' funding by a day or longer, thus enabling the Acquirer to accumulate interest on the held funds. Holding or delaying funds for an extra day, or longer on a large portfolio, can allow an Acquirer to make money on the "float" or interest. This practice is most appropriate when there is a high potential risk of merchant fraud or the merchant going out of business and the Acquirer being left responsible for loss of daily discount fees and trailing charge backs.
The operational policies outlined above are just a few of the key ways Acquirers drive additional profitability. As our industry gets more competitive by the day, Acquirers are looking for more ways to drive profitability into their portfolios. Not all Acquirers implement these policies and some markets are not conducive to certain policies. Recently, a large Acquirer confessed to me, "We are facing lower prices and greater competition, with greater risk than ever before. We are forced to find new ways of driving profitability into our portfolios."