Hidden Fees and Costs

There are two types of costs that merchants should be aware of. While payment processors often charge add-on or ancillary fees, there are also cases where the merchant’s true costs can be completely hidden. The most usual cases arise when merchants choose to be charged using a bundled discount model. Under this pricing model, which aggregates the fees of all players, there is a greater opportunity for unclear accounting.

This is not to say that the payment processor is necessarily hiding fees from its customers. More often it is a result of business or technological limitations. Even so, it is the merchant’s responsibility to determine whether it is receiving a proper accounting of its dealings with its payment processor. Following, you will find several common examples of hidden fees.

Interchange not Returned on Refunds

According to the card 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. 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.

In the case of a bundled arrangement, the Interchange fees that the processor must pay the Associations are included in the merchant’s bundled discount. With a sale transaction, the processor pays interchange to the Association. With a refund transaction, the Associations pays interchange back the processor. So where does this returned refund Interchange go? Sometimes the processor returns the interchange to the merchant. Sometimes the processor keeps the interchange as an additional fee. In most cases, the merchant actually agrees to this type of billing, known as being “discounted on gross.”

This practice is not against the regulations per se, but many consider it to constitute a gray area. Merchants might therefore attempt to structure their discount on net sales, or abandon bundled pricing in favor of a pass-through arrangement.

Debit Card Interchange

When merchants operate under a bundled billing arrangement, they may also be at some disadvantage with regard to debit card Interchange. In the spring of 2003, Visa and MasterCard lowered the interchange fees on virtually all debit cards. Not all merchants enjoyed this Interchange relief. In particular, many merchants processing under a bundled discount agreement receive no benefit at all. In fact, these new rates provided their processors with an unintentional yet substantial windfall.

Again, with a bundled arrangement, the Interchange fees that the processor must pay the Associations are included in the merchant’s bundled discount. When debit card rates were lowered, merchants continued to pay processors the same discount rate. The processors, however, were responsible for paying less to the Associations. In essence, this is a case of the processors’ costs going down while the merchants’ costs stayed the same. What makes this issue so important is that is that debit card usage represents a significant percentage of overall card transaction volume. In the one year period ending Sept. 30, 2006, Visa reported that debit cards represented approximately 43 percent of the U.S. dollar volume crossing their card networks.

While this only affected merchants processing at the time, it is a good example of why merchants should look at their discount rates very carefully. If possible, you might obtain separate discount rates for credit and debit cards, so you may enjoy the benefits of lower interchange. Asking for a pass-through arrangement instead of a bundled rate would also provide this benefit.

Downgrades

Payment processors often quote bundled discount rates using a tiered model. These tiers are typically called “qualified,” “mid-qualified” and “unqualified.” As you might expect, qualified transactions receive the lowest fees. Mid-qualified and unqualified transactions – also known as “downgrades” – receive higher fees.

In most cases, qualification is based on the timeliness and quality of the data passed to the card associations. When a transaction fails to meet all of the necessary standards, the merchant receives a less-than-optimal discount rate. Regrettably, many merchants receive downgrades on a substantial portion of their total volume. Some of these downgrades are unavoidable like those from rewards cards, corporate cards and certain international transactions. A high downgrade rate may indicate that your processor does not know the standards or that it may be reluctant to implement best practices or new rules changes. Be advised, however, that such problems may also be due to the way you process your orders, and may have little to do with your payment processor.

Merchants can minimize their downgrade rate by insuring that they pass along the correct information (for example, address verification data), and submit settlements in the appropriate time frame. Merchants should therefore work closely with their payment processors to insure that the proper data and settlement standards are incorporated into their sales processes. Your processor should also be reviewing your account and suggesting ways to reduce these downgrades.