Interchange Optimization: Are you getting the best rate?

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1 2012 Interchange Optimization: Are you getting the best rate? Northpark Town Center 1200 Abernathy Road, Suite 1700 Atlanta, Georgia (800)

2 There are many costs associated with accepting credit and debit cards as payment. The largest cost is interchange, and it can represent 70 to 95 percent of the total cost of processing credit and debit cards. Interchange cannot be negotiated but it can be managed. This white paper provides a background on interchange and identifies specific strategies that can be employed by companies to reduce the cost of interchange. What is interchange? Interchange (IC) is the wholesale price charged by the card networks (Visa, MasterCard, Discover) for authorizing and settling a transaction. All the IC that a merchant pays goes to the bank that issued the card. For instance, if a Citibank Visa credit card is used at a Macy's department store for a $100 charge - the IC cost of $1.61 (Visa CPS Retail interchange rate of 1.51% + $0.10) goes to Citibank. For card issuers, interchange revenues pay for the cost of money (the bank provides an interest free loan, to a person s credit limit, if the card balance is paid in full), rewards programs, internal costs including fraud, and profit. Chart 1 Flow of a Credit Card Transaction GATEWAY 1. The merchant submits a credit card transaction to processor from a Web site, retail location, call center, or a wireless device. 2. Transaction is routed through a gateway, if applicable, to the merchant acquirer or processor 3. Processor submits the transaction to the card network or card interchange system (a network of financial entities that communicate to manage the processing, clearing, and settlement of credit/debit card transactions). 4. The Credit Card Interchange routes the transaction to the customer s Credit Card Issuer. 5. The Credit Card Issuer approves or declines the transaction based on the customer s available funds and passes the transaction results, and if approved, the appropriate funds, back through the Credit Card Interchange. 6. The Credit Card Interchange relays the transaction results to merchant processor. 7. Merchant processor relays the transaction results to gateway, if applicable. 8. Gateway stores the transaction results and sends them to the merchant. This communication process averages three seconds.

3 Why are there so many interchange rates? Interchange rates are set by Visa, MasterCard, and Discover and they have setup a complex scheme of more than 700 interchange rates. With so many different rates, it s no wonder businesses have a difficult time understanding and calculating their overall costs. The U.S. has the highest interchange rates in the developed world. Various considerations are involved in how interchange rates are set in the U.S., including the following macro and micro considerations. Macro Considerations Competition amongst card networks Card network and issuer strategies Emerging markets/verticals Legislation Micro Considerations Merchant's industry type (MCC Merchant Category Code) Type of card (Visa Traditional, Visa Rewards, Visa Signature, Visa Debit, etc.) Method of entry (swiped vs. keyed) Risk and adherence to compliance standards What is a recent example of a macro impact on interchange? Of all the factors impacting Interchange, the most recent has been the Durbin Amendment, part of the Dodd-Frank Act. The Durbin Amendment gave the Federal Reserve the power to set interchange rates for debit cards. The Fed imposed a cap on debit interchange fees for cards issued by regulated financial institutions. The debit interchange fee limitation consisted of 3 components: 1. Interchange cap of $0.21 per transaction % of the transaction value as ad valorem fee for fraud loss recovery 3. $0.01 per transaction fraud-prevention adjustment (allowable if issuer certifies to its network that is has adopted certain fraud-preventative policies and procedures) With the implementation of the Durbin Amendment, at most merchants will pay $ % for a regulated debit card (applies to both signature and PIN debit cards) transaction. Since implementation, Durbin will have saved merchants approximately $8 billion in its first year according to a Federal Reserve study released earlier this year. While the debit fee caps have benefited most merchants, some are paying higher fees as a result. The table below shows how different verticals were impacted by the Durbin Amendment. Note that the parking industry has seen increased costs since implementation of the Durbin Amendment due to small ticket sizes being subjected to the same interchange rate as larger transactions.

4 Vertical Company Size Debit Interchange Fee Cost & Savings PreDurbin Post Durbin Cost/Txn Cost/Txn Average Debit Ticket Debit Savings/Txn Annual Interchange Savings Retail $340M $38.00 $0.59 $0.24 $0.35 $1.3 million E-Commerce $54M $ $4.57 $0.35 $4.22 $0.6 million B2B $80M $ $13.35 $0.49 $12.86 $0.4 million Parking $90M $3.75 $0.09 $0.22 -$0.13 -$1.4 million How can I take advantage of lower debit rates? Most merchants are not taking full advantage of the benefits received as a result of the Durbin Amendment. Nationally, regulated debit transactions have averaged 70% and we have seen them as high as 90% in some localized markets. There are ways to maximize your savings potential by using Durbin to your advantage. 1. Ensure that you are receiving Interchange pass-through pricing merchants with bundled pricing do not receive the savings from Durbin amendment 2. Promote debit (signature, PIN, and PINless as applicable) with signage at retail POS or web checkout page 3. Evaluate incentives to drive customers to pay with debit or less costly payment tenders Bluenile.com offers 1.5% discount for bank wire Ikea offers a 1.0% debit discount that is good towards future purchase Some gas stations offer cash and debit card discounts Meijer grocery stores offers extra bonus points for PIN debit usage 4. Evaluate PINless debit if you are in government, telecom, insurance, utility, or education vertical 5. Use analytics to ensure unregulated transactions are receiving the best interchange rate (e.g. transactions are not downgrading to Visa EIRF, Standard, etc.) What are some things I can do to minimize interchange costs? Although Interchange cannot be negotiated, internal processes can be managed and optimized to obtain the lowest Interchange available for each transaction. All interchange can be grouped into six meaningful categories: 1. Consumer traditional cards 2. Consumer rewards cards 3. Signature debit cards 4. Commercial cards 5. Downgrades 6. Refunds

5 Not all interchange categories can be improved only downgrades can be optimized to receive lower interchange rates. In certain retail scenarios, signature debit cards can be optimized through PIN prompting. So what is a downgrade? A downgrade occurs when a transaction does not receive the best available interchange rate due to a sub-optimal process. Some examples of downgrades include: 1. Not performing AVS (Address Verification System) for key entered or card not present Visa Cards 2. Not complying to standards set by the card networks, including: a. Not receiving an electronic authorization b. Time between authorization and settlement of a transaction exceed set limits c. Authorization and settlement sales amounts do not match (exceptions allowed for industries supporting tips; including, hair salons, restaurants, etc.) 3. Not submitting Level 2 or 3 data for business, commercial, corporate, fleet and purchasing cards Majority of these downgrades can be improved by reviewing and automating internal processes. For business to business merchants, majority of their downgrades tend to be from not submitting Level 2 and 3 data for business cards. What is Level 2 and 3 Data? When a credit card transaction is processed, different levels of information are required depending on the type of card used. Consumer cards require basic Level 1 data, such as the merchant name, the total transaction amount, and the date of purchase. Business and purchasing cards require enhanced data to be transmitted to the cardholder s company in addition to the vital data required for consumer cards. Transmitting this enhanced data in the settlement file will qualify that transaction for lower interchange rates. If the required data is not sent, then the transaction is downgraded. Downgrades can be cost businesses from tens to hundreds of thousands of dollars in incremental processing costs. All MasterCard business, corporate, purchasing and fleet cards are eligible for Level 2 or 3 processing. Visa corporate and purchasing cards are eligible for Level 2 or 3 processing (business cards are only eligible for Level 2 processing).

6 What are the benefits of Level 2 & 3 Processing? There are many benefits to qualifying for Level 2 and 3 processing. The rate differential between various levels of processing ranges from 0.05% to 1.30% for larger ticket transactions. A client of ours processed a $1M transaction with a Visa Purchasing card at rate of 2.65%...if they had passed Level 3 data, they would have saved $7K on that single transaction alone. This table shows a sampling of interchange rates that can qualify for Level 2 and 3 processing. Notice the lower interchange possible with each additional level of processing and the savings potential. Level 1 Level II Level III Interchange Name Rate % Rate $ Rate % Rate $ Savings Rate % Rate $ Savings Visa Corporate Card Not Present 2.20% $ % $ % 1.95% $ % Visa Purchasing Card Not Present 2.65% $ % $ % 1.95% $ % Visa Business Bus to Business 2.10% $ % $ % 2.05% $ % MC Corporate Data Rate I 2.65% $ % $ % 1.90% $ % MC Business Enhanced Data Rate I 2.77% $ % $ % 1.92% $ % MC Business World Elite Data Rate I 2.87% $ % $ % 2.02% $ % MC Corporate Large Ticket % $ % $ % 1.35% $ % Average Savings 0.40% 0.68% Savings for Every $10M Processed $40,000 $67,857 How do I start and optimize my interchange? Here are basic steps to get started. If you need help, do not hesitate to contact us. 1. Analyze your interchange data to identify the extent of downgrades and opportunity size for improving interchange costs 2. Use PIN Prompting for signature debit transactions, if applicable 3. If you have significant business card downgrades, ensure your acquirer and gateway, if applicable, can support Level 2 and 3 processing 4. Configure your POS or ERP system to capture and transmit Level 2 and 3 data 5. Implement ongoing analytics to track and measure the success of your efforts

7 Investing the time to understand interchange and how to qualify for the best interchange rates can significantly lower the cost of credit and debit card processing. If your organization does not have the resources to manage and optimize your payment costs, it may be a good idea to have an outside expert come in to take care of that portion so you can concentrate on your core business. By investing some time and/or resources now, you can improve your bottom line for many years to come. Northpark Town Center 1200 Abernathy Road, Suite 1700 Atlanta, Georgia (800)

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