Credit Card Processing 101

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1 Credit Card Processing 101 Customers have come to expect credit cards as a payment option. With ATM fees continuing to rise, some consumers may even exclusively choose to take their purchasing power to businesses that accept credit cards. But no business owner enjoys paying the processing fees associated with credit cards, and understanding how the pricing for credit card processing works can be intimidating for anyone just starting out. Unexplained and ambiguous terms like basis points, qualified transactions, downgraded transaction, discount rate, and interchange fees create confusion and frustration for savvy business owners who are tracking every expense. With this white paper, new or even experienced business owners can get plain and simple truths about payment processing: how it works, how to evaluate quotes, and how to obtain a merchant account. Benefits of Accepting Credit Cards Accepting credit cards costs merchants money and adds another layer of paperwork and complexity to the business process. Do the benefits of accepting credit cards outweigh the cost? Customer Expectations and Convenience Simply put, if you are a retail business, allowing payment by credit card is almost a necessity. In fact, if you look at trends over the past ten years, you can see how payments by credit and debit cards have continued to increase while the use of cash and checks has decreased. Source: From Visa Payment Panel Study 2006 Payment Trends Summary Increased Sales by Existing Customers

2 Not only are consumers using cards and electronic methods of payment more, but the average credit card sale is greater than when the buyer uses cash. The additional sales dollars easily make up for the cost of accepting credit cards. Source: umers_pay.html Here's what consumers typically spent in franchise businesses last year, by type of payment. Larger Pool of Potential Customers Without a credit card option, consumers need cash in hand or in the bank to make a purchase. Merchants who accept credit cards benefit from the ability to sell goods to buyers who may not have funds readily available. In addition, the merchant doesn t have to extend credit to the consumer to complete the sale. The resulting windfall to businesses over the years has been tremendous. Business Building Opportunity with Loyalty Cards and Gift Cards Loyalty and gift cards help you attract new customers and retain existing ones. The ability to process credit cards provides you with the option of offering and honoring loyalty and gift cards quickly and easily. Background/History: Process Overview At first glance, the process seems simple: A merchant accepts a customer s credit card, swipes it, gets an authorization code and prints a receipt. The merchant gets paid, and the customer sees a charge on his monthly credit card statement. Pretty simple, right? On the surface, it is. But developing a system that was efficient and virtually seamless to both the cardholder (consumer) and the merchant took many years and involved hundreds of companies - from banks and payment processors to card brand companies like Visa and MasterCard. The Players

3 It s beneficial for a merchant to recognize the major players and their role in the process to be able to put a face to a name with regard to costs and fees. Let s start with the actual cards themselves. Cards are issued to consumers by issuing banks, or issuers for short. When a merchant applies for the ability to accept card payments, the bank that accepts the application is called the acquiring bank, or acquirer. There is a bank on both sides of the process. Between those banks are the card brands, such as Visa, MasterCard, American Express, Discover, etc. Many of these card brands are now publicly traded companies (and not just non-profit organizations) who set rules and regulations with their member banks on both sides of the equation. Simply put, regardless of who sells, supports, and processes credit cards for merchants or consumers, banks ultimately take the risk and extend the credit. Sales organizations and software/hardware companies provide services and equipment to merchants. There are literally thousands of these service organizations. These businesses are really the extended sales force for the acquiring banks that set up the merchant account. Application Process The application process is reasonably standard, regardless of the acquiring bank. Primarily, banks want a basic profile of the business, including what the business sells and how it is sold (i.e., in person, online, or at a distance that requires shipping). In addition, the bank requires basic personal information about the owner of the business and reviews the applicant s credit history. The due diligence process is performed on a personal level for two reasons: Banking and federal regulations. Potential creditors must confirm that funds being charged on credit cards are not being funneled to anyone related to a terrorist organization or other types of dangerous entities. Financial risk. If a merchant goes out of business, doesn t deliver the product as expected, or doesn t perform the agreed-upon service, the bank may have to reimburse funds to the affected customers. These funds are called chargebacks because the amount of the original transaction is typically charged back to the merchant. Pricing and Fees The business cost to accept credit cards falls into several categories: Equipment Cost. The cost for equipment varies widely from a few hundred to a few thousand dollars, depending on the complexity and capability of the equipment you choose. With the advent of the Internet and Smart phones, merchants can find very inexpensive solutions that will enable them to use these devices or an existing computer to process payments. One-Time Fees. Banks will charge a number of initial fees, including an application fee, setup fee, programming fee, installation fee, training fee, and configuration fees, to get your account set up and ready to use. Monthly Fees. As the name implies, these fees are billed each month and can include statement fees, monthly service or account fees, and support fees. Chargeback Fees. A consumer may request a refund through their credit card company instead of working directly with the merchant. The credit card company charges back the amount of the original transaction to the merchant, along with a chargeback fee of $20.00 to

4 $ Chargebacks are rare and tend to occur when a merchant is not responsive to a customer s complaint. Miscellaneous Fees. People refer to these costs as hidden fees because they are exactly that hidden from the initial quote or sales presentation. Transaction Processing Fees. The method banks use to calculate transaction processing fees varies from bank to bank. Most monthly statements do not give merchants a clear explanation of how the fees on transactions are assessed. Unfortunately, this also makes it difficult for merchants to compare quotes from competing banks, since this is generally where the bulk of the cost for the service lies. Read on to learn more about how transaction processing fees are derived. Credit Card Transaction Processing Fees Explained The basic fee structure for processing is fairly clear. Each transaction will cost you a percent of the amount that s processed, plus a flat amount per transaction called the authorization fee. For example, the transaction fee on a sale of $ at a rate of 1.79% + $0.25 per transaction would roughly be $2.04: ($ x 1.79%) + $0.25 = about $2.04. However, not every transaction costs the same. The rates for processing card transactions are determined based on interchange rates, which are set by card associations (i.e., Visa, MasterCard, and American Express). Over 300 different interchange rates can be applied to a transaction, depending upon factors such as the type of card, the type of merchant, and how the transaction is sent by the merchant. The rates are modified twice a year, usually in April and October. This variability has prompted merchants to ask for government legislation to address the standardization of interchange rates. Because the cost for each transaction is different, credit card processors offer merchants a variety of pricing methods. Understanding the basics of each method will allow you to interpret quotes and compare pricing from different vendors. Pricing Options Tiered Pricing. The most popular pricing method by far is tiered pricing. In tiered pricing, the processor groups all of the merchant s transactions into several (usually between two and six) categories called tiers and assigns a rate to each tier. Three-tiered pricing is the most common and is probably the easiest for merchants to understand. The three tiers are as follows: Qualified Rate Tier A qualified rate is the rate merchants (business owners) are charged when they accept a regular consumer credit card and process it in a manner defined as standard by the processor. This is usually the lowest or best rate a merchant will incur when accepting a credit card. The qualified rate is also the rate commonly quoted to merchants when they inquire about pricing. For the most accurate pricing comparison, merchants must get rates for all of the tiers. The qualified rate is created based on the method credit card information is gathered for a majority of credit cards. For a typical retail merchant, the qualified rate is based on the transactions that will be swiped; hand-keyed transactions will fall into a higher rate tier.

5 Mid-Qualified Rate Tier Also known as a partially qualified rate, the mid-qualified rate is the rate merchants are charged when they accept a credit card that does not qualify for the lowest rate (the qualified rate). Examples include: o o a consumer credit card is keyed into a credit card terminal instead of being swiped, or a special kind of credit card, such as a rewards card or corporate card, is used Non-Qualified Rate Tier The non-qualified rate is usually the highest rate merchants are charged when they accept a credit card. In most cases, transactions that are not classified as qualified or mid-qualified fall into this tier. Reasons for a non-qualified tier include: a consumer credit card is keyed into a credit card terminal instead of being swiped and address verification is not performed; a special kind of credit card, such as a business card, is used and all required fields are not entered; or a merchant does not settle the daily batch within the required 48 hours from the time of authorization. (Most merchants are now set up for automatic batching features to reduce the likelihood of this situation.) Settling the daily batch is the process of confirming at the end of a shift or a day that all transactions are good to be settled financially from having authorized the transactions throughout the day. Interchange Plus Pricing. With Interchange Plus Pricing, the merchant is billed the interchange cost for each transaction plus a specific amount on each transaction for the processor s profit. The extra amount is expressed as an additional percent and per item fee such as an extra.5% percent + $.20 per transaction. For small merchants, there s usually not a lot of benefit to Interchange Plus over tiered pricing since the volume of processing is so low. Most new businesses tend to prefer tiered pricing because the calculation method is more transparent. Other Pricing Methods. Most other pricing methods, including Interchange Differential, Interchange Differential Plus, Enhanced Interchange, are basically variations on tiered pricing and Interchange Plus. One method that is rarely offered is flat fee pricing. With flat pricing, the same fee is applied to all transactions, regardless of their cost or interchange category. New Regulations: PCI Compliance There are regulations or standards and rules that merchants and processors must adhere to. PCI Compliance, also known as PCI-DSS (Payment Card Industry Data Security Standard), is a set of industry standards for protecting the security of consumers credit card numbers. The rules apply to anyone involved in accepting or processing credit cards. The requirements differ based on the number of credit card transactions a business processes; however, any businesses that accept credit cards must adhere to the requirements, which consist of a yearly review of systems and procedures, documentation, and possible scanning of computer systems. It is the responsibility of the merchant s card processors to ensure all the merchants for whom they process are complying with the requirements. Processors generally

6 pass along the cost to their merchants; some charge a yearly or quarterly PCI fee while others provide a detailed monthly service and charge a nominal fee. Choosing a Payment Processing Provider Many local and regional companies can compete aggressively on price for your payment processing. However, as a prospective buyer there are many other critical details to take into account when choosing the vendor that s right for you. Here are some questions to consider as you begin comparing vendors. 1. How fast can the processor fund the transactions to your business bank account? 2. Can the processor settle gross vs. net amounts (minus daily transaction fees) daily, which makes reporting and reconciliation easier? 3. Does the processor offer convenient online reporting for your bank reconciliations and accounting needs? 4. Does the processor offer additional services, like electronic check services, gift cards, and merchant cash advances that can be seamlessly added in the future? Or will you have to contract with separate companies to expand your processing needs? 5. Does the processor offer you full PCI support to ensure you are compliant with new industry security requirements? 6. Did you get a complete quote of all the fees you will incur? Are you aware of any hidden fees? 7. How long has the processor or the sales agent/company been in business? 8. If you want to end the contract and switch providers, what will it cost you? Credit card processing is a competitive industry with many different vendors in the marketplace selling credit card processing services. Some specialize in specific technology and software solutions that cater to the preferences of merchants. Others try to sell on price. All processors pay the same interchange fees, so pricing is a matter of marking that cost up and providing the right solutions and support for your business. As you research different companies, remember to analyze what you need and which vendors can not only offer you full disclosure in their pricing but can truly deliver the features that make the service easy and effective for your business. The information in this paper is furnished for informational use only and should not be construed as a commitment by Paychex, Inc. Paychex provides such information as a service and is not implying its endorsement of, or agreement with, such opinions, information, analyses, recommendations, or conclusions. If legal advice or other expert assistance is required, the services of a competent professional should be sought Paychex, Inc. Paychex, Inc., 911 Panorama Trail South Rochester, New York

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