June 18, 2014
by David Goodale
Interchange Plus Pricing
Interchange plus is a pricing model in which a credit card processor clearly discloses the exact margin (profit) they will make for each credit card transaction they process. It is also sometimes referred to as "cost plus" pricing.
How Interchange Plus Pricing Works
Instead of quoting a traditional fixed discount rate (for example like 2.5%), a credit card processor can disclose their exact processing margin or profit above the straight interchange cost from Visa and MasterCard. (For example, interchange + 0.50%).
In order for this explanation to have any meaning, you must understand what interchange is. We have a separate in-depth article about interchange which can be found here. However, we can summarize by stating:
How much does interchange cost?
It is important to clarify that interchange is first and foremost affected by the region. All credit card processors within a region (for example, Canada) are charged the same interchange structure from Visa and MasterCard. Secondly, we have to consider that different types of credit cards have a different interchange cost associated with them.
For example, at the time of writing this article in June 2014 the Canadian interchange rate on a basic Visa card is 1.65%. The Canadian interchange rate on a Visa Infinite card (a rewards card) is 1.85%. The point is that rewards and points cards will have a higher interchange rate associated with them than for basic cards. Whether you choose Merchant Accounts.ca to be your credit card processor, or if you went with one of our competitors, no processor within the same region (ie: Canada, USA, UK, etc) can give you a better interchange rate because it is set by Visa and MasterCard.
A practical example
For an example, if you had a business in Canada and processed a basic Visa card (which in Canada has an interchange rate of 1.65%), and your quote was for interchange + 0.50%, the actual fee for that transaction would be:
1.65% (interchange) + 0.50% (fee to processor) = 2.15%
Interchange is also affected by the location of the cardholder
The interchange fee is also affected by the location of the cardholder. If you process a credit card issued in another country there will be an additional cross-border fee charged by Visa and MasterCard. That is why domestic sales (to folks in the same country that your business is established in) will always cost less than foreign sales (to folks that live in a different country).
It doesn't matter which credit card processor you choose to work with (at least as far as interchange goes) because all processors have the same cost structure from Visa and MasterCard within a region. That cost structure can be a little bit complicated if you want to dig into it on a granular level, but you really just need to understand that basic cards cost less, while rewards and foreign issued credit cards have a higher interchange cost. However, if you want to dig into it further you should check out our in-depth article about interchange, or better yet contact us to discuss your questions.
Why is interchange plus pricing less expensive than flat pricing?
Once you understand that your credit card processor has a cost that they must pay each time you run a transaction, and you understand that the interchange rate is determined based on the type of card used by the cardholder, you begin to understand that a credit card processor could actually lose money if they quoted a rate that was too low. A credit card processor cannot quote under interchange cost (or at least definitely should not) because they would lose money.
That is why flat discount rates cannot mathematically be quoted as low as an interchange plus rate. Flat rates do not fluctuate (regardless of the type of card used or the location of the cardholder). It's an old fashioned pricing model that was popular before cross border fees and super-premium cards were prevalent. It was often referred to as the "discount rate" or "merchant discount rate" (MDR). These days, flat pricing can only be quoted so low or the processor risks losing money on the rewards cards and especially foreign issued cards.
For example, if I were to quote a very low flat rate to a client (for example, 2.10%), and if by chance that client happened to process a lot of rewards and foreign cards, it would mean that the interchange costs on many transactions would be higher than my quote of 2.10%. As a processor, we would be at risk of actually losing money. That is why larger merchants usually get interchange plus pricing. Large merchants require a low rate because they do a lot of transaction volume, but the processor needs assurances that they won't lose money when processing the transactions. By disclosing their margin above interchange ("Interchange plus") a processor is able to go as low as they want (right down to flat interchange) without risk of loss. At the same time, the merchant gets the additional benefit of total transparency into the fees they are paying to the processor, and can be confident of the value they are receiving in relation to the payment processing service that is being provided.
Beware Qualified / Non-Qualified PricingIn this article we are comparing interchange plus pricing and flat pricing. Both are good, honest pricing models that provide good value to merchants. Although it is beyond the scope of this article to talk too much about it, in a future article (UPDATE: that article has now been published and can be found here.) we will be exploring the 3rd pricing model that is prevalent in the payments industry: qualified / non-qualified pricing. In summary, it is our strong opinion that merchants should never in any circumstance ask for qualified/non-qualified pricing. It is a pricing model that is based on providing a very appealing low rate to a merchant. The low rate might sound good at face value, but unfortunately the merchant will rarely pay that low "qualified" rate. At Merchant Accounts.ca we do not ever provide qualified/non-qualified pricing to our clients. Although there is nothing intrinsically wrong with that pricing model, it's simply unclear and gives merchants no accountability when they are negotiating their pricing. When the new article is published about qualified/non-qualified pricing we will update this article to link to it. In the meantime, we suggest staying away from qualified/non-qualified pricing, and if you have any questions about qualified / non-qualified pricing do not hesitate to contact us.
Disadvantages of Interchange Plus Pricing
|-||It can be a bit confusing to understand because the rate fluctuates based on the type of card used. (Rewards card, points card, airmiles card, corporate issued card, etc.)|
|-||You won't know how much you'll be charged for any transaction until after the transaction occurs (because the actual interchange rate will depend on the type of card used). If you are trying to control these costs or work them into your product margins it's very difficult (or impossible) to do precisely when using interchange plus pricing.|
|-||It can require a little bit more bookkeeping and administrative effort when reconciling transactions because of the fluctuating rate from interchange plus transactions.|
|-||Smaller merchants may prefer the easier to understand simplicity of flat rates, even if it's a bit more expensive.|
Advantages of Interchange Plus Pricing
|-||The absolute lowest way to price an account, especially for large merchants. A processor cannot offer a flat rate as low as an interchange plus rate (because if they guessed wrong and quoted a flat rate too low they could take a loss on the transactions.)|
|-||Total cost transparency, and assurance of the value you are getting in exchange for the fee you are paying. (You never have to wonder how much money your credit card processor is earning from your account).|
|-||If interchange is lowered by Visa and MasterCard the cost savings will be automatically passed onto you. (Not normally going to happen if quoted a flat rate).|
|-||It's much easier to compare proposals if you are shopping around to receive quotations between various potential processors.|
|-||With interchange plus pricing there is no chance of hidden fees whatsoever.|
There is a reason why we put all of our large clients at Merchant Accounts.ca on interchange plus pricing: it's the only pricing model that transparently discloses how much money we (the processor) will earn from every transaction you process.
For that matter, there is a reason why we recommend flat pricing to most of our smaller clients (it's simple and easy to understand), and why we never, ever recommend qualified/non-qualified pricing to anyone. (If you are curious about our credit card processing rates head on over to our rates page).
If you operate a smaller business you may prefer old fashioned flat rates. Flat rates are always easier to reconcile and are definitely easier to understand. In some cases, a savings of a few dollars per month aren't worth it if reconciling your transactions is something that you struggle with. It depends on your preferences, your situation, and... well, it really comes down to a matter of preference.
If you are a larger merchant, or want the lowest rate, you absolutely should ask for (or demand) interchange plus pricing. The best thing about interchange plus pricing is it's like walking into a car dealership and asking the sales person "so, how much, exactly, will you make on the purchase of my new car?". With interchange plus pricing, the sales person has to answer, and answer honestly. It discloses everything, and gives you, the business owner, confidence and control when negotiating your processing costs.
If you haven't reviewed your processing costs in a while take a moment to view our rates.
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