What cost structure should you offer your new clients? This is a very important question and one that 90% of merchant sales people don’t really understand. You need to understand how cost structures like Tier Pricing and Interchange Plus really work in order to save money for a merchant. I am personally moving back to selling interchange plus pricing or “Cost Plus Pricing” exclusively. In this article I will help you understand cost structures and residual compensation. I’ll also share how to save prospects and merchants a lot of money over time by using this knowledge.
In order to simplify credit card processing, I am going to split up the total cost to process credit cards into three categories:
- “Processing Costs”
- “Margin” or “Mark Up”
There are actually many other ways you could look at this and split up the fees, but I have simplified the concepts for today’s article. Let me explain each of these costs:
- “Interchange” – For the purposes of this article, I am referring to interchange as the pass-through costs from the banks and brands. Every check or credit card is backed up by a bank. These banks are called the “issuing bank,” meaning they issued the card to the consumer. When a $100 transaction is completed, somewhere around 1.5% of the total transaction is kept by the issuing bank on average. This number varies a lot by card type with check cards being much lower. However, last year in the U.S. market the average interchange cost was a little over 1.5% of all transactions. I am also including dues and assessments from Visa and Mastercard in this number.
- “Processing Costs” – These are the costs on the “Schedule A” that you get from your processor. Technically, these fees cover the costs of moving the money from the issuing bank to the acquiring bank and then to the merchant’s bank account. In other words, they cover costs of getting that $100 transaction out of the consumer’s bank account and into the merchant’s bank account. In reality, these fees are marked up to cover other costs such as customer service, tech support, equipment placement, risk, etc. I realize this is a huge grey area that varies from one processor to another. But for the sake of simplicity, I am just lumping all the Schedule A costs into this category.
- “Margin” or “Mark Up” – This is the profit from which residual is calculated.
To better understand this, let’s use an example merchant:
Let’s say that a pizza shop processed $10,000 in volume and paid $350 in total fees. We will make a very rough estimate that about $160 was for interchange, $75 was for processing fees, and the remaining $115 was mark-up. If your residual split was 50%, you would get $57.50 in residuals on this account ($115 x 50%). The way most sales people make sales in this business is by giving away some of their profit since this is the only category over which they believe they have control. In other words, for this example the sales person might lower the total fees to $300, which saves the merchant $50 per month. The interchange and schedule A costs would remain the same. So this account would now generate $65 in total margin or $32.50 in monthly residual with a 50% split.
Now that you understand the costs, let’s shift gears and talk about how those costs are charged to the merchant. For the purpose of this article, I am going to split all the cost structures into two categories: (1) Cost Plus Pricing and (2) Bundle Rate Pricing. Let me explain the difference.
“Cost Plus Pricing” – This is also called “Interchange Plus Pricing.” It means that when the merchant in the example above gets his or her statement, the Interchange Fees are itemized and passed through “at cost.” So the merchant pays whatever the processor pays to the issuing banks and to the card brands like Visa, Mastercard, Discover, and American Express. Then in addition to paying the interchange pass-through costs, the processing costs and mark-up are represented using three types of fees on the statement.
#1 – Authorization / Transaction Fee – This is a per item (transaction) fee that is charged on every transaction, no matter how large or small. Again, this fee is in addition to the true interchange costs. An average example for the industry would be charging a merchant a $0.10 transaction fee. Usually $0.04 of that is processing costs from the schedule A, while the remaining $0.06 is margin that goes towards residual income.
#2 – Basis Points of Mark-Up – A basis point is 1/100th of a percent. So if I gave a merchant who processes $10,000 in volume interchange plus 40 basis points, he or she would pay 0.40% x $10,000 = $40 in basis point mark-up. While the authorization fee has some processing costs and some mark-up, the basis points are usually pure mark-up. The exception is if schedule A has something called a “Bin Sponsorship” fee which is a small percentage, usually 2 to 5 basis points, that the processor keeps before sharing the remaining mark-up using the residual split.
#3 – Monthly Fees – These usually contain a combination of Schedule A and mark- up. For example, there might be a monthly statement fee that has a “Schedule A” cost of $5.00; you sell it to the merchant for $10. So you “mark-up” the cost by $5.00, generating a profit.
Let’s take a quick time-out to calculate the total profit in the example above. Suppose the merchant previously mentioned who is processing $10,000 per month is a pizza shop with an average ticket (average size of a transaction) of $30. $10,000 / $30 means that this merchant does an average of 330 transactions per month. We already know in the example that we don’t make any money on the interchange fees. So let’s look at the three fee types mentioned to calculate our total monthly margin or profit on this account.
#1 – 330 transactions x $0.06 profit per transaction = $19.80
#2 – $10,000 x 40 basis points (0.004) = $40
#3 – Monthly Statement Fee $10.00 minus $5.00 schedule A costs = $5.00
The total monthly profit on this account would be $65, which is exactly the number I used above. Therefore, this is a very realistic estimate of your monthly residuals on an average account. If you get a 50% residual split like we pay, your monthly residuals would be $32.50
One other quick side note – In the last few weeks I have been speaking to many reps selling for other companies who don’t get any up-front bonus and in some cases, also have to sell or lease credit card terminals.
Now that you have an understanding of how Interchange Plus Pricing Works, tomorrow I will post Part 2 in this mini-series. Part 2 explains how Tier pricing and other bundle rate plans differ and why I believe selling Interchange Plus Pricing exclusively is the best option moving forward.
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