How Payments Processing Really Works (Part 2)

Let’s talk money.

In this, the second in a two-part series, I explain different interchange pricing models, and how ISOs and agents make money from payment processing.

First revenue. There are four pricing models that determine the revenues ISOs and agents earn on credit card processing.

1. Flat-Rate pricing, where every transaction gets assessed a flat rate, say 2.75%, plus a small per-item fee. So, for a $100 transaction, where interchange is 2%, the merchant might be charged 2.75% plus 25-cents, which provides $1 in margin. ($100 x 2.75% = $2.75 + 0.25 = $3, with $2 going to the card issuer in the form of interchange).
2. Interchange-Plus is the simplest and most transparent pricing model. Each transaction is assessed the true-cost of interchange, plus a consistent markup, like 50 basis points (0.05%) and 10-cents. The downside: statements can be complicated to decipher given the complexity of interchange tables.
3. Tiered pricing is a bit like Flat Rate pricing, except there are multiple Flat Rates, depending upon type of card and other variables, as well as whether the card is present and run through a terminal, or not. Rates can also vary based on how the processor classifies the transaction – Qualified, Mid-Qualified and Non-Qualified. A Qualified transaction is the lowest rate, and is typically reserved for non-rewards cards. Rewards card, and those transactions where the card number is keyed in, are commonly classified as Mid-Qualified. Non-Qualified rates are most often reserved for high-level rewards cards, and ecommerce transactions submitted without the customer’s billing address.
4. Differential pricing. This includes compliant surcharging, cash discounting and other dual pricing models that have nothing really to do with merchant per-transaction fees. In all these cases, the cost of processing is borne by the card-paying customers. It’s a flat rate – or two, with one for credit and one for debit – and generally a pretty high percentage (3-4%), which makes this a very profitable pricing model from the ISO and agent perspective.

Next, costs.

Costs include interchange and card brand/network fees, which I described last week, as well as acquirer/ processor fees. These are called Schedule A costs, and include POS technologies, customer support, fraud prevention, etc.

Processor fees can be expressed as dollars and cents as well as basis points. For example, the processor might charge $6 per month for each unique merchant ID (MID) plus 5 basis points on every transaction.

Whatever is left after Schedule A costs are calculated and deducted is the ISO’s revenue, which shares it with agent that signed the merchant account.

An agent’s cut of the revenue will vary by processor and ISO, employment status, relationship with the ISO or processor, and other factors. The revenue share for a W2 employee, for example, differs from that paid a 1099 sales rep. Some ISOs agree to pay residuals for the lifetime of an account, others pay a lump-sum for a set period of time (12 months of anticipated revenues, 18 months, etc.) upfront.

Now you know the basics of payment processing. But this is a changing industry. It’s best to stay on top of changes and build your expertise.

Don’t forget to follow us on SoundCloud! See you for our next episode.

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