Merchant Credit Card Processing Costs: The Whole Story

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Ask a typical merchant what it costs to accept credit cards, and they'll probably rattle off a number around 2%, and brag a bit if it's less. But the discount rate they're thinking about isn't the only cost. If you're running a business, you need to know the whole story.

Once you understand, if you want a simpler alternative they're now available. There are services that require no contract, have no startup or monthly costs, don't need special hardware or terminals, and have a simple fee structure. We'll get to that below the fold.

The Real Cost Of Accepting Credit Cards

Until recently, to get into the credit card game you had to ante up application and startup fees — a huge barrier and an expensive part of doing business with plastic. Fifteen years ago they could add up to $800-$1000; fortunately those fees are rare today. However, if you're looking for a merchant services provider (MSP) you may still find one that tries to charge such fees, but they'll probably drop them if you insist.

Once you've signed up, you'll need some way to capture credit card data for the transaction. If you're a retailer, a card terminal by the cash register is the typical solution, and may be provided free as part of your deal with the merchant service providers. Solutions for handheld devices (including iPhone/iPad) are emerging, and web-based virtual terminals make sense for low volume situations. More about those coming up.

Once you're in the game and ready to play, the fun begins. For starters, that discount fee most people have in mind when they think of their credit card costs only applies to so-called "qualified" transactions. If certain criteria aren't met, discount surcharge fees will be added to the costs.

MSPs use different criteria: One MSP might have a low rate for qualified transactions, but will downgrade, say, two-thirds of them to more expensive "mid-tier" or the highest rate "non-qualified" status and add a surcharge accordingly. Another MSP may have a higher qualified rate, but will only downgrade 5-10% of the transactions. The difference in cost (which could be substantial) depends on the nature of your business and how your transactions are classified.

For example, if you pay a 2.5% discount rate but address verification (AVS) fails, the transaction will be downgraded because of the implied risk and the discount surcharge fee could pop the cost up another 2% to 4.5%. If you're a retailer, where most cards are swiped on a terminal, the low qualified rate MSP is the way to go. If you run a website you might want to find one that has a low non-qualified rate.

If you're an Internet or mail-order merchant the address verification service fee can be significant because it will be charged on every transaction. AVS matches street and zip information entered online with the cardholder's issuing bank records as a security check. Note that AVS is not available for foreign cards — one reason they're considered higher risk, and they will cost you more in surcharges.

Beyond the discount rate and AVS fee, there's also a per transaction fee, but what that includes varies. Some MSPs charge a fee for each authorization and charge a separate network fee, WATS (telephone) fee, or network inquiry fee. Others bundle all that together. At best confusing and at worst deceptive, make sure you know your true per transaction costs.

But, wait, there's more.

Visa and MasterCard are associations of member banks. Discover, Diner's Club, and American Express cards are offered by businesses that aren't part of either association. As such, they're considered "non-bank cards" so MSPs (and thus you) are charged a "piggyback" fee. You won't pay a Visa or MasterCard discount rate on the transaction, to be sure, but you will pay a transaction fee plus the card's discount rate. When you look for an MSP and compare what they cost you, keep in mind that these piggyback fees are fixed and can't be marked up or discounted by banks or MSPs. If they are, there's some funny business going on.

Each credit card transaction results only in an authorization, so periodically — generally at close of business — you transmit all your authorizations in a batch and set into motion the process that begins the funds transfer between each card holder's bank and your bank. A batch fee is incurred each time a batch is settled, no matter how many you do each day and regardless of whether it's 1 or 100 transactions.

That's it for the day-to-day fees. But there are also monthly and recurring fees.

There may be a statement fee that pays for printing and mailing, and other administrative costs. There may even be recurring help desk fees for customer support. Be sure to find out if your MSP offers online reports and statistics, which can be a huge help; but watch out for extra charges for the service. Some MSPs include it as part of the statement fee and some don't (but should).

You'll also pay a chargeback fee in the $15-$25 range if a customer disputes a transaction (and wins). How quickly you're notified, how long you have to respond, and how the MSP handles a chargeback claim varies considerably. One MSP may not accept an email receipt generated by an online shopping cart as proof of order, while another will without question.

There's a lot you can do to prevent chargebacks. Many occur because the customer simply doesn't recognize the charge on their credit card statement. Since you control what prints on their receipt and therefore their statement, be sure it is something that clearly identifies the nature of the charge. Your phone number or website name are good choices.

When you shop for an MSP, there are some other important costs to consider. If you're a startup or low volume merchant, watch out for a monthly minimum fee. If you don't batch a nickel, you still will pay statement and gateway fees and you'll have to pay the monthly minimum fee — all for the privilege of collecting no credit card income. Keep an eye out for annual fees and cancellation fees, too. In today's competitive market, these are often negotiable, but they can be significant and have to be figured into your total cost of accepting credit cards.

Simple and Low Cost Alternatives

So, is there a better solution for low volume or infrequent transactions? In fact, there is.

If you only occasionally need to accept a customer or client credit card, you clearly don't want to buy a credit card terminal and pay those statement, annual and monthly minimum fees. Sure, you could use PayPal, but as huge as they are, the company has a certain lowbrow reputation that you may not want to be associated with. Happily, there are or other payment and virtual terminal services such as those offered by Chase Paymentech, Square and AcceptPay.

Chase Paymentech offers what amounts to a web-based point-of-sale terminal. No hardware, no dedicated phone lines, no complicated fee structure. Log on to the Paymentech Orbital Virtual Terminal through your web browser, and enter customer information and credit card numbers. Then click an on-screen button and the transaction is authorized, click another and it's batched. Ka-ching. It takes about three days to sign up, mostly faxing paperwork back and forth. The (negotiated) cost boiled down to no setup fee, a $6 monthly minimum, a 25¢ authorization and batch fee, and a two-tier discount rate of 2.6% for qualified and 3% for non-qualified transactions.

New iPad owners will find mobile phone payment options such as Square an interesting solution. There are no contracts, fees or hidden costs. They'll even send you a little gizmo (also free) that plugs into the earphone jack so you can swipe cards. Sign-up only takes about 5 minutes, and you'll pay a card-present discount rate of 2.9% and card-not-present rate of 3.5%.

American Express has its own low cost solution called AcceptPay which comes in a Lite version that allows 10 transactions a month and has no contracts, fees or costs other than a 2.89% discount rate plus a 15¢ transaction fee for American Express cards or a 2.29% discount plus a 29¢ fee for other major payment cards. Sign-up is as easy as creating a website membership and providing bank routing and transit information off the bottom of your check. A full-featured version is also available for $20 a month.

U.S. cardholders, 176 million of them, carry 610 million credit cards and they used them 9 billion times to buy over a $1 trillion in goods and services in 2009 — about 60% of retail sales. Accepting credit cards sales may be a complicated game, but it's a good bet for any business.

This is a guest post by Tom Harnish. Tom is a serial entrepreneur. He learned what works (and what doesn't) when raising money by spending countless (and often fruitless) hours in front of lenders and investors.