Back to the Basics: A CNP Payments and Fraud Primer, Part 2

By Karisse Hendrick, Editor-at-Large,

Back to the Basics: A CNP Payments and Fraud Primer As kids, many of us dream of becoming a fireman, a ballet dancer, a ball player or a pop star. A card-not-present payments and fraud professional? Not so much. For most, ending up in your current career was a happy accident. There are no college courses that prepare you to set up or manage CNP payment processing, nor are there are any standardized courses on fraud management. Because there’s no clear career path, everyone comes to their job with a varying degree of understanding regarding the plumbing of the industry.

At, we often are asked for a basic explanation of the overall payments process by individuals throughout the ecosystem and at many levels of experience. A review of basic information can help merchants understand the partners they need and help providers better understand the role they play in the ecosystem. Last time we looked at the payment, authorization and settlement process. Today, we examine the basics of merchant processing fees—what they are, how they are structured and when you can negotiate them. If this is a review for you, pass it along to someone you think it will help. If you don’t need it as a resource, someone in your organization does.

Understanding Merchant Processing Fees

While each partner in the CNP payments process has a separate fee structure, the most complex statement a merchant receives every month is likely from its payment processor. Understanding these fees, and which fees are negotiable, is vital from a cost perspective. 

When online and mobile merchants partner with a payments provider to accept cards, it is important to remember there are two types of fees: those that go to your processor and those that flow through to issuers. Interchange is the fee paid to the bank that issues the card used in a transaction that is processed through your merchant ID. All other fees on your statement most likely go to your processor.

Understanding and Optimizing Interchange

Interchange is typically a percentage of the value of a transaction plus a flat fee that is paid directly to the issuing bank by your merchant processor. There more than 700 different interchange categories defined by Visa, MasterCard and Discover card. Revenue from interchange helps issuers pay for the cost of lending the funds to cardholders, rewards programs, and other operating costs, such as fraud and credit review programs.

The interchange percentage rate varies based on credit card type, the type of merchant and the way the transaction was processed. Some of the factors that affect rates include type of card (e.g., the interchange rate usually is higher for a credit card with a rewards program than a standard credit card with no rewards program), Address Verification Service status and type of merchant.

These fees differ by card brand and are not negotiable, though there are process improvements that can “optimize” interchange. Processing AVS, settling a transaction within three days of the authorization and ensuring that your business is properly explained utilizing the correct Merchant Category Code are some of the ways to ensure that you are paying the best possible interchange rates for each transaction. Additionally, programs like 3DSecure for CNP transactions can also lower the interchange paid by up to 15 basis points (.15%). Ultimately, optimizing processes to decrease interchange can also lead to improving the way you do business, which has impacts beyond a cost savings benefit.

One fairly recent change to interchange rules as been the Durbin Amendment, part of the Dodd-Frank financial reform in 2010. This amendment limits the interchange rate for regulated debit cards to a maximum of $.22 cents + .05% per transaction. This change was expected to save merchants over $8 billion in its first year. However, unless your payment provider is charging you on an “interchange plus” or “interchange pass-through”—rather than “bundled”—basis, it can be difficult to tell if you are getting any savings. Interchange plus is more transparent: The processor is only passing on the interchange paid for the transaction to the merchant, with no additional fees. It is fairly easy to tell if this is the pricing structure your processor is using by looking at the interchange section of a recent merchant statement. If you see rows of interchange codes and various types of interchange fees, most likely you are set up on this system.

Bundled pricing generally is set up in a bucketed or tiered structure that places all interchange fees into a number of buckets or tiers. The most common approach processors use is a three-bucket approach, applying terms like qualified (best pricing), mid-qualified (middle rates) and non-qualified (the highest interchange rates) to all 700+ interchange categories, and sometimes charging the merchant the average rate of each of the interchange rates that make up each bucket. Others will charge the merchant the highest interchange rate in each bucket. This interchange pricing structure most often is found in small to mid-level merchant accounts. Most processors offer both interchange-plus and bucketed pricing, though they may have minimums for the amount of dollars processed through a merchant account before upgrading from tiered pricing to the more transparent billing process. It is important to understand which pricing structure you have, especially when comparing potential processing partners. While one processor may have smaller percentages for other fees, if they pass on interchange in a tiered structure, it may be cheaper to pay a higher rate overall, but have pass-through interchange rates.

Understanding Processing Fees

All other non-interchange fees most likely go to your merchant processor to cover costs associated with processing and depositing your transaction volume. The main fee paid to your processor is known as a “merchant discount rate.” Because “discount” usually is associated with a cost-savings, this term can be deceiving. In this case, it is the fee you pay your processor. Unlike interchange, which varies by the network associated with the card used in the transactions, processing fees apply equally to all Visa, MasterCard and Discover transactions (American Express charges their fees as a combination of interchange and processing fees, as they are both the issuer and merchant processor. This article assumes that most Visa and MasterCard processors also process and charge for Discover).

Your processing fee can be charged in several ways. In some cases, it is a straight percentage of your transaction volume. Or, like interchange, it could be a hybrid between a percentage and a per-transaction fee (e.g., 2% + $.10 per transaction). In some cases, the discount pricing is separate from interchange, while in others it is “bundled” for an inclusive percentage plus flat rate, making it difficult to know which fee is going to which party.

There are several factors to consider when determining the best pricing structure for your business. One is your company’s average ticket price. For example, if the average transaction amount for a business is $10, it may be more advantageous to be charged a straight percentage, over less basis points, but with a per transaction fee. If your average transaction is significant, a smaller percentage + a per-transaction amount may be better. 

Miscellaneous Fees for Payment Processing

You may also face additional charges like authorization or settlement charges. Authorization fees are charged for each transaction that is sent through the authorization process, while settlement charges are typically per batch, though sometimes they can also be per transaction. Knowing your business is always key when setting up a merchant processing contract. For example, if your business is digital delivery, you may have a card-testing fraud issue. As an example, if you pay $.10 per authorization, you could be paying for each attempt made on your website without being paid for those transactions, due to fraud. Alternately, if you have a high rate of authorized transactions being settled, it may make sense to have an authorization rate, if that translates to a smaller discount rate. Settlement charges are not charged to all merchants, but may be beneficial, depending on its impact to the overall processing rates.

International payment processing brings additional fees such as foreign exchange and currency conversion fees. Working with your processor to understand these and to know if it is better to process payments locally or cross-border in each market is in your best interest. The answer typically depends on each country and the volume processed, so consulting with your payment processor or other experts in the industry is the key to minimizing international processing costs.

Chargeback fees, including notification and re-presentment fees, are also common, though they vary significantly. As with all charges, knowing your business is key in accepting these line items in a contract. In most cases, it is unrealistic to request $0 chargeback fees, as there are costs to the processor to process the chargeback. Should your chargeback rates exceed the limits set by the card networks, you may be charged an excessive chargeback monitoring fee. This fee is passed on by the processor from the card networks and cannot be negotiated or changed. It also may impact your overall risk profile, increasing the rate you pay your processor for future transactions. Some processors may also require a reserve deposit or x day hold on transactions being deposited into your bank account to lessen the risk to them as well, especially when a business is just starting out or had a sudden spike in chargebacks.

While this list is not an exhaustive, it should account for the majority of the line items you are paying your processor for. As evidenced by this list, fee structures vary by each processor, and also by merchant. Processors are assessing your risk level to their business, as well as your average ticket size, total volume and other factors to determine the rate they will charge you for processing your transactions.

It’s Negotiable (Maybe)

It is important to understand the different types of fees you are being charged and if the rates you are paying are competitive. Aside from interchange, these rates are not standardized or regulated and are open to negotiation with your processing partner. But, it’s important to look at your business holistically. While one charge may seem high, it may make up for a less expensive rate somewhere else. Some experts recommend going through the RFP (Request For Proposal) process every three years or less to determine if your rates are competitive. This process is especially important if there have been significant changes to the transaction volume.

While understanding the terms and where the fees go, it can be difficult for a merchant to know the most competitive rates specific to their business model. Most enterprise level companies employ dedicated resources or teams of experts to continually monitor payments fees and to negotiate better rates. But, for merchants that do not have these dedicated experts, there are companies that advocate and negotiate for them to ensure they receive the fairest pricing from their current or prospective processor. Howard Goldstein, Regional Director at Merchant Advocate, is one such expert.

“The payment processing industry is confusing and the waters are muddy. Merchants needs someone on THEIR side and we’re the ones who work and advocate on their behalf,” explains Goldstein. “We know what the market will bear, what’s reasonable and not reasonable for a merchant to pay in fees, dependent on the business model and other factors in the industry.”

Companies like Merchant Advocate engage with processors to negotiate lower rates for merchants. In the cases where they can’t agree with the current processor, Merchant Advocate works with preferred processing partners to set up a new account. Goldstein sees this as an opportunity to “regulate an unregulated business and to redistribute funds to help businesses be more successful”, and as businesses put money back into their business to grow, this can, in turn increases the processing volume.

When exploring a new processing relationship, it is also important to note that price should not be the only factor when determine the best partner for payment processing. Customer service, technical compatibility and other services provided by a processor, such as alternative payment processing and currency conversion in other countries are just a few of the other factors that should be considered when making the best decision. The old adage of “you get what you pay for” is just as true for credit card processing as it is for other aspects of business.  It is also important to note that processors and issuers should not be seen as “the bad guys.” Most are fair and ethical in their pricing. However, if your volume has increased or if you have a new business model, most also will not contact you when you qualify for a better rate. Merchants must be diligent in revisiting their contracts when needed.

The message? Even a basic understanding of the complexities of processing fees is helpful. It enables you to explain the line item to cross-functional teams and leadership, to facilitate communication with your processer and to know who is charging what, helping formulate an optimization strategy. If you are unsure of what constitutes fair rates in your market, however, contacting an advocate may be very beneficial, ultimately making you a hero in your company.

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