Credit Card Processing
In 1946, a bank in Brooklyn, NY created a new service for depositors called "Charg-It". Charg-It was a bank-issued card that let cardholders charge purchases at local merchants to the bank. The Charg-It card only worked within a two square block radius of the bank because merchants had to bring the sales slips to the bank in order to get paid.
In 1950, Diner's Club proved that charge cards could be used anywhere in the country by sending sales slips and payments back-and-forth in the mail. Starting with 200 cardholders and 14 restaurants in New York City, Diner's Club, in five years grew to 300,000 cardholders and thousands of restaurants. Just like credit cards today, restaurants signed merchant agreements to honor the card and pay the associated interchange fee: about 7%.
Then came the card brands. The card brands created a standardized network for different banks to interchange sales slips and payments and issued plastic cards that could be imprinted, rather than hand-written. These cards worked at stores all over the country, not just restaurants, and unlike Diner's Club, did not need to be paid off every month. The credit card was born.
The banks agreed to follow the network rules and to pay fees to the card brands, in order to keep improving the card network, and expand it to more and more banks, and more and more cardholders. It became easier to conduct business with strangers and over longer distances. Processing has begun, but is still largely paper-based.
Enter the credit card processors. The processors created credit card terminals that could swipe cards and connect to the card networks over a telephone line, much faster than imprinting drafts and mailing them. Now the credit card processing infrastructure we know today begins to take shape.
Card brands, banks, and processors worked together to create a system where processors connect merchants and cardholders to the card networks and the banks with ever improving speed, efficiency, and security. Card brands and banks empowered credit card processors to not only process credit cards, but to also sell processing services along with their terminals, in order to expand credit card acceptance to more and more merchants. Processors paid a fee to the network each time they processed a card, and were in turn allowed to charge fees directly to the merchant in order to cover their costs and make a profit.
Card brands and processors have spent decades developing their networks. Trillions of transactions are transmitted back and forth seamlessly every second. Terminals and phone lines have given way to payment apps and 5G.
The credit card networks charge the credit card processor an Interchange Fee each time they process a credit card for the merchant. Why is it called an “Interchange” fee?
Consider what happens when a credit card is processed. Even though it takes fractions of a second, processing a credit card transaction is a complex procedure involving multiple players and various steps.
First, the cardholder presents their card for payment. The merchant transmits the transaction to their processor. The processor sends the transaction on to the cardholder's bank via the card networks. The cardholder's bank approves the transaction and transmits all the way back in reverse to the merchant. Then the cardholder's bank transmits the funds to the processor, who deposits them into the merchant's bank account completing the transaction. That’s a lot of people (cardholders, merchants, card brands, banks, and processors) interchanging a lot of things (card numbers, dollar amounts, approval codes, and ultimately, money).
There are hundreds of different Interchange fees covering all the different types of cards. Interchange fees are published in publicly available rate schedules and all processors pay the same Interchange fees when they process a card.
The processor charges the merchant a processing fee over the cost of the Interchange fee they must pay to the card networks. Although they all "buy" credit card processing at the same cost (Interchange), processors are free to charge the merchant for card processing any way they see fit: in tiers, a flat rate, interchange plus, or a combination of these.
In tiered and flat rate pricing the processor acts as a middleman, buying from the card brands and selling to the merchant.
In interchange plus pricing, the merchant pays the exact Interchange fee, Plus a fixed mark up for processing services. Rather than being in the middle, "buying" interchange and "selling" processing rates, the processor passes through the interchange fee to the merchant at cost, and charges a fixed processing fee on top of each transaction.
For most merchants, most of the time, interchange plus pricing delivers the lowest credit card processing fees.
Why is Interchange Plus Pricing Better?
Lower Fees. Paying the exact interchange instead eliminates inflated margins and lowers credit card processing fees.
Transparent Pricing. Interchange plus pricing shows the exact cost of every card, so you know what you are paying for, and it is easy to make apples-to-apples comparisons. Interchange fees can be optimized to lower processing costs further. All fee components are broken out clearly and transparently and can be matched against the published interchange rates.
Eliminates the Middleman. Since Interchange Plus passes card fees directly to you at cost, when Interchange fees go up or down, you automatically pay more or less. When the processor is in the middle setting the rate, they get to decide whether you pay more or less, and when interchange fees are lowered via optimization, the processor decides whether to pass on the savings to the merchant.
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