Why Tiered Pricing for Credit Card Processing Is The Most Expensive Option (And How To Avoid Overpaying)
There are few things about running a business that will get your head spinning faster than looking through your monthly merchant account statement and trying to figure out why your processing charges are so much higher than what you expected them to be. After all, your sales agent promised you that his or her company had the lowest rates in the industry. What happened?
You probably already understand that not all of the fees your provider charges you for processing credit and debit card transactions go directly into their coffers. Your provider has to pay interchange fees (sometimes also called interchange reimbursement fees) to the credit card associations and issuing banks before they can see any profit for themselves. In fact, the bulk of the fees collected for a given transaction go to paying these interchange fees – very little of the fees that you pay actually go to your provider.
If you want to know whether you’re getting a good deal or not, you need to be able to separate out the interchange fees and your provider’s profit (also called the markup) for any transaction. It should come as no surprise that providers don’t always make this easy for you to do. Regardless of who you sign up with, your account will be governed by a processing rate plan that specifies how much you’ll pay to your provider for each transaction. This rate plan will be specified in your contract (sometimes called the “fee schedule”), although the rate information provided may or may not be sufficient to make these calculations without additional information.
In the processing industry, providers have settled on four different types of processing rate plans, each of which uses a different method to determine how much you’ll pay to process a transaction. These four types of rate plans include (1) interchange-plus, (2) membership (or subscription-based), (3) flat-rate, and (4) tiered pricing. In our experience, interchange-plus and membership pricing plans work best for medium-sized and larger businesses, while flat-rate pricing is often the most affordable choice for small businesses. So, what about tiered pricing? Unfortunately, the only businesses that benefit from this type of pricing are the merchant account providers that offer it. As a merchant, tiered pricing offers no financial benefit to you whatsoever. The only purported benefit of using a tiered pricing plan is that your processing rates will be simpler and easier to understand. Needless to say, this doesn’t help you at all if those rates are too high.
In this article, we’ll discuss how tiered pricing works, and how to tell if your merchant account uses it. We’ll also explain how providers use deceptive marketing practices to fool you into thinking that tiered pricing is a better deal than it actually is, and why this type of pricing plan will usually cost you much more money than the other types of plans. Finally, we’ll give you some recommendations for alternative pricing plans that will save you money. In most cases, this will usually involve switching to a different provider.
What Is Tiered Pricing?
The tiered pricing plan for determining processing charges originally grew out of merchants’ frustration and confusion in trying to decipher the interchange fees assessed by the major credit card associations. Over the years, these fees have gradually been broken down further and further to make finer distinctions between transactions based on factors such as card-present vs. card-not-present, transaction size, type of card being used, nature of the goods or services being sold, and more. On top of that, each major credit card brand (i.e., Visa, Mastercard, Discover, American Express, etc.) publishes its own interchange fee schedule. As a result, there are literally hundreds of rates – only one of which will apply to a given transaction.
Tiered pricing was created in an attempt to simplify this situation by condensing your actual processing rates down to a more manageable number by combining similar transactions into tiers. Instead of having to deal with hundreds of possible interchange rates, you would only have a small number of general rate categories that your transactions could fall into, making the entire rate structure easier for merchants to understand (and for sales agents to explain).
There’s only one little problem with this approach. Your merchant account provider has to ensure that they don’t lose money when processing any of your transactions. Thus, if they combine several dozen interchange rates into a single processing rate, they’ll have to base the rate for that tier on the highest of those interchange rates. The end result of this policy is that, while you’ll pay a fair rate for some of your transactions, you’ll be overpaying – sometimes by quite a lot – for almost all of the other ones.
Similarly to flat-rate pricing, tiered pricing aims to reduce the number of rates you could pay down to the lowest number possible. (Note that, despite the name, even flat-rate pricing plans always include multiple rates to account for the inherent differences between card-present and card-not-present transactions.) The number of rates in a tiered plan can range from as few as two to as many as about twelve, depending on how your provider arranges their tiers.
Tiered pricing rates are usually categorized as either qualified or non-qualified, although many providers also include a mid-qualified rate as well. In addition to setting their own rate schedules, each provider is free to set their own rules regarding whether a transaction will fall under the qualified, mid-qualified, or non-qualified category. As you might expect, qualified transactions have the lowest processing rates, while non-qualified transactions have the highest. What you might not expect is how much of a difference this determination makes in your actual cost. In general, non-qualified rates can be as much as two to three times higher than qualified rates from the same provider.
To make matters worse, it’s increasingly likely that the majority of your transactions will be non-qualified. Why? Because most providers lump rewards cards that give out frequent flyer miles or cash back rewards for their use into the non-qualified category. These types of rewards cards have become increasingly popular with the general public in recent years, resulting in a tremendous increase in non-qualified transactions.
To be fair, however, rewards cards have significantly higher interchange fees, so even if you’re on an interchange-plus pricing plan, you’ll still be paying for your customers’ credit card perks.
Because merchant account providers are free to set their own tiers and establish their own criteria for qualified and non-qualified transactions, it can be very difficult to compare rate plans between providers. For example, a mid-qualified transaction with one provider might be non-qualified with another competitor. Adding to the confusion and lack of transparency, providers don’t always disclose their criteria for differentiating between these transaction categories.
Tiered pricing also makes it nearly impossible to determine how much of a markup your provider is charging you for any given transaction. Unless you’re willing to track down the underlying interchange fee that was charged for a transaction, you won’t know whether your provider is taking a fair and reasonable markup, or ripping you off. This situation is in stark contrast to interchange-plus pricing, where your provider’s markup is a distinct part of the rate itself and doesn’t vary from one transaction to the next.
With so many obvious drawbacks, you would expect that tiered pricing plans would be very unpopular with merchants, and that they’d see little use in the business community. Unfortunately, that’s not the case. Tiered pricing is the most commonly used pricing plan today among merchants, with over half of all merchants in the United States currently being on a tiered plan. How can this be? There are two main reasons.
For one thing, tiered pricing is very lucrative for merchant account providers, who aggressively push these types of plans when setting up new accounts. Most providers offer a combination of both tiered and interchange-plus plans, but don’t always disclose that you might have a choice between the two. Instead, your sales agent will offer you a tiered plan, but make no mention of interchange-plus pricing unless you specifically ask for it. The other main reason for this situation is that the majority of merchants aren’t aware of the differences in pricing models. With the expectation that credit card processing is going to be an expensive, but necessary, part of running their business, they’ll simply accept what they’re offered and sign up without giving the matter a second thought. Hopefully, you won’t fall into this trap after reading this article.
Why Your Quoted Rate For Tiered Pricing Probably Isn’t Accurate
Perhaps one of the worst aspects of tiered pricing is the deceptive way in which it is frequently marketed to unsuspecting merchants. If you check out a prospective merchant account provider’s website, you’ll often see a “Rates As Low As…” claim, followed by a number that seems (and is) too good to be true. Is it false advertising? Well, not quite – but it is very deceptive. In all likelihood, the company really does offer that rate. However, it will only apply to certain types of transactions, and, in most cases, it will only be offered to businesses with very high monthly processing volumes. These limitations aren’t mentioned, of course, because the provider wants to lure you in with the promise of an extremely low rate that you don’t think their competitors can match. What they aren’t telling you is that (1) that rate will only apply to a very small number of your transactions, and (2) it might not be available to you at all because your monthly processing volume isn’t high enough.
If you see a “Rates As Low As…” quote that seems to be even lower than the average interchange rate, the provider is probably quoting a PIN debit rate that won’t apply to your credit card transactions. In fact, it won’t apply to your debit card transactions, either, if you’re having customers verify their identity with a signature rather than entering their PIN.
Even customized quotes obtained directly from a sales representative should be looked at with caution. When a merchant requests a rate quote for their business, the provider often quotes a single rate – the qualified rate. As we’ve mentioned above, a transaction has to meet a strict set of criteria to be considered qualified, and process at the lowest rate. If the transaction doesn’t meet the provider’s criteria for qualified transactions, it’s downgraded to either the mid-qualified or non-qualified tier and will cost much more to process.
While there are some honest and ethical sales representatives working in the industry who will explain all this to you and divulge the mid-qualified and non-qualified rates, the majority of them will not disclose this information unless you specifically ask about it. After all, those additional rates are usually spelled out somewhere in the fine print of your contract. (You did read your contract before you signed up, didn’t you?)
As we’ve discussed above, knowing your rate for qualified transactions is not very helpful for estimating your overall monthly costs for credit card processing. In most cases, very few of your transactions will be qualified today due to the increasing use of rewards cards. eCommerce-only merchants should be particularly wary, as card-not-present transactions are usually downgraded to the nonqualified tier. In this case, knowing your qualified rate is useless, as none of your transactions will ever be qualified.
The Best Alternative To Tiered Pricing Structures: Interchange-Plus Pricing
So, how do you avoid the many pitfalls of tiered pricing? The best solution for many businesses is to find a merchant account provider that uses interchange-plus pricing. With this type of pricing, interchange fees are passed on to you at cost, and your provider takes a fixed markup that’s included as part of your rate quote. Thus, an interchange-plus rate quote looks something like this: Interchange + 0.30% + $0.15 per transaction. In this case, your provider’s markup will always be 0.30% + $0.15 for every transaction. You don’t have to worry about whether or not your transaction is downgraded. The tradeoff is that interchange fees vary widely from one transaction to the next, so you won’t know in advance how much it will cost you to process a transaction – unless you’re willing to dig into the various interchange fee tables published by the credit card associations. Nonetheless, almost all medium-sized and larger businesses will save a significant amount of money on their processing costs under an interchange-plus plan, mainly because your provider can’t obscure the amount of their markup. If they want to be competitive, they have to offer you a lower markup than the other providers on the market.
The truth is that most providers offer a combination of tiered and interchange-plus pricing plans to their merchants. However, they’ll almost always try to set you up on a more expensive tiered plan, unless you specifically ask for interchange-plus. It also pays to shop around when looking for a provider offering interchange-plus pricing. Unlike tiered pricing, it’s easy to make valid comparisons of competing rate quotes because the interchange fees aren’t set by the providers. You’ll pay the same interchange fees for a given transaction regardless of which provider you’re using.
The good news is that there now are a number of excellent merchant account providers that offer interchange-plus pricing exclusively. You won’t have to worry about being set up with a tiered pricing plan, and most of these providers advertise their interchange-plus rates right on their website, eliminating the need to negotiate this aspect of your service.
We’d be remiss if we didn’t mention that interchange-plus pricing isn’t the best option for all merchants. Small businesses (i.e., typically those processing less than $5,000 per month) will usually save money overall with a flat-rate pricing plan, such as that offered by Square (see our review) or PayPal. If, on the other hand, your business has a very high monthly processing volume, you can often save a significant amount of money over a traditional interchange-plus plan by utilizing a membership (or subscription-based) pricing plan. This type of pricing eliminates the percentage-based markup on your transactions, substituting a single monthly subscription fee that also covers the cost of all your account maintenance fees. Membership pricing is available from providers like Fattmerchant (see our review) and Payment Depot (see our review).
The Key Takeaway: When It Comes To Payments, Transparency And Predictability Beat “Simplicity”
Tiered pricing may have begun as a good-faith effort to simplify processing rates so merchants could understand them better. Ironically, it’s now the most confusing rate plan you could end up with, mainly because of the way it’s advertised. Opposition to tiered pricing has been growing for years, and today it’s gradually fading as interchange-plus pricing becomes more dominant. Nonetheless, as we’ve mentioned above, the majority of merchants in the US are still on a tiered plan – either due to lack of an alternative or through indifference to paying higher costs than necessary. Don’t be one of them! If you find that you’re still on a tiered plan, either call up your provider and ask about switching to an interchange-plus plan (you might need to negotiate a bit), or find a new provider.
As we’ve seen, there are several types of processing rate plans available to merchants today. Of the four major plans, three of them offer some kind of advantage to merchants who fit a particular business profile. Tiered pricing is the lone holdout. Put simply, tiered pricing offers no benefit to you as a merchant under any circumstances. All it does is make more money for your provider.
Understanding credit card processing rate plans is a complex subject, and this article only covers one of the ways in which your processing charges can be calculated. For a more in-depth look at other processing rate plans, please see our article, The Complete Guide To Credit Card Processing Rates & Fees.
If you’re in the market for a new merchant account provider and don’t know where to start, take a look at our Merchant Account Comparison Chart. Here, you’ll find side-by-side comparisons of our highest rated providers. All of them offer low rates, reasonable fees, month-to-month billing, and excellent customer service – and none of them use tiered pricing. Good luck!