The Actual Cost of Accepting Credit Cards: Understanding and Managing the Cost Components, Anand Goel, Founder, Optimized Payments Consulting

1. Understanding and Managing Your Payments Effective Cost
Pricing in the credit card processing industry is very complex and most merchant statements do
not make it any easier to understand. There are so many technical and industry laden terms
(Interchange, qualification tiers, downgrades, batch fee, ACH fee, authorization fee, settlement fee,
AVS fee, PCI compliance fee, etc.) that even a sophisticated financial manager can get cross-eyed.
So how do you really understand your true cost of credit/debit card processing, and then use that
knowledge to ensure that your company is getting the best value for merchant services? This
article will help you understand and manage the effective cost of different payment cards.
Let’s begin - obtain paper or electronic copies of your most recent monthly merchant statements
and start with the following calculations. It is helpful to maintain an Excel spreadsheet with all of
this data. This methodology will take a little time to setup but will become easier and routine over
time. One output of this exercise can be a dashboard with the following information – the effective
cost/rate by card type. This analysis can be done on a monthly or quarterly basis to identify trends
and issues with payment processing costs. The chart below shows a hypothetical example of a
retailer with $100 million in card sales and an average ticket of $40.
Effective Cost of Processing by Card Type – February 2010
Calculating Effective Rate for Visa & MasterCard Credit Cards
 Since the cost of accepting and processing Visa and MasterCard (VM) credit transactions is
very similar, they are combined together for easier analysis.
 Add all fees from interchange categories related to credit card transactions (do not include

2. any interchange categories for debit transactions).
 Add fees from assessments and dues. Assessments are not typically broken out separately
for credit and debit transactions but they can be easily calculated since they are uniform for
all Visa transactions at 0.0925% and for all MasterCard transaction at 0.0950%. Dues are
small fees charged per transaction by VM. Some fees from dues include the $0.005 fee per
VM authorization and the upcoming $0.0185 Network Access and Brand Usage (NABU) fee
from MasterCard.
 Add all transaction fees (authorization, settlement, and AVS), batch fees, chargebacks fees,
statement fees, reporting fees, annual fees, monthly fees, and other miscellaneous fees.
Do not add authorization fees relating to American Express and Discover. All fees in this
grouping are levied by the payment processor and a portion of these fees should be
allocated to VM signature debit cards based on weighted average of all VM transactions. For
instance, if VM credit transactions represented 70% of VM total transactions then 70% of all
processor fees should be allocated to VM credit and the other 30% to VM debit.
 For companies who have qualified and non-qualified rates – add all fees from discount
charges, downgrades, and surcharges.
 Divide the sum of all the above fees by net sales (total sales minus refunds/credits). The
result is the effective rate or cost for accepting VM credit cards. In the chart above, the
effective rate for VM is 1.95%.
 Take this rate and multiply it by the average sales ticket for VM transactions. The result is
the average cost to process an individual Visa or MasterCard transaction. In the chart
above, the average cost to process a single transaction is $0.78 (1.95% x $40).
Calculating Effective Rate for Visa & MasterCard Debit Cards
 The process for calculating effective rate for VM debit cards is exactly the same as credit
cards.
 Remember to allocate a portion of all of the processor fees to debit cards based on the
weighted average of all VM transactions.
Calculating Effective Rate for American Express Cards
 Most businesses have a direct merchant relationship with American Express (AmEx). Add
all discount and other fees from the AmEx statement.
 Add the AmEx authorization fees from your payment processor.
 Divide the sum of the above fees by net AmEx sales (total sales minus refunds/credits).
The result is the effective rate for accepting AmEx cards. In the chart above, the effective
rate for AmEx is 3.10% and the average cost to process a transaction is $1.24.

3. Calculating Effective Rate for Discover Cards
 Most large businesses have a direct merchant relationship with Discover. In the last two
years, Discover has partnered with merchant acquirers to allow the acquirer to authorize
and settle Discover transactions. If the processing relationship is directly with Discover then
add all fees from the Discover statement and add the Discover authorization fee from your
payment processor.
 If the processing relationship is through your payment processor, add all Discover
interchange, assessments, and processing fees. For companies who have qualified and non-
qualified rates – add all discount charges, downgrades, and surcharges.
 Divide the sum of the above fees by net Discover sales (total sales minus refunds/credits).
The result is the effective rate for accepting Discover cards. In the chart above, the
effective rate for Discover is 1.93% and the average cost to process a transaction is $0.77.
Calculating Effective Rate for PIN-Debit Cards
 Add all interchange and switch fees from Electronic Funds Transfer (EFT) networks like
Interlink, Star, Pulse, NYCE, etc.
 Add the per transaction processing fees related to PIN transactions
 Divide the sum of the above fees by net PINed sales (total sales minus refunds/credits).
The result is the effective rate for accepting PIN cards. In the chart above, the effective
rate for PINed cards is 1.20% and the average cost to process a transaction is $0.48.
After the individual card effective rates are calculated, the overall effective rate for all cards can be
calculated by taking a weighted average based on sales. Alternatively, you can add ALL the fees
and charges of all card types and divide by their net sales volume. Once completed, a dashboard
not only provides insight into the average cost for each card type, but it can also identify savings
opportunities. For instance, the dashboard above shows that 20% of sales are going through VM
signature route and 12% of sales are going through PIN-debit route. In this example, PINed
transactions cost $0.16 less than signature transactions and since most debit cards can be routed
through either route, a Bank Identification Number (BIN) management strategy can be used to
prompt consumers to enter the PIN. This strategy can drive the signature debit sales to less than
10% and increase PINed sales and thus, reduce overall payment costs.
Next, since AmEx transaction cost significantly more, a merchant may decide to stop accepting
AmEx cards to reduce payment costs. Obviously, this is a complex decision that involves
evaluating payment preferences of your customers, competitive pressures, your company’s profit
margins, etc. A dashboard will simply quantify the savings opportunity but other important factors
need to be considered.
Another observation is that over 60% of all the payment processing costs come from VM credit
sales. Applying a business intelligence (BI) tool or even Excel –based filters, you should be able to
drill down and identify the major cost drivers for VM transactions. Click here to read an article on
how to analyze interchange and processor fees.
A common mistake when calculating Visa/MC credit effective rate is that some financial
professionals underestimate the cost by including AmEx sales but not AmEx fees. AmEx sales are
typically authorized and reported on the same statement as Visa and MC sales but they settled
directly by AmEx. Since the Visa/MC statement does not include AmEx fees, AmEx sales must be
excluded when calculated Visa/MC effective rate.

4. As a general rule of thumb, the following matrix identifies the savings opportunity based on a
company’s overall effective rate if it processes at least $5 million in annual credit/debit card sales.
For instance, if annual card sales for a company are $50 million and the overall effective rate to
process these sales is 2.65% then there is a high probability that savings can be realized if
payment products, pricings, and processes are optimized. Few exceptions to this rule include
grocery stores, utilities, and businesses with average sales ticket of less than $10. Grocery stores
and utilities have effective rates well below 1.80% due to low interchange rates for these
industries. And businesses with small average tickets have their effective rate skewed higher due
to the significant role per transaction fees play in the overall effective rate.
Savings Opportunity Based on Effective Rate
<1.80% 1.81% - 2.50% >2.51%
Low-
Retail High High
Medium
Internet/Not
Low Medium High
Face to Face
In order to manage the overall cost of card payments, it is important to benchmark effective costs
by card type. A dashboard will assist identifying current costs and it will prioritize next steps based
on trends and issues presented. Small reductions in overall effective rates can yield profound
savings when applied to any company with significant card sales. A 10 basis points savings in the
retail example above can yield $100,000 in processing fee savings per year. In the current
economic environment, any and every savings opportunity is significant. Perhaps, it is time to
calculate the effective cost of your card payments.
This resource was contributed by Anand Goel (anand@optimizedpmts.com) who is an expert in the
payments industry and founder of Optimized Payments Consulting.