How Does Merchant Pricing Work? The Components of Card Processing Fees Explained

Go to the website of any well-known payment provider like Square or Stripe, and you’ll find pricing clearly outlined.

Merchants can easily find the information they need so they can get a good idea how much they’ll pay for payment processing. These days, payment pricing is pretty transparent.

If you’re a merchant, that is.

Behind the scenes, things appear much more complicated. The published rates are made up of other fees, like interchange and network fees. They’re split among different parties. Those parties’ own rates might change, depending on the type of transaction or the card that is used.

In this post, we’ll break down the components of transaction fees to demystify who gets paid what for every payment transaction—and how that’s determined.

Related Content: Webinar—Unlocking Merchant Pricing

Who gets payment processing fees?

Every card payment transaction involves five types of companies between the merchant and the consumer.

Those types are:

• Card networks. The card brands—Visa, Mastercard, American Express and Discover—are essentially the rails over which transactions are routed from the merchant to the consumer’s bank and back again.
• Issuing banks. These banks are on the consumer end of the transaction. They issue credit and debit cards to consumers.
• Payment processors. These are companies that provide the technical infrastructure to manage the movement of transaction and settlement data between the card networks and issuing and acquiring banks.
• Acquiring banks. These banks sit on the merchant end of the transaction. They are responsible for funding the merchant or the payments company.
• Payment providers. These companies package payment services and sell them directly to merchants.

Example: J.P. Morgan Chase—acquiring bank, processor & payments provider in one

In some cases, the same entity will play more than one role. Many acquiring banks operate payment processing services, and they also sometimes sell payment services directly to merchants rather than going through a third party.

Let’s look at J.P. Morgan Chase as an example. Chase is an acquiring bank, it operates as a payment processor, and it sells its payment services to merchants. Its payments customers tend to be large merchants with high transaction volume.

In this case, Chase is the merchant customer-facing payment provider, the processor and the acquiring bank rolled into one.

Example: Drake Software—embedded payment provider

At times, though, each role is filled by a different entity. Merchants—especially small ones—might get their payment services directly from companies that are neither acquiring banks or processors. These include independent sales organizations (ISOs), marketplaces, or embedded payment providers such as payment facilitators and software companies.

These are all payment providers that work directly with merchant customers and rely on partnerships with other companies for the processing and acquiring bank roles.

Drake Software, for example, provides tax preparation software and other services to tax preparers. They also enable their customers to accept payments through a product they call DrakePay.

Because they’re marketing payment services to their customers, they’re serving as the payment provider. Drake partners with SVB/First Citizens Bank to fulfill the acquiring bank and processor roles.

How are payment processing fees divided?

The company operating as the payment provider—the one selling the payment services directly to the merchant—sets the pricing for those services. Rates typically run about 2 to 5% of each transaction.

The provider collects this fee from their customers for each transaction. Those fees are then split among the other parties involved.

The fees that merchants pay for processing card transactions can be divided into four components:

Example fees based on a $100 Transaction at a rate of 3.5%+$.30”

1. Interchange is paid to the issuing bank. The card networks control interchange rates, which are highly variable. These determinations are based on a number of factors, which include:
   1. The network used. Each card network, such as Mastercard or Visa, sets its own rates.
   2. The type of merchant where the payment was initiated. Merchant types that carry a higher risk of fraud, for example, often incur a higher interchange rate.
   3. The type of card the consumer used. Debit, credit and rewards cards can have different interchange rates. The rates also vary between what are considered higher-value cards vs. regular consumer cards.
   4. How the transaction is processed. Interchange rates are different for transactions whether they are card present, card not present, tapped, dipped or keyed in.
2. Processing fees. Processing fees are paid to the processor and the acquiring bank to cover their cost for processing the transaction.
3. Network fees. These fees are paid to the card network associated with that particular transaction.

The first three categories are fixed and, except for interchange, are set by the companies that receive them. This brings us to the fourth category:

4. The payments provider receives the margin—what is left of the payment fee after the other parties take their portions.

Recall that the payment provider sets the overall payment fee that the merchant pays. That means that they have some control over how much margin they receive. This is where comes from for providers like software companies that offer payments to their customers.

The fees are typically set based on one of three models: flat rate, tiered, and interchange plus. We’ll cover those models and how they affect payment provider revenue in a future blog post.

To talk to an expert about how to get more from offering payments on your software platform, contact Infinicept.