Clearly Payments Dark Logo
Support Get a Quote

Payments Research

●

  • Payment Processing Fees

Why Most Merchants Overpay in Payment Processing

Why Most Merchants Overpay in Payment Processing

Many merchants unknowingly pay more than necessary in payment processing. This overpayment impacts a business’s profitability and growth. 

This article covers the reasons for overpayment, including hidden fees, pricing models, merchant account setup, lack of transparency, and practical steps merchants can take to reduce these costs.

The Complexity of Payment Processing

The payment processing value chain has multiple participants and steps, including the merchant, the customer, the acquiring bank, the issuing bank, and the payment processor. Each entity requires compensation for their role, resulting in a complex fee structure. The primary fees include:

  • Interchange Fees: Interchange fees are paid by the merchant’s bank to the customer’s bank for processing the transaction.
  • Assessment Fees: Charged by card networks (e.g., Visa, MasterCard) for using their network.
  • Processor Fees: Imposed by the payment processor for handling the transaction.

These fees vary based on the type of card used (debit, credit, rewards), the transaction size, and the merchant’s industry.

Hidden Fees and Surcharges

A big reason merchants overpay is due to hidden fees and surcharges that aren’t immediately obvious. Payment processors often advertise low rates, but these rates may only apply to specific types of transactions or under certain conditions. Common hidden fees include:

These hidden fees can quickly accumulate, significantly increasing the overall cost of payment processing for merchants.

Pricing Models and Their Impact

The pricing model chosen by a merchant greatly influences their payment processing costs. The three primary pricing models are:

  1. Flat Rate Pricing: A single rate applied to all transactions. While simple and predictable, it can be more expensive for merchants with low-risk transactions.
  2. Tiered Pricing: Transactions are categorized into qualified, mid-qualified, and non-qualified tiers, each with different rates. The tiered pricing model can be opaque, making it difficult for merchants to understand their true costs.
  3. Interchange Plus Pricing: The interchange fee is passed through to the merchant with an added fixed markup. The interchange plus model is generally more transparent and can be more cost-effective but requires a better understanding of interchange rates.

Merchants often overpay because they are placed on pricing models that are not optimal for their transaction profile. For example, a merchant with primarily low-risk transactions may overpay on a flat-rate model.

Incorrect Setup of the Merchant Account

Setting up a merchant account correctly is important for businesses to avoid unnecessary fees and optimize their payment processing costs. An incorrect setup leads to higher fees, impacting the overall profitability of a business. Here are some common setup mistakes:

  1. Incorrect Merchant Category Code (MCC): Each business type is assigned a Merchant Category Code (MCC) that indicates the nature of the business. An incorrect MCC can lead to higher interchange fees because the risk associated with different business types varies. For example, a business misclassified into a higher-risk category will face higher fees. For example, a low-risk retail business misclassified as a high-risk online gaming site can see interchange fees increase by 0.5% to 1% per transaction.
  2. Improper Transaction Data Entry: Accurate entry of transaction data is essential for minimizing fees. Missing or incorrect information, such as an incorrect cardholder address or expiration date, can result in downgraded transactions, leading to higher fees. For example, transactions without proper address verification (AVS) may be downgraded, incurring additional charges of 0.1% to 0.3% per transaction.
  3. Non-Compliance with PCI Standards: Payment Card Industry Data Security Standards (PCI DSS) compliance is mandatory for businesses handling card transactions. Failure to comply can result in hefty non-compliance fees and increased transaction costs. For example, monthly non-compliance fees can range from $10 to $30, and in the event of a data breach, non-compliant businesses may face fines of up to $500,000.
  4. Inadequate Fraud Prevention Measures: Without adequate fraud prevention measures in place, businesses are at a higher risk of fraudulent transactions, which can lead to increased chargeback fees and higher processing rates due to the perceived higher risk. For example, chargeback fees typically range from $10 to $100 per incident, and a high chargeback ratio can lead to an increase in processing fees by 0.5% or more.
  5. Unoptimized Payment Processing Settings: Settings such as batch processing times, settlement periods, and the use of outdated payment terminals can lead to higher fees. For instance, settling transactions outside of the optimal time frame can incur additional charges. For example, late settlement fees can add up to $0.10 to $0.50 per transaction, and using outdated terminals can lead to higher processing rates and increased risk of fraud.

Lack of Merchant Negotiation Power

Many merchants end up paying higher fees because they do not negotiate effectively with payment processors. This lack of negotiation generally happens because of a lack of knowledge about the industry, an underestimation of their bargaining power, or simply accepting the first offer presented by the processor. Payment processing fees are not set in stone and often have room for negotiation, especially for businesses with high transaction volumes or a strong credit history.

Without proper negotiation, merchants may miss out on lower rates, better terms, or waived fees that could significantly reduce their overall processing costs. For instance, merchants might agree to standard rates without questioning or understanding the potential for lower interchange rates, volume-based discounts, or reduced chargeback fees.

Choosing the Wrong Processor

Selecting the right payment processor has a big difference on minimizing payment processing fees. Merchants who choose a processor that is not well-suited to their business size or transaction volume often incur higher fees.

Smaller Merchants and Aggregators

For smaller merchants, especially those with annual transaction volumes below $200,000, using a payment aggregator like Square, PayPal, or Stripe can be cost-effective. Aggregators offer simplicity and convenience, as they provide an all-in-one solution with straightforward pricing structures and no long-term contracts. They typically charge a flat rate per transaction, which can be beneficial for businesses with low or inconsistent sales volumes.

  • Example: Square charges a flat fee of 2.6% + $0.20 per swipe transaction, which is predictable and easy to manage for smaller businesses.

However, as the business grows, these flat-rate fees can become disproportionately high compared to the more customized pricing models available through dedicated merchant accounts.

Larger Merchants and Merchant Accounts

Larger merchants with annual transaction volumes exceeding $200,000 should consider obtaining a dedicated merchant account, such as those offered by Clearly Payments. Dedicated merchant accounts provide more tailored solutions, including lower interchange rates and the ability to negotiate fees based on transaction volume and risk profile.

  • Example: A business processing $1,00,000 annually might reduce its effective rate to around 2% (in North America) with a dedicated merchant account compared to the flat-rate fees of 2.6% with an aggregator, resulting in substantial savings.

Dedicated merchant accounts often come with additional benefits such as enhanced customer support, more robust fraud prevention tools, and greater flexibility in terms of payment options and integrations.

Lack of Transparency and Education

Another major factor contributing to overpayment is the lack of transparency in the payment processing industry. Many processors do not fully disclose their fee structures, making it challenging for merchants to compare options and understand their costs. 

Additionally, merchants often lack the education needed to navigate the complexities of payment processing. Without a clear understanding of how fees are structured and what options are available, merchants are at a disadvantage when negotiating with processors.

Strategies to Mitigate Overpayment

To avoid overpaying for payment processing, merchants can take several proactive steps:

  1. Conduct a Detailed Fee Analysis: Regularly review processing statements to identify hidden fees and understand the true cost of transactions.
  2. Negotiate with Processors: Use the information from the fee analysis to negotiate better rates and eliminate unnecessary fees.
  3. Choose the Right Pricing Model: Evaluate different pricing models to determine which one aligns best with the business’s transaction profile.
  4. Educate Yourself and Your Staff: Invest time in understanding payment processing and train staff on best practices to manage costs.
  5. Consider Alternative Processors: Don’t be afraid to switch processors if better terms are available elsewhere.
  6. Set up your Merchant Account Properly: Ensure you set up your merchant account properly. 
  7. Work with a Consultant: There are payments consultants that can help with a full payments strategy which will optimize your payments and reduce your fees.
Back to Main Blog Page
Facebook
Twitter
LinkedIn
Email

Latest articles you might like