In payment processing, tiered pricing is one of the most common pricing models used for fees by payment processors. However, it is generally the pricing model where merchants pay the most.
Tiered pricing categorizes transaction fees into different tiers based on different criteria. This makes it important for merchants to understand its structure, implications, and suitability for their operations. In general, we have seen most merchants overpay with tiered pricing so we recommend avoiding it at all costs.
This article provides an overview of tiered pricing in payment processing and goes into how it works, benefits, and drawbacks.
How Tiered Pricing Works in Payments
Tiered pricing, also known as bundled pricing, groups transaction fees into a few broad categories or tiers.
Typically, these tiers are divided into three main categories: qualified, mid-qualified, and non-qualified. Each tier is associated with a different fee level.
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Qualified Rate: This rate applies to transactions considered to have the lowest risk and cost for processing. Typically, these are generally standard, straightforward transactions using debit or non-reward credit cards swiped through a card terminal. The qualified rate offers the lowest fees within the tiered structure.
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Mid-Qualified Rate: This intermediate category generally covers transactions that involve a slightly higher level of risk or processing effort, such as transactions where the card is manually keyed in but address verification is used, or transactions using reward cards. The fees for mid-qualified transactions are higher than those for qualified rates.
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Non-Qualified Rate: The highest rate in the tiered model applies to the most risky or costly transactions. These might include corporate cards, foreign cards, or manually keyed entries without additional verification. Non-qualified transactions incur the highest fees.
Advantages of Tiered Pricing
Tiered pricing can offer several benefits:
- Simplicity: One of the advantages is its simplicity. Merchants can easily understand the types of transactions they have. This, of course, assumes that merchants clearly know how the tiers work. However, this is rarely the case.
- Predictability: For businesses with very consistent transaction types, tiered pricing can provide a predictable cost structure.
- Cost-Effectiveness: For merchants predominantly processing low-risk transactions, tiered pricing can be cost-effective, particularly if the majority of their transactions qualify for the lower rate tiers. For example, if a merchant knows all their transactions are within the “qualified rate”, this could benefit a merchant if they negotiate a very low rate for that tier.
Bad Things About Tiered Pricing in Payments
Despite any advantages, tiered pricing primarily comes with drawbacks.
- Lack of Transparency: One of the big criticisms of tiered pricing is its lack of transparency. Merchants might not always know in advance which tier a particular transaction will qualify for, which can lead to unexpected costs. In addition, these transactions may not be clear in their monthly statements.
- Potential for Higher Fees: Since the criteria for categorizing transactions into tiers are set by the payment processors and can be arbitrary, merchants might find that many transactions fall into higher-cost tiers than anticipated. This is what we see happening all the time. We see some merchants coming to us after years of paying 9.6% payment processing fees.
- Complexity in Comparing Offers: The simplicity of the tiered structure can be deceptive, as it may be challenging for merchants to compare rates between different processors effectively due to differing definitions of what constitutes a qualified or non-qualified transaction.
Considerations for Merchants
Choosing the right pricing model is crucial for merchants to manage their payment processing fees effectively. Here are a few considerations:
- Understand Your Transaction Patterns: Analyze the types of card transactions you process most frequently. Understanding whether your transactions are likely to fall into the qualified or non-qualified categories can help you predict your costs more accurately.
- Compare Pricing Models: Besides tiered pricing, consider other pricing models like interchange-plus pricing, which offers more transparency. Comparing different models based on your business’s specific needs can lead to better financial decisions.
- Negotiate with Processors: Armed with knowledge about your transaction patterns and the different pricing models, you can negotiate more effectively with payment processors to secure terms that best suit your business.
Recommended Pricing Model for Merchants
At Clearly Payments, we always recommend that merchants opt for interchange-plus pricing to ensure clarity and fairness in their payment processing fees. This pricing model is distinguished by its transparency, as it distinctly separates the interchange fees, which are set by the credit card networks, from the markup added by the payment processor.
Benefits of Interchange-Plus Pricing:
Transparency: One of the most significant advantages of interchange-plus pricing is its transparency. Merchants can see exactly what they are being charged for each transaction. This breakdown includes the exact interchange rate charged by the card networks and the specific markup by the processor.
Fair Pricing: Interchange-plus pricing aligns the merchant’s cost directly with the actual cost of processing each transaction. This means that merchants pay a consistent markup regardless of the type of card used by their customers. Whether it’s a standard debit card or a premium credit card, the processor’s fee remains the same, making it a fairer system for the merchant.
Cost-Effectiveness: For many merchants, especially those with a significant volume of transactions, interchange-plus pricing can be more cost-effective. By paying only the actual interchange rate plus a fixed markup, merchants can often save money compared to more opaque pricing models where the markup can vary.
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