Each time Gabe Connell takes a credit card as payment for a pizza, an invisible hand reaches into his pocket.
Connell, the founder and co-owner of Indianapolis-based HotBox Pizza, pays what's known as an interchange fee each time one of his customers uses a credit card. Depending on the type of card the customer uses, those fees can add up to as much as 5 percent of the transaction, although most cards carry a fee of around 2 percent of the transaction total.
He's not alone, either. Everyone who accepts credit cards in the course of doing business pays those fees.
Despite the hit, Connell says credit cards are a necessary part of his business.
Along with the convenience factor for the customer, Connell said credit card customers tend to spend more than cash customers, which makes paying the fees more palatable. When a customer places a large catering order, it's always paid for with a credit card.
"About 55 percent of our business is in the form of credit cards," he said. "Could we operate on a cash-only basis? Absolutely not."
What it all means
Interchange fees are those fees that a merchant's bank pays a customer's bank when the merchant accepts credit cards such as Visa and MasterCard for purchases. When a customer uses a credit card to, say, buy a large pepperoni pizza, the bank that issued that customer's card deducts the interchange fee from the amount it pays the bank that handled the transaction for the pizzeria.
That bank then pays the pizzeria operator the transaction amount after subtracting the interchange fee and an additional, smaller fee for itself. The fees go to paying the expenses related to issuing credit cards and operating the credit card networks.
"The interchange system is quite complex," said Henry Helgeson, president and co-CEO of Merchant Warehouse, a provider of credit card processing services. "There are over 200 different interchange categories."
In Connell's case, when a customer phones in an order and pays with his or her credit card, he pays a higher fee than he would if the customer had the card swiped in the store.
"The actual interchange rate charged may vary based on the way the card information is provided, the type of card used and the kind of transaction," said P. Gayle Hoskinson, interchange and compliance manager with Heartland Payment Systems, a provider of credit card processing services. "For example, rewards cards have higher rates than basic cards, and mail order or phone transactions have higher rates than transactions where the card is physically presented at the time of purchase."
What you can do
Operators can't avoid paying interchange fees, Hoskinson said. It's part of the cost of accepting credit, debit and prepaid cards.
However, there are steps operators can take to make sure they are getting the best interchange rates possible on their transactions:
- Swipe cards whenever possible. The lowest interchange rate for a transaction occurs when a card is swiped through the terminal.
- If operators must key in credit card information by hand, they can lower the increased interchange rate by using Address Verification Service, a fraud prevention tool. AVS automatically compares components of the cardholder's address, such as the zip code, to the billing address of the card.
- Settle - or "batch" - terminal and transactions at the end of each day. Payments processors only have two days to process transactions and forward them to Visa and MasterCard, which in turn forward them to the issuing bank. If an operator settles their accounts only weekly or monthly, the transactions miss the two-day time frame, resulting in higher interchange fees.
And under most circumstances, fees for debit card transactions can be significantly lower than credit card transactions.
"The biggest way you can save is by asking credit or debit," Helgeson said. "We've found typically that only 30 to 40 percent of consumers will actually go for the PIN debit when it is a debit card, and the other 60-70 percent will still run it as credit. It's not the best system in the world, but certainly it does help."
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Helgeson's company, Merchant Warehouse, offers a cost reduction product called BinSmart, which identifies the card type used at the point of purchase, analyzes transactions to determine the most cost-effective processing method and automatically prompts for PIN or signature, depending on which payment method delivers the lower cost.
And different processors can charge different fee structures. Connell's processing provider, Advanced Bank Card Systems, offered HotBox a processing program that doesn't charge per-transaction fees.
"A lot of companies seemed to have pretty low interchange rates, but they got us on the per transaction fee," he said. "When we are talking about an average transaction of $20 or less, 10 cents or 15 cents per transaction can be a killer."