Most merchants gave up trying to read their monthly credit card processing statements a long time ago because of how unbelievable complex most providers choose to make them.

For those merchants that occasionally look at them, they may be surprised to see a new ‘PCI DSS Compliance’ fee in the amount of $4 to $20 per month. This fee is a bit perplexing to me because the merchant account provider, in all the cases I’m familiar with, is not actually providing any product or service to the merchant related to PCI DSS Compliance.

If a merchant get’s breached, the Card Associations fine the acquirer and then the acquirer passes the fine down to the merchant. So while the Card Associations have put the responsibility on the processors to make sure that their merchants are compliant, the merchant is ultimately responsible for becoming compliant and paying the fines if breached.

So why again are merchant account providers charging businesses this fee?

Most merchants mistakenly believe that processing a cardholder’s three or four digit CVV2 value for a ‘card not present’ transaction (e.g. ecommerce) will help qualify for lower credit card rates. The CVV2 value is only valuable to protect against credit card fraud and has nothing to do with rate qualification. CVV2 is most often confused with Address Verification Service (AVS) which can be used to qualify for lower credit card rates.

CVV2 stands for Card Verification Value and was introduced by MasterCard in 1997 and Visa in 2001. For ‘swiped’ transactions, the value is referred to as CVV1. Each of the card brands has its own acronym:

Visa: CVV2 - Card Verification Value
MasterCard: CVC2 - Card Validation Code
American Express: CID – Unique Card Code (and 4 digits)
Discover: CID – Card Identification Number

Merchants are able to configure payment processing systems to accept or decline transaction requests based upon the match or mismatch of CVV2 information. So for example, if a merchant creates a rule to decline all transactions where the CVV2 value does not match, the authorization request could be successful with the issuing bank, but the transaction will be denied by the merchant. Even though the transaction was denied by the merchant, the consumer’s card will still be authorized.

PCI DSS Compliance prohibits merchants from storing the CVV2 code. For recurring billing, merchants can accept and validate the CVV2 value during the initial authorization but cannot store it for additional transactions. After the initial validation, there really is no value in storing it.

Other Related Blog Posts
PCI Prohibits the Storage of CVV2 Data
PCI DSS Compliance Basics
Where do Credit Card Fees Come From?

Interchange is the wholesale pricing of Visa, MasterCard and their co-issuing financial institutions in the credit card processing industry. Visa and MasterCard branded cards account for roughly 70% of all transactions.

When financial institutions issue credit or debit cards to a consumer or business, they make the Interchange fee every time that card is used to purchase something. Visa and MasterCard, the co-issuers, make a very small margin on top of the financial institutions set fee. The financial institutions make roughly 80% of all credit card fees charged. Businesses of course that accept credit cards as a form of payment pay these fees.

Discover and American Express are non-bank cards meaning that they don’t use the thousands of banks nationwide to issue their cards to consumers and businesses. Discover and American Express determine their fixed, almost non negotiate rate structures.

Discover recently announced that they will be changing their business model to be more like Visa and MasterCard and have a set Interchange structure that merchant service providers can mark up and then bundle with Visa and MasterCard credit card processing. The move is to try and broaden acceptance and simplify processing for merchants who will now only receive consolidated pricing and one monthly statement for Visa, MasterCard and Discover. American Express will still be separate.

The exact Interchange rate that is charged on a particular transaction depends on a number of variables. In fact, there are over 170 different interchange rates that are determined based upon the card type (e.g. debit, credit, rewards, corporate), business type (restaurant, retail, ecommerce, gas station, etc. ), acceptance method (swiped, internet, phone), settlement or batch time frame and what information is submitted with the transaction (e.g. Address Verification Service (AVS)). There are a few other more advanced variables that influence the Interchange rate.

Merchant account providers mark up the wholesale Interchange rates and offer merchants credit card processing services. To simplify the complexity of the Interchange structure, most merchant service providers will offer a 3-Tier pricing program. This means that a merchant will have one rate for swiped transaction, another for non-swiped cards and another for corporate cards. Sometimes a 4-Tier pricing structure is issued with the addition of a swiped debit card rate.

The interesting thing about these pricing structures is that a there may actually be 40 different interchange rates that are charged to the merchant but the merchant account provider just buckets all of these rates into the three different categories. Some merchant account providers may bucket Reward cards in the the second most expensive tier and another company may bucket them into the third and most expensive tier. That’s why it’s very challenging to compare rates from one provider to another.

Other related posts:
Where do credit card fees come from?

Effective January 15th, 2008, MasterCard will raise three categories of it’s international interchange.

• International Consumer: Interchange rates will increase between .24% and .05% basis points on transactions where a non U.S. consumer credit card is used at a U.S. based merchant.
• International Commercial: Interchange rates will increase .15% basis points on transactions where a non U.S. commercial credit card is used at a U.S. based merchant.
• Cross-Border Assessment: Rates will increase by .20% whenever the cardholder’s country code is not the same as the merchant country code.

The European Union wasn’t too pleased with the increase they announced for European merchants and have given MasterCard six months to drop the increase or else face a daily fine of 3.5% of daily global revenues? (Can they really do that?)

In years past Visa and MasterCard would announce interchange changes on an orderly schedule, usually in the spring. When announced, most credit card processing providers in the industry would attempt to capitalize on these increases and raise the margins they were getting from their customers. So for example if rates went up .20% basis points they would increase their rates .40% basis points, which in my opinion is not a fair practice. It’s understood that rate increases will be passed on but not added to.

At the same time, this topic is very complicated so I don’t want to oversimplify it. At the heart of the problem is the highly complicated interchange structure which consists of roughly 170 different rate categories. Read here for more detailed explanation of where credit card fees come from and how they are determined.

For large providers, because pricing changes must be made to the entire portfolio, averages are passed on to all the merchants. These international increases are a good example. Most merchants don’t process a lot of international cards regularly so the interchange increases would have minimal impact on the credit card provider. But because it’s logistically very challenging for the larger providers to drill down and evaluate each merchant’s processing, averages are used to determine increases.

So when you receive your new few monthly credit card processing statements that you never read, look for the message at the top where a rate increase will probably be announced.

Discover has started the process of bundling their credit card processing with Visa and MasterCard. This means that merchant account providers will soon be offering merchants a single daily deposit for Visa, MasterCard, and Discover, a consolidated monthly statement and one phone number for customer service. If merchants accept American Express they will still receive a separate deposit and monthly statement for related sales.

This change should help simplify things for both providers and merchants. Discover has been around for 22 years and currently has roughly 4 million merchants in the U.S. Visa and MasterCard have about 35% more merchants. This move is to try and close that gap. in the near future, merchants will be automatically signed up to accept Discover.

Discover Card is also beefing up efforts with it’s offerings to consumers to try and increase the number of cardholders. After all, if they lock up the supply side but can’t improve the demand side, nothing has been gained.

The FTC is suing MPI, a provider of credit card processing services to businesses, for engaging in deceptive sales and marketing practices. In other words, they getting nailed for misrepresenting to business owners the true costs of using them for credit card processing.

The FTC made the following allegations:

• Count One: Deception. MPI misrepresented fees to merchants and overstatement of expected savings.
• Count Two: Deception. MPI failed to disclose additional credit card fees such as surcharges for certain types of transactions.
• Count Three: Deception. MPI misrepresented lease buy-outs. Stated that they would pay off balances on merchant existing leases but did not do so.
• Count Four: Unfairness. MPI made unilateral modifications of contracts after merchants signed the agreements and without their knowledge requiring merchants to pay substantial fees and surcharges.

This is how they did it.
MPI would approach merchants and tell them that if they leased a certain credit card machine for $39.99 per month for 48 months, they would get very low credit card processing rates. MPI sales people would perform a cost savings analysis and show merchants that even with the increased cost of the machine they would be lowering their overall processing costs.

In the process however, MPI failed to disclose all of the other fees such as surcharges on certain types of credit cards. With the additional fees included, merchants would usually end up paying more for credit card processing.

The practice by merchant service providers of offering an enticing low rate and not disclosing other fees is not unique to MPI. They were just more egregious and aggressive with their practices and ended up on the FTC radar screen.

Here is the FTC’s formal complaint:

There are quite a few ways that merchant service providers can structure the pricing of credit card fees. Some companies will offer a ‘Qualified’ rate of something like 2.69% and $.30 and then a ‘Non Qualified Rate’ of 3.47% and $.30. There are similar variations with three and four different categories instead of two. Sometimes companies will offer a category only for ‘Debit’ cards and other times they will bundle the credit and debit card rate into one. Neither one is necessarily better than the other. It just depends on what the other categories are and the price of each.

Merchant service providers can typically choose any of five or six different pricing structures when offering credit card processing services. Regardless if you have two, three, or four different rate categories, there are reasons why certain cards will be charged the respective rates.

Most of the time, if you process a consumer credit or debit card and you successfully capture their correct billing address (known as Address Verification Service, or AVS) the transaction will fall into the ‘Qualified’ bucket and get charged the Qualified rate. If you don’t correctly capture the billing address, then the transaction will be ‘downgraded’ and will fall into a category with a higher rate.

Corporate, business and international cards typically fall into the higher rate categories regardless of whether AVS is captured. Some rewards cards also fall into these higher categories.

Other reasons why transactions may be assessed a higher rate include not settling transactions within 24 to 48 hours, authorizing credit cards and then capturing them after a predetermined amount of time, and authorizing a credit card and then capturing it for a different amount.

While there are some standard guidelines in the industry, processing companies have discretion about what types of cards fall into what categories and for what reasons. So in this regards, it’s always difficult to do a direct comparison from one provider to the next.

It’s helpful to always understand all of the different categories that your provider will be charging and the general guidelines they’ve assigned to each.

Most everyone who has a merchant account understands that a chargeback results when a customer successfully disputes a sale that has been paid by credit card. A customer can initiate a chargeback with their issuing bank based upon a wide variety of things. There are about 35 reasons why a chargeback can be initiated by a consumer. Examples include improper or broken goods, product not received, and services not as described, cardholder did not authorize transaction, error in amount, and incorrect transaction date.

What most merchants don’t understand is how exactly the chargeback process works. In a three part post, I’ll include the details of how a chargeback is handled by the issuing bank, Acquirer, and Association (Visa & MasterCard) from start to finish.

I. First Chargeback Phase:

A Cardholder writes a letter or fills out a “Dispute Resolution Form” and submits it to their Credit Card Issuing Bank. The Issuing Bank then processes a chargeback along with the “Chargeback Documentation” (i.e. Cardholder letter) through the corresponding Association (Visa or MasterCard) and is then credited the disputed transaction amount. The Acquirer or “Merchant Bank” then receives notification of the Chargeback upon receipt of the “Chargeback Documentation” and is subsequently debited for the disputed transaction amount. At this point the Acquirer’s internal database assesses the Merchant a “Chargeback fee”. Acquirer’s systems then run the Chargeback through a series of simple filters to check to see if the Merchant issued credit and for certain technical errors. At this point one of two scenarios occurs: (more…)

I have been outspoken about unscrupulous sales practices in the credit card processing industry. A comparable environment exists in the mortgage industry and the similarities between the two are many. Both industries have very complicated products and services (credit card processing is more complex). Sellers of both these services have a disproportionate knowledge advantage over buyers and often take advantage by extracting higher fees in sneaky ways. Both industries are very fragmented. And both have low barriers to entry allowing admittance to just about anyone in who wants to be in the business.

So the question is: what is the best way to discourage such practices and protect consumers from falling prey? It’s an issue that the credit card processing industry has just started talking about. Some within the industry have begun speaking out advocating that the industry better clean itself up before regulators have to engage. My take on that approach - good luck. With a sales environment so loosely controlled and transient, you’ll never be able to play ‘on your honor’.

There is an article on the front page of the Wall Street Journal today Illinois Tries New Tack Against Predatory is Loans. In it, Amy Merrick rehashes the current turmoil in the credit markets that is stemming from subprime lending, and one its biggest causes, predatory sales practices.

The article focuses on what the state of Illinois is doing to combat predatory practices: government intervention. This is apparently a new and improved approach from the first go around of attempts where regulators threatened fines and penalties to deter bad behavior. 30 states, including Illinois, have predatory lending laws that prevent certain practices.

However, when that proved inefficient in curbing bad behavior, the new solution the Illinois legislature is now advocating requires prospective borrowers to sit down for 1 to 2 hours with a counselor prior to completing a loan. I can see the logic in providing expertise to those who don’t have it, but requiring?

It’s an interesting topic and one which is very tricky. I don’t see any sort of regulation or oversight happening anytime soon in the credit card processing industry. Businesses receive different treatment than consumers from regulatory bodies. So in the meantime, you are all on your own, without a credit counselor to help you with your next credit card processing purchase decision. Good luck with that.

The credit card processing industry is notorious for complexity, hidden fees, not-so-great providers, and generally considered by many to be one of the most challenging parts of running a business, and rightfully so. Buying credit card processing is like getting your car repaired in that consumers usually do not know enough about what they’re buying to ensure that they’re being treated fairly. Sellers end up having a significant knowledge advantage over their customers and can hide fees, overcharge for the service, or charge them for things that are unnecessary.

The rub for me has always been that the overwhelming majority of all merchant service providers don’t play by the rules and capitalize on the industry’s complexity for their own benefit. By ‘rules’, I simply mean shooting straight with buyers. Some providers of course are more egregious law breakers than others. Despite being rule breakers, these companies are often rewarded because they win the business of even astute buyers over other companies who refuse to use the same sneaky tricks.

QuickBooks’ Merchant Services and Costco Wholesale are two great examples of ‘Rule Breakers’. I could have chosen any number of companies as my examples but I wanted to demonstrate that even the largest players, with the greatest amount of perceived ‘trust’ are using the same sneaky tactics as everyone else.

Let’s look at QuickBooks first. Here is the screen shot for their main merchant services web page. I’ve highlighted the area in red where they show their rates: 1.72% for swiped and 2.44% for key entered. Fair enough, competitive rates. But…..

If you look down in the fine print you’ll see that some “Non Qualified Transactions” will be charged 3.27%. That’s a significant bump from the advertised rates. That’s important to know because depending on a few variables, anywhere from 10% to 80% of your transactions are going to be Non Qualified and fall into the 3.27% rate category. I know this from poring over my own customers transaction data every month. As a consumer, I need to know about this ‘minor’ detail.

But let’s say that you didn’t read the fine print and then clicked on the “Try it!” button on the side to see just how much you should budget to pay for credit card transactions. What comes up is a comparison with only the 2.44% rate represented. The 3.27% rate for “Non Qualified Transactions” is nowhere in sight. So now they’ve provided two data points to demonstrate to you that you should expect QuickBooks Merchant Services to charge you 2.44% on your credit card transactions. That’s simply not the case.

Finally, after not being upfront with their own fees, they make a disingenuous gesture and try to become your caretaker by announcing:

Now let’s take a look at Costco, they’re worse than QuickBooks. If you look at their website, they offer merchants a swiped rate of 1.64% and $0.20 and 1.99% and $0.27 for internet or mail order transactions. No where on their website do they disclose that Non Qualified cards are charged 3.47% and $0.31. You have to pick up the phone and speak to a sales person before you can squeeze this minor detail out of them.

A few things about this:

1) It’s not just Costco and QuickBooks doing this. The overwhelming majority of providers in the credit card processing industry use these same selling strategies.

2) Most merchants don’t ever find out about these higher fees because they’re not disclosed upfront and the monthly reporting statements are so confusing that it’s nearly impossible to tell what you’re paying.

3) Most experienced merchants I know just get overwhelmed with the dismal nature of this industry and have given up on trying to find a straight shooting provider. That’s what makes QuickBooks and Costco’s behavior so reflective of the industry as a whole. Consumers see them as a safe haven from the wild wild west nature of the industry and then end up with the same thing they would get elsewhere.

Summary
The problem I have with every provider who is selling this way is that it’s underhanded. These are the same selling tactics that have been used in the mortgage and title business and what ultimately got congress to start regulating those industries.

Companies who use these types strategies bet that even though customers will become irritated when then find out the reality, they’ll stick around to avoid the cost and effort of switching to another provider, who will probably just be the same. It’s certainly a way to play the game, but definitely not one that I could ever be proud of.