Choosing the right card processor will add to profit margins
Whether you own a restaurant or auto repair service, are a veterinarian or a motel owner, or if you knit sweaters and sell them at craft shows, you have to accept credit/debit cards to be a viable business today. There are more than 23 million small businesses in the U.S. and on average, about 60 percent of all gross revenue is generated by sales paid for with plastic. Accepting cards is one of the only expenses that are a direct hit on profit margins. Yet this cost of doing business that brings in 60 percent of your gross revenue is the least understood aspect of the day-to-day operations in any business across the country.
Herein, I hope to clarify some of the nuances of the electronic card processing industry that will help you make better informed decisions about your card processing provider.
Visa, MasterCard, Discover and American Express are not, and will never be, processors of cards. They are card associations that back cards issued by financial institutions. For you to accept cards, you must contract with a registered card processing company. Registered means that the processing company has registered and pays a fee to VISA, MasterCard, Discover or American Express to process their cards.
There are different types of processing companies. For simplification, we will call them levels.
Level 1 – primary processors
There are only about six major primary processors in the world. They are all registered with the major card associations and either directly or indirectly (explanation later) process all card transactions throughout the world. As a business owner, this is where you want to be. The primary processors are First Data, Chase Paymentech, RBS Lynk, Heartland, Global Payment Systems and Bank of America. A primary processor is where you will generally find your lowest processing costs.
Level 2 – financial institutions
Many financial institutions (FI) provide “merchant services,” i.e., card processing service. Generally, they create an independent sales organization (ISO) or division of the FI to manage the revenue stream for the institution. In doing so, they will contract with a primary processor to do the actual work. They must also register with all the major card associations. But most of the smaller, more localized FIs will contract with a level 3 ISO to perform this service, and by doing so, do not register with the card associations. Both the FI and the ISO (if structured that way) will add a little to the fees to create a revenue stream for themselves.
Level 3 – independent sales organizations, financial institution-related or other
As discussed in level 2, some ISOs are ISOs of a financial institution. But there are many independent companies that are ISOs not affiliated with an institution. When you do a general Google search, these are most likely the processors that will pop up. These ISOs must also register with the card associations and contract with a primary processor to do the actual work. Again, the ISO will add a small part to the fee structure for themselves.
Level 4 – agents or merchant services representatives
All three levels above operate with an agent sales force, so your agent is affiliated with one of the three levels above. An agent may be a local business person, like you; a road warrior passing through towns and states, usually high pressure, “act now” type people; or telemarketers, again high pressure people, trying to get you to send them your statement. These are the people who most likely try to contact you daily. And once again, the agent adds a little more to the fees for their income.
Levels 2 and 3 processors and the agents are all adding small amounts to the primary fee, which becomes a revenue source at each level. So if your agent is a level 4, you are paying four entities within your fee structure. This is how primary processors indirectly are processing all transactions throughout the world.
If your processor is someone you found on the Internet or you gave into on the phone, or someone who passed through town and talked you into switching, you are most likely with a level 2 or 3 processor and likely paying a higher fee structure with no local representation.
Another point I would like to make in this article is that it’s not about the rate!
The most frequently asked question when I am speaking to a business owner is, “What’s your rate?” First of all, there is never just one rate. There are always many different rates and fees you can be charged in any given timeframe. There is no one rate-size-fits-all in electronic payments. Another thing: there is always a fee on every transaction. Processors who tell you there is no charge on debit cards – well, let’s just say they are less than truthful.
So, let’s get back to “What’s your rate?”
Nobody ever asks me:
How much is your annual account fee?
How much is your monthly statement fee?
How much is your monthly service fee?
How much is your gateway fee?
How much is your PCI compliance fee?
How much is your authorization fee?
How much is your monthly minimum fee?
How much is your batch fee?
Well, you get the idea. These are just a few of the multitude of stated and/or hidden fees that can come into play. I could give you the lowest rate you will ever get, but if I double or triple one or a combination of several of the above, I’m making up the $$ here. So again, it’s not about the rate!
A better way to negotiate with an agent is to first know your net effective rate (NER). This is the overall cost to accept cards. To calculate, divide your total fees paid in one particular month by the total card sales volume for that month. This percentage is the real and actual hit to your profit margins to accept cards. Take that percentage and convert it to dollars by multiplying the percentage by your average ticket or sale.
So why not work off this percentage rate and dollar amount rather than the transaction rate, which is just a portion of the total? It encompasses the whole picture and will keep the agent honest and your negotiations more meaningful. For example, if you find your NER is 3.25 percent, your approach with the agent should be, “If you can reduce my net effective rate by 1 percent, then we can proceed.”
You see what you just did? You changed the conversation to actually adding 1 percent back to your profit margins rather than discussing transaction rates. If you know 1 percent equals $X, the NER becomes a much more tangible and real result for your negotiation efforts. Refusing to discuss transaction rates will totally throw the agent off his/her game and most likely they will disengage because they don’t want to talk in these terms, as they can’t hide fees.
In summary, always know your net effective rate and use this to negotiate with card processing companies.
Rick Montgomery is a former bank executive with 20+ years in commercial lending. In 2007, he started Northern Air Merchant Service, locally providing solution-based services to small businesses. Rick may be contacted at (715) 889-2409.