About Interchange

• MasterCard and Visa are competing card associations and have different Interchange pricing and qualification schedules.
• MasterCard and Visa Interchange is the single largest component of your merchant discount rate pricing.
• All banks and merchant processing companies operate from the exact same Interchange, Dues and Assessment costs.
• Card Association Interchange is the fee paid by the merchant to the cardholder's issuing bank for processing a transaction through the system.
• Interchange is priced at the transaction level and depends on the combination of your industry category code, the method by which you accept the card, the card product you accept and sometimes even varies by transaction size.
• You will likely have card transactions throughout any given day all qualifying at different Interchange levels.
• The Interchange pass through pricing model displayed on this site is by far your best option. Don’t settle for any other rate structure – get all other comparative quotes on the Interchange pricing model.

1958: Bank of America Corp. introduces the first bank credit card, BankAmericard. Within a few years, there is a competing group, the Interbank Card Association. Interbank became today’s MasterCard Worldwide, while BankAmericard is now Visa U.S.A.

1971: Bank Americard establishes an Interchange fee to be paid by the merchant’s bank to the cardholder’s bank. The fee is initially set at 1.95% per transaction. MasterCard follows suit. The fee is explained as compensation for the risk of card-issuing banks.

1979: National Bancard Corp. (Nabanco) sues Visa U.S.A alleging that when member banks set Interchange rates it amounts to price fixing.

1986: A federal appeals court rejects Nabanco’s claim, observing that the card industry is nascent, so price-fixing and other antitrust allegations don’t hold up. At about the same time, Visa and MasterCard begin “incentive pricing” of Interchange to encourage merchant adoption of electronic card capture.

1996: Retailers file a class-action lawsuit against Visa and MasterCard challenging the “honor all cards” rule, which requires merchants accepting any MasterCard and Visa products to accept all such products. Vantage Card Services Incorporates.

1998: The U.S. Department of Justice files antitrust actions against MasterCard and Visa over so-called exclusionary rules that preclude member banks from issuing nonblank cards, like those of American Express Co. and Discover Financial Services, LLC.

2001: A federal court strikes down the bankcard assocations’ exclusionary rules. Visa and MasterCard appeal, but the appeal ultimately gets rejected by the U.S. Supreme Court. Vantage Card Services launches MerchantRates.com.

2003: MasterCard and Visa agree to multi-billion dollar out-of-court settlements with retailers, and to decouple credit and debit card acceptance.

2005: Visa and MasterCard announce new Interchange schedules, which, for the first time, tie assessments to the types of cards used. So, for example, transactions using cards that are tied to rewards programs are assessed higher Interchange rates.

2006: With nearly a dozen legal challenges to Interchange by retailers and their champions, a federal district court consolidates them into a single case. MasterCard Goes Public.

2007: State lawmakers and the media enter the fray. Stories on Interchange and other concerns raised by the merchant acquiring community appear regularly in the mainstream press, including publications like The Wall Street Journal and USA Today. Visa takes first steps toward IPO.

2008: March 19, 2008, Visa raises $17.9 billion in record IPO. The largest in US history.

Interchange keeps the payment system in balance and is designed to maximize both merchant acceptance and card issuance. It’s important to understand that there are two consumers of payment systems – the cardholder and the merchant.

Two types of payment systems:

1. A four party payment system like MasterCard and Visa which is characterized as an open loop system with explicit Interchange. The four parties are: 1) Issuer 2) Cardholder 3) Merchant 4) Acquirer.
   
   The four party payment system:
   • The cardholder’s issuing bank markets and issues payment cards to consumers, and extends credit to cardholders from the time a purchase is made until payment is due.
   • The cardholder uses a payment card to purchase goods and services at millions acceptance locations around the world.
   • The merchant accepts payment cards in exchange for goods and services, and receives increased sales.
   • The acquiring bank enrolls merchants into programs that accept payment cards.
2. A three party payment systems like American Express which is characterized as a closed loop system with implicit Interchange. In proprietary three party systems, managers chose customer and merchant fees to maximize its profit.
   
   

Organization of Payment Networks
In the US, payment card networks coordinate the activities of thousands of financial institutions that issue cards, millions of retail locations that accept them, and several hundred million consumers that use them. This coordination may include the collective setting of certain prices and other network rules.

• Card issuers are banks that offer cards to consumers and determine the level of any fees or finance charges their customers see on their regular statements.
• Merchants also have banks, called acquirers that process card payments on their behalf. Merchants pay their acquirer for these services by accepting a merchant discount.
• Bankcard Associations coordinate through Networks, Rules & Pricing. In a 4 party system, with so many participants, coordination is essential.

Dues & Assessments fees comprise the component of Merchant Discount that goes to the Card Associations. An open payment network like MasterCard and Visa allow many banks to participate. The association builds and maintains much of the infrastructure: the lines and switches required to route transaction information between different acquiring and issuing banks. The associations specify that for each transaction an interchange fee be paid to the bank issuing a card by the bank acting as the acquirer for the merchant.

Dues & Assessments represent the percentage of the sale that the card associations make to pay for their role to:

• Operate the network
• Set rules
• Set pricing
• R&D (develop new technology, combat fraud)
• Marketing/Branding

With multiple issuers and acquirers…

• Setting the fee at the network level eliminates costs associated with bargaining between individual card issuers and acquirers
• Eliminates the uncertainty about the actual costs of a card transaction. “Hold up” economics suggest that pricing would be higher if each transaction was negotiated separately after the sale. By not funding the merchant in a timely manner, issuers could demand higher fees.
• Consumers are more likely to use a payment card if they know where it will be accepted and on what terms.
• Other methods are more costly.

So why are card issuing banks not paying merchant acquiring banks or put another way, why are cardholders not paying merchants to use their card?

• The answer lies in properties of “network effects”. To achieve greater growth of the payment system, the economics of network effects shows that in order to maximize the value of the payment card network, it is necessary to impose more of the costs on those participants who are least likely to stop using or accepting the card.

Also…

• By providing incentives for card issuers, Interchange encourages banks to innovate and develop new payment options, broaden the range of card programs available to consumers, and invest in cutting-edge security and fraud prevention measures
• Issuers bear cost of non payment (cardholder risk), financing the interest free period enjoyed by cardholders, and costs resulting from transaction processing

Again we point to the properties of Network Effects. Like eBay is a network, so too Visa is a network. In a "two-sided" market, more buyers equals more sellers. The goal of Interchange is to optimize both sides.

• More cardholders in network enhances value proposition to merchants to accept cards.
• More merchants creates positive value to cardholders

For example, no barriers for buyers on eBay, brings more buyers to the marketplace, thus attracting more sellers to the value of both.

Payment card systems are not the only case such two-sided markets exist. Software industry, video games, internet portals, medias and shopping malls. In all these industries, the crucial challenge for the platform is to get both sides of the market on board while making a profit overall.

The economic value of Adobe PDF software comes in great part from the fact that any potential reader can download for free the complementary software. Software programs like Adobe distribute readers from free and charge the writers and content providers. This price structure results from the fact that readers have a lower willingness to pay for the software than the writers.

Thus Interchange is crucial for payment networks to find an effective method for balancing the prices on the two sides of the market.

Interchange is set to maximize network volume. Default Interchange is established at levels aimed at ensuring maximum participation in the card network system by both merchants and cardholders It motivates financial institutions to innovate and issue cards, allows merchants to benefit form accepting them and maximizes the number of cardholders who use them.

It is not in the interest of an association to choose interchange that deviate markedly from social optima. Even a monopoly in a two sided market would benefit from a very high or low interchange. High interchange results in substantial merchant resistance and would induce many merchants to reject the card. Very low interchange would lead to correspondingly higher cardholder fees and discourage consumers from holding and using cards. Network externalities by themselves induce restraint.

Merchants want cardholders to spend. Cardholders want their card accepted at merchants.

The business decision is quite complex and takes many factors into consideration.

Guiding Principles:

• Maximize the network (# of cardholders, merchants, transaction volume)
• Establish rates on the value of accepting cards delivered to each industry
• Promote acceptance of both credit and debit cards
• Incentive for merchant acceptance and new acceptance categories (QSR)
• Incentive for best practices (swipe cards or use AVS for example)
• Facilitate a competitive position against other payment networks and payment instruments (i.e. Cash, Check & AmEx)
• Consider member costs of both issuing and acquiring transactions
• Consider cost of introducing new payment card programs and technologies that enable the participants in a four party system to provide leading-edge payment opportunities

With these "network effect" principals in mind, is Interchange Working? The answer would appear to be yes! Both cardholders, merchants and volume grew to the benefit of all stakeholders:

• Equal growth of cards and merchants from 1995 to 2005
  • Cardholders grew at 7.3%
  • Merchant locations grew at 7.4%

To achieve this growth the number of Interchange categories also grew:

• The number of Interchange categories has literally doubled and then doubled again in the last five years alone.

Interchange Trends:

• Security
  • Compliance with Patriot Act, Homeland Security, banking and payment system infrastructure protection mandates (PCI)
• Competition
  • Pressures from other card issuing competitors who offer higher Interchange income
• Litigation
  • Increased legal expenses and settlement costs
• Governance
  • Federal and State Laws
  • Visa independent board; MasterCard goes Public
• Technology
  • Contactless, micropayment, prepaid and other payment schemes to further eliminate paper cash and check transactions.
• Card Association Rules
  • Signature Not Required example to speed transactions
• Pricing
  • Volume tiered & transaction size qualifications
  • Registration requirements
  • Compliance requirements

In recent history, 3 events have shaped the Interchange landscape:

1. Wal-Mart filed case was settled in 2003 with the bankcard associations agreeing to revise their honor all cards rules so that merchants can separately decide whether to accept their brands of credit and debit cards, reduce the interchange fees charged on signature debit cards and pay damages over a 10 year period.
   • Transactions during the period of Oct ‘92 to Jul ’03
   • 494,000 payments of more than $600,000 million mailed March 31, 2006 with more payments to be ready by end of 06 and 07. 23,000 payments mailed Dec 05.
2. In October of 2004, the Supreme Court refused to hear an appeal on US vs. Visa & MasterCard – which in effect, freed card issuers to partner with payment networks outside of the card associations.
   • MBNA and CitiCorp then announced plans to issue American Express cards. Facing the real threat of losing issuing bank members and with it valuable share of the consumer card market, both MasterCard and Visa created incentives to maintain their member loyalty.
   • In April 2005, each made a strong play to keep member banks from partnering with AmEx and Discover by upping Interchange fees and thus issuers revenue. Competitive forces are pushing card associations to raise rates domestically.
3. In re Payment Card Interchange Fee and Merchant Discount
   • Status of pending case: The Judicial Panel on Multidistrict Litigation ordered all related cases transferred to the Eastern District of New York for coordinated or consolidate pretrial proceedings. The case represents millions of card-accepting merchants in the US including four of the largest merchant associations, National Association of Chain Drug Stores, the National Association of Convenience Stores, the National Community Pharmacists, the Association of National Grocers and American Booksellers Association.

The likely goal of the Interchange lawsuit is to put in place cost-based Interchange. However, caution should be exerted before regulation of Interchange. Lower Interchange fees will increase fees that cardholders pay (annual fees, transaction fees or interest rates). In turn this could reduce cardholders and cardholder spending.

MYTH: INTERCHANGE FEES ARE A “HIDDEN TAX” PAID BY THE CONSUMER.

FACT: Interchange fees are not paid by consumers. In choosing to accept debit and credit cards, retailers receive more sales, greater fraud protections, and faster payment. Some retailers would lead you to believe that they should not pay for these benefits. They don’t want you to know that the cost of offering electronic payments is part of the cost of doing business. Consumers understand that retailers factor all of their costs into their prices. The price of an item is the same to consumers whether they use a credit card, debit card, cash, or check. Retailers are also free to offer discounts for cash, but few actually choose to do so. Attempts to classify such fees as a “hidden tax” on consumers would be similar to trying to misrepresent businesses’ rent or salaries for employees as a “hidden tax” on their customers.

MYTH: INTERCHANGE FEES NEGATIVELY IMPACT BUSINESS.

FACT: Electronic payments help retailers. Retailers see more sales, greater fraud protections, and faster payment when customers use electronic payment cards. In fact, using the technology offers huge savings and adds to the bottom line of small and large businesses alike. Benefiting from flexible terms and ease of use, small businesses manage monthly expenses, track purchases, and weather short-term fluctuations in cash flow. This technology also levels the playing field, encourages entrepreneurship, and allows smaller retailers to compete with larger businesses.

MYTH: INTERCHANGE FEES ARE UNKNOWN TO RETAILERS.

FACT: Visa and MasterCard make their interchange rates publicly available. Moreover, retailers know what percentage they are being charged by their banks for electronic payment transactions.

MYTH: RETAILERS HAVE NO CHOICE BUT TO PAY A SET INTERCHANGE FEE.

FACT: If retailers don’t want to pay fees associated with offering electronic payments, they have several options: they can provide discounts to those who pay with cash, negotiate a different merchant discount rate with their bank, choose among competing networks for electronic payments services, or accept only cash and checks.

MYTH: INTERCHANGE FEES ARE ANTICOMPETITIVE.

FACT: On a daily basis, card payment systems compete with each other, with cash and checks, and with other new forms of payment such as PayPal, Debitman, and Google Checkout. For years, competition has rewarded consumers with greater access, lower costs, and more choices while expanding business opportunities for retailers.

MYTH: REGULATION OF INTERCHANGE FEES IS NECESSARY TO HELP RETAILERS PASS SAVINGS ALONG TO CONSUMERS.

FACT: Where price controls have been imposed the results have been clear: higher consumer costs and fewer choices for cardholders. There is no evidence that retailer cost savings have been passed along to consumers. Maintaining, operating, and expanding global electronic payments systems isn’t free. Retailers welcome the opportunity to offer consumers the convenience of electronic payments, but now, they want to shift their business costs to bolster their profits.

Visa USA Interchange rates are published at
http://usa.visa.com/merchants/operations/interchange_rates.html

MasterCard Interchange rates are published at
http://www.mastercard.com/us/merchant/how_works/interchange_rates.html

Read Guide to Merchant Rates article on Work.com.

1. Lots of cardholders with spending power.
2. Merchants are consumers in a 4-party payment system.
3. The largest component of merchant discount pricing is Interchange, paid to the card issuing bank, and Dues & Assessments, paid to MC/Visa.
4. Interchange is known in advance, set at the card association level and is the same for all participants.
5. Interchange (through network effects) is set to maximize network volume in a “two-sided” market of cardholders and merchants.
6. Market trends points to more complexities in how Interchange will impact merchants.
7. Your price structure is more important than a rate quote.
8. Moving to an Interchange pricing plan, coupled with a focus on your rate structure and managing Interchange qualification will lower your bottom line costs.