Interchange: Are You in the Right Lane?

Learn techniques to properly assess your interchange qualification, challenge the status quo, and ask your acquirers the right questions

Editor’s note: This article was sourced from the AFP 2020 Virtual Experience session “Interchange: Are You in the Right Lane?” Speakers Dan Carter, CTP, CPP, Associate Director at Redbridge, and Ed Burke, Vice President of Credit, Collections & Cash Optimization at Airgas Inc. discuss how interchange qualification works and review techniques for properly assessing qualification to ensure merchants are asking their acquirers the right questions. To download the session slides, please scroll to the end of the article.

“Is 3.5% a good or bad effective rate for a merchant?” People frequently ask me to tell them whether their rate is right for their business.

My answer is the same each time: “it depends.” Without knowing the “context” – the merchant’s vertical, customer profile, and card mix – determining whether the rate is good or bad is difficult, if not impossible. When discussing interchange fees, context matters.

For example, a 3.5% effective rate may be the best rate a merchant with an average ticket of less than $13, from primarily consumer debit cards and operating in a general merchandizing merchant category code (MCC) can expect. Again, understanding context is key to set realistic expectations about your interchange rate.

Interchange basics

What is interchange?

Interchange makes up the greatest amount of fees that a merchant pays; typically, interchange accounts for 70%-85% of total fees. Interchange is paid to the card-issuing bank (i.e., the bank that issued the credit card to the customer who is paying you), and the rates are set by the card networks (e.g., Visa, Mastercard, Discover, etc.), with input provided by the card-issuing banks.

Because the card-issuing bank plays a significant role in handling each card transaction, they are entitled to the largest percentage of the interchange fee. The fees cover the extending of credit, the expense of fraud losses, and handling costs.

How are interchange rates assigned?

Anyone who works with card transactions should review an interchange guide. Interchange rates follow several key dichotomies:

• Transaction type: Is it a card-present or a card-not-present transaction? Card-not-present examples include e-commerce, mail order/telephone order (MOTO) transactions, and key-entered transactions.
• Card type: What type of card was used? Was it a vanilla card like a student card that doesn’t have any rewards attached to it, or was it an airline miles card? Was it a business card? A small business card? A debit card?
• Business industry (which is coded with four digits known as the MCC): What type of industry does your business operate in? Are you a utility? Are you a non-profit? Are you a retailer? What may be a Rewards 2 transaction for one merchant might be a charity transaction to another merchant depending on their MCC – even though it might be the same card used by either merchant.

In practice, the most critical action that a merchant can take to minimize interchange is to ensure that the appropriate MCC has been assigned to their business and that each transaction qualifies for the lowest rate.

What is a downgrade?

The term “downgrade” is often misunderstood and should only be used to describe transactions that fail to meet base qualification levels. Failure to meet such levels is typically caused by a processing error or a merchant’s inability to follow best practices. This often contrasts to an acquirer’s use of downgrade, which may apply to any transaction that does not meet optimal qualification. When you decide to manage your interchange in the future, understanding your objective – tackling problems or greater optimization – is essential.

The canary in the coal mine

Poor interchange has ripple effects. Suppose you see your effective rate is increasing over time and your fees are going up. In your analysis, if you see several downgrades occurring, the problem might be human errors (not following proper procedure), software glitches, unnoticed process changes, or communication problems (electronic handoffs of data fail). Interchange faults or inefficiencies create higher and, sometimes, additional fees like Visa’s transaction integrity fee for each non-qualified transaction. Little problems can quickly grow into big problems if not identified and fixed.

A game plan for merchants to control interchange

A challenge for merchants is being able to access your data, then compile and analyze the information. An additional obstacle is identifying the team members and researchers capable of effectively addressing the interchange problems to ensure transactions are correctly qualified.

Accessing the right data

Treasurers typically view data and trends on a macro level and miss the details necessary to identify and diagnose interchange problems. They may fail to understand that a single person or team cannot resolve many issues. As you go forward, additional resources with interchange expertise might be needed. As Ed Burke, Vice President of Credit, Collections, & Cash Optimization at Airgas Inc., found in the company’s interchange project, the team members did not comprehend the “different flavors in interchange in cards. Realizing all of the relationships and trying to stay on top of [the dynamics] was eye-opening for sure.”

Having reliable electronic access to your statement data is critical. Your access should have been established when you created your merchant account with a description and explanation of the multiple reports. If you are unsure what reports are available through your portal with the interchange, your acquiring partner can walk you through the offerings.

Most portals provide vast amounts of information, sometimes in numbers that confuse rather than enlighten. If information is readily available in report form, the portal administrator might recommend a different process to get the information you need.

Data is critically important, so make sure you have access to and understand the bells and whistles of your reporting portal.

Building historical context

The ability to scrape data – a technique where software extracts data from the human-readable output from another computer program – is essential to save time and ensure the small data elements – address verification service (AVS), transaction addenda, terminal ID, the actual time of the transaction – are present. Properly sorting the data in report form is especially important to diagnose and prioritize issues in the interchange accurately.

Twelve to thirteen months of recent data is essential to get a good look at the interchange activity. Seasonality is sometimes a factor since types of transactions may vary during different times of the year. For example, a fruitcake distributor is likely to experience higher volumes and various types of transactions during the October-December months than the rest of the year. Similarly, companies that focus on young adults may see greater debit card use at the beginnings of school terms, lowering their interchange since debit cards have lower rates than credit cards.

Creating a template that coherently presents data, automatically sorted by specific attributes, saves you time, money, and sore fingers. A properly designed template simplifies the identification of trends, often leading to issues sometimes lost in general reviews.

There are several different attributes to be reviewed, including

• Card mix. Different cards in different circumstances are subject to different interchange rates. An online view of the Wells Fargo interchange matrix illustrates the potential categories affecting that issuer’s cards. There are prime consumer, rewards, debit, and different types of business cards, each with a rate. Other issuers have similar matrixes.
• Average ticket. Ticket size significantly affects the interchange rate. Generally, the higher the average ticket amount, the lower the interchange fee, but not in all cases. The interchange fee for a debit card transaction of $13 or less varies according to the card issuer. The interchange for a debit card issued by a bank with at least $10 billion of net worth (regulated) is 0.05% of the transaction value plus 22 cents or a total of 22.65 cents. Debit cards issued by smaller banks are unregulated and subject to a fee of 1.65% plus 4 cents or 4.21 cents. The difference to a merchant – 18.44 cents – is enormous.
• Payment channel. Despite the buzzwords “channel” and “omnichannel,” the real meaning is “was the transaction completed card present or not present?” The interchange rate is 30 basis points higher than the transaction interchange for a card present in the latter case.

Payment card acceptance and business practices

Written policies and procedures encourage correct acceptance and handling transaction practices. Factors that can affect the qualification rate include your batching system, delayed processing of transactions, and verification practices (Do employees ask for AVS information?). A general review of business practices is always worthwhile as processes become outdated, loaded with unnecessary tasks, and redundant effort.

Documenting the lifecycle of a typical transaction from the moment a customer enters details online, an associate accepts payment over a phone, or a card is swiped in a terminal to the receipt of payment in your account is necessary to identify the potential trouble spots that result in an under or missing qualification.

Diagnose and triage issues

Diagnosis begins with a comparison of expected standards versus practice. Business planning requires logical assumptions about your customer base and their use of cards. A goal of diagnosis is identifying the incidents where assumptions and results do not match. Triaging prioritizes the identified issues and their impact on the problem, initially attacking those areas with the biggest bang for the buck (return versus cost and effort).

Factors that always seem to need attention are

• Changes in the card mix. Looking at the interchange on a macro level can identify significant change or trends in the rate but offer little information that affects the movement. For example, a high-end retailer’s treasurer might not recognize a difference due to a different card mix composition or the factors that affect the composition. Analysis reveals a greater use of debit cards than in the past. Is the effect seasonal? Is it due to a special promotion? Has your customer base changed? Will the trend continue? These are some of the questions merchants should seek to answer.
• Card-not-present transactions. Higher proportions of card-not-present transactions can affect interchange fees quickly and dramatically. Issues of this type can be incredibly challenging to diagnose due to the variety of potential causes. Are the rates higher online than in brick-and-mortar facilities? Are they higher or lower in specific regions or times of the year? Do they involve purchases of particular products or amounts? What is the common denominator of the card-not-present transactions?

Your acquiring partner can be an excellent source of information due to their experience with different issues and clients. Many companies fail to take advantage of this resource due to the difficulty of finding the right person at the acquirer, misunderstandings of industry jargon, or different levels of expertise in interchange matters.

I always advise clients not to be discouraged if their initial efforts to involve their acquiring partner in the project is less than needed. Keep engaging them, preferably face-to-face or telephonically, to avoid communication problems. In many cases, the acquirer has tools to quickly identify and isolate downgrades, eliminating the tedium and time of information gathering and building historical context.

Staffing the right resources

Assigning resources with the right skills and the time is an essential element of project management, whether fixing interchange issues or reviewing acceptance practices. Interchange issues typically cross-functional lines, particularly IT systems. In the few seconds that a transaction pings around in your system or hands off to the acquirer’s system, potential failure and errors are present.

The vastness and variability in data can be a huge challenge to pull together, as Ed discovered in the Airgas project. He likened the experience of data gathering and analysis as “almost like you were a detective. There are little clues here and there, and you’ve got to pull all those clues together to get what the root cause is, where the culprit is.”

A common reaction to finding a problem is to seek a scapegoat: “It’s my gateway” or “It’s my acquiring partner.” While the source may be elsewhere, it is also possible that the merchant company is responsible. The problem and its solution are not external but internal. Maybe our system is not relaying a particular data field we expected it to relay. Maybe what we hoped was happening in a central batching process is not happening at the right time. Perhaps there is something that we are doing or not doing that causes the issue.

Attacking an interchange issue is best accomplished if you have standard procedures to ensure that no factor or nuance of the interchange process is overlooked. Interchange involves every area of a business. It is an ecosystem where everything touches everything else. Most companies do not deal with interchange analysis every single day; it is just one of the processes that occur in the organization. Expecting employees to bring the same level of expertise to the table as those who specialize in the area is a mistake. According to Ed, the contrast between the two is comparable to the knowledge of a child in kindergarten and a Ph.D.

The Airgas-Redbridge engagement

Having the right people on the project team is important. The Airgas-Redbridge project began after Ed and his team spent several months collecting and analyzing data to lower their interchange. Ed decided to hire us to either confirm the Airgas team had done everything possible to reduce the rate or find areas to improve for further reductions. He considered our engagement as a win-win for the company.

Despite the Airgas team’s significant achievements before our involvement, Ed recognized that their staff did not have the bandwidth or expertise to understand the factors and relationships that affected their interchange.

The year-long project exceeded expectations, both in optimizing the Airgas interchange and educating other people in the company about the importance of interchange. Ed recalled the project as having a “huge educational component within a relatively short period of time…it was one of the top projects in my career that I had the privilege to work on…it was a big team and, ultimately, a huge success.”