Understanding Merchant Pricing Models

Pricing is a fundamental part of any go-to-market strategy—one that significantly impacts your bottom line whether you’re selling goods or services.

So, understanding how transactions are priced is a must for anyone looking to optimize the revenue they earn from selling payments on their platform.

The best pricing strategy will be unique for each provider depending on their transaction mix and other operational factors. But it all starts with a fundamental understanding of the different pricing models.

About Merchant Pricing Models

Merchant pricing typically uses one of three models: interchange plus, flat rate and tiered.

In the explanations of these different types below, we’ll use some representative rates and make some assumptions to keep things simple. Your own portfolio will, of course, be unique.

Also, keep in mind that each pricing model has its pros and cons. For example, some are easier to understand or more transparent, and some are simpler to calculate. We’ll cover how to think about the different models strategically and what to consider as you choose the best one for your business in a future blog post.

This post assumes some understanding of the different components that go into each transaction fee. For more background on that, read How Does Merchant Pricing Work? The Components of Card Processing Fees Explained.

Related Content: Webinar Replay—Unlocking Merchant Pricing

How Does Merchant Pricing Work? The Components of Card Processing Fees Explained

Interchange Plus

With interchange plus pricing, the payments provider charges a fixed fee above their costs for every transaction.

Example transaction: Scott’s Shakeshack, $25 purchase

In this example, the customer taps a Visa rewards credit card.

Costs for this transaction:

• Interchange rate= 2.10%
• Network & processing fees:
  • Assessment fee = 0.14%
  • APF fee = $0.0195
  • Processing fee = $0.07

The payments provider will pass these fees on to the merchant, adding their margin. In this example, they’re charging 75 basis points (0.75%) + $0.10.

Here’s how these costs will break down for this interchange plus transaction:

Total transaction fee = [interchange fee] + [network & processing fees] + [margin]

Total transaction fee = [$25.00 x 2.10%] + [($25.00 x 0.14%) + $0.0195 + $0.07] + [($25 x 0.75%) + $0.10]

= [$0.525] + [($0.035) + $0.0195 + $0.07] + [($0.1875) + $0.10]

= [$0.525] + [$0.1245] + [$0.2875]

= $0.937

The total transaction fee charged to the merchant will be $0.937, with $0.2875 for the payment provider’s margin.

What is an effective rate?

The effective rate is the percentage of each transaction the merchant pays in fees. This may vary or be consistent, depending on the model the payment provider is using.

Effective rate across card and transaction types for interchange plus pricing

Flat rate

With flat rate pricing, the payments provider charges the same rate for every transaction. This means that the margin amount varies on every transaction.

Example transaction: Dave’s Dentistry, $25 dental visit co-pay

In this example, the patient inserts a Mastercard debit chip card at the time of service.

Costs for this transaction:

• Interchange rate= 0.05% + $0.22
• Network & processing fees:
  • Assessment fee = 0.1375%
  • NABU fee = $0.0195
  • Processing fee = $0.07

The payments provider is charging a flat rate of 3.50% + $0.30 for every transaction.

Here’s how these costs will break down for this flat rate transaction:

Margin = [Total transaction fee] – [interchange fee] – [network & processing fees]

Next, we’ll plug in the formulas to determine each of these amounts for this $25 transaction:

Margin = [($25.00 x 0.035) + $0.30] – [($25.00 x 0.05%) + $0.22] – [($25.00 x 0.1375%) + $0.0195 + $0.07]

= [$0.875 + #0.30] – [($0.0125) + $0.22] – [($0.0344) + $0.0195 + $0.07]

= [$1.175] – [$0.2325] – [$0.1239]

= $0.8186

The total transaction fee will be $1.175, and $0.8186 of that will be the payment provider’s margin. The fee will be $1.175 for every $25 transaction; it’s the margin that’s different with flat rate pricing.

Effective rate across card and transaction types for flat rate pricing

Tiered

With tiered pricing, providers typically group transaction and card types into multiple tiers based on their interchange rates. It’s worth noting that tiered pricing can be abused, as providers sometimes conceal the basis they use to set tiered pricing. But done with transparency, it’s generally accepted as a fair pricing model.

Here are two examples of tiered pricing to demonstrate the differences between the tiers.

Example transaction 1: Lauren’s Landscaping, $25 invoice

In the first example, the customer taps a terminal to pay their invoice with a Visa consumer credit card.

A card-present transaction using a Visa consumer credit card incurs a relatively low transaction rate. This transaction will go into the payment provider’s least expensive tier, also known as qualified.

Costs for this transaction:

• Interchange rate = 1.51 % + $0.10
• Network & processing fees:
  • Assessment fee = 0.14%
  • APF fee = $0.0195
  • Processing fee = $0.07

The provider charges a qualified rate of 2.50% + $0.30 for every transaction.

Here’s how these costs will break down for this qualified transaction:

Margin = [Total transaction fee] – [interchange fee] – [network & processing fees]

Next, we’ll plug in the formulas to determine each of these amounts for this $25 transaction:

Margin = [($25.00 x 2.50%) + $0.30] – [($25.00 x 1.51%) + $0.10] – [($25.00 x 0.14%) + $0.0195 + $0.07]

= [($0.625) + $0.30] – [($0.3775) + $0.10] – [($0.035) + $0.0195 + $0.07]

= [$0.925] – [$0.4775] – [$0.1245]

= $0.323

So, for this sample transaction, the total transaction fee will be $0.925, and the payment provider’s margin will be $0.323.

Example transaction 2: Lauren’s Landscaping, $25 invoice

In the second example, the customer pays their invoice online with a Visa Signature Preferred credit card.

A card-not-present transaction with this type of credit card incurs a much higher interchange rate, so this will fall into the payment provider’s non-qualified (most expensive) tier.

Costs for this transaction:

• Interchange rate = 2.50% + $0.10
• Network & processing fees:
  • Assessment fee = 0.14%
  • APF fee = $0.0195
  • Processing fee = $0.07

The provider charges a non-qualified rate of 3.90% + $0.30 for every transaction.

Here’s how these costs will break down for this non-qualified transaction:

Margin = [Total transaction fee] – [interchange fee] – [network & processing fees]

Next, we’ll plug in the formulas to determine each of these amounts for this $25 transaction:

Margin = [($25.00 x 3.90%) + $0.30] – [($25.00 x 2.50%) + $0.10] – [($25.00 x 0.14%) + $0.0195 + $0.07]

= [($0.975) + $0.30] – [($0.625) + $0.10] – [($0.035) + $0.0195 + $0.07]

= [$1.275] – [$0.725] – [$0.1245]

= $0.4255

For this sample transaction, the total transaction fee will be $1.275, and $0.4255 of that will be the payment provider’s margin.

Effective rate across card and transaction types for tiered pricing

Once you understand how merchant pricing works, the next step is to determine how you’ll price your own transactions. Pricing is a significant part of your strategy for maximizing revenue from your payments. We’ll cover that in another blog post. Contact Infinicept to talk to an expert about how to get more from offering payments on your software platform.