You Want Fees With That

April 12, 2002
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GRAND RAPIDS — The debit card looks like a credit card, swipes like a credit card and typically bears the familiar MasterCard or Visa logo like a credit card.

And, like a credit card, the merchant has to pay a charge every time a customer uses a debit card in transaction.

Whether cardholders use their debit card in a signature-based or PIN-based transaction, the merchant absorbs a cost. But there is a way they can lower the cost to themselves.

A cardholder’s selection of “credit” or “debit” on the PIN pad controls how the authorization for the transaction gets routed.

If the debit card carries the Visa or MasterCard brand and the cardholder uses a PIN in a merchant transaction, the transaction is routed to the cardholder’s banking institution for settlement.

When a cardholder selects “credit” and signs his name in a debit card transaction, it’s authorized by Visa or MasterCard but ends up getting posted to the cardholder’s account like a regular debit transaction.

The merchant pays a fee for the transaction as if it’s a credit card transaction, which is usually higher depending on the type of merchant and the type of card they’re accepting, explained Larry Magnesen, marketing director for Fifth Third Bank Western Michigan.

For the consumer that means a couple of things, he said. If processed as a credit card transaction, the consumer has a little more purchase protection under the credit card rules.

“When processed as a debit transaction, consumers aren’t necessarily protected under the same set of rules, although as a practical matter, if someone were using it in a fraudulent sense most of the banks will tend to protect you, but you don’t necessarily get the same purchase protection.”

Jeff Trachtman, Fifth Third vice president of bankcard products, said the bank doesn’t charge the merchant a fee for a PIN-based debit transaction, but whether a PIN-based or MasterCard transaction, a fee has to be paid to the acquiring processor in the transaction.

In merchant processing, a retailer signs an agreement with one or more credit card companies to accept different brands, such as Visa, MasterCard or Discover. That’s one relationship.

That same merchant processor could also give a merchant access to a number of different PIN-based brands, such as NYCE, Star, Jeanie and Pulse. That’s another relationship.

PIN-based debit transactions follow a different set of railroad tracks — namely, the EFT (electronic fund transfer) networks, which settle debit transactions back to the banks, said David Fountain, chief financial officer for National Processing Company (NPC), the second largest credit card processing company in the world. The Louisville, Ky.-based NPC is a subsidiary of National City Corp. and handles all types of card-based sales.

There are a lot of different regional networks around the country, all of which are interconnected but owned by different parties — generally banks in those regions.

A merchant who accepts a debit card in a PIN-based transaction has to have a processor that can route the transaction out to the debit networks.

The PIN-based debit is an on-line transaction and the signature-based debit is an off-line transaction because it follows the same railroad tracks as Visa and MasterCard, even though it comes out of the cardholder’s bank account. But merchants still pay interchange just as they would if it were a credit card transaction.

Off-line transactions represent the majority of transactions today, Fountain noted.

“At the end of the day, from the merchant’s perspective, he wants to promote PIN-based debit because if he can get a PIN-based debit transaction, it costs him less than a credit card transaction. He does have to pay a transaction fee, but it’s much less than what he would typically pay on a credit transaction.”

Credit card brands are widely accepted whereas PIN-based brands don’t have the same level of acceptance everywhere, Trachtman noted. A customer from New York vacationing in Florida who has a PIN-based card branded NYCE, for example, may have trouble finding an NYCE merchant.

All PIN-based brands started as ATM brands. People used their PIN at ATMs to withdraw cash and, as time went on, those same brands evolved into PIN-based brands that can now be used at point-of-sale.

The revenue-expense dynamics of a PIN-based brand are considerably different than they are for a Visa or MasterCard brand for both the issuer and the merchant.

The merchant pays more in acceptance fees if he were to accept the card as a Visa or MasterCard credit-type transaction.

However, on the upside, there is a charge-back process that merchants as well as cardholders can use to dispute and ultimately resolve a cardholder transaction that didn’t go the way the parties involved thought it would, he said.

As Trachtman sees it, the real issue for a small business owner in deciding what types of brands to accept is how many payment choices they want to give customers and weighing the cost of the transaction with the convenience for customers.

If a cardholder presents a payment card that could be successfully routed as either a Visa or MasterCard transaction or through a PIN-based network, then for the merchant the cheapest alternative will almost always be the PIN-based brand, Trachtman said.

However, a merchant who contractually agrees to accept Visa and MasterCard has to sign an “honor all cards” agreement that requires him to take Visa or MasterCard whenever presented.

If a merchant prefers that a customer pay with a check, cash or a PIN-based brand, he can suggest alternate payment vehicles; he could even encourage them through discounts or some other method.

But the rule is, if the cardholder wants to pay with a Visa or MasterCard, the merchant is obligated to process the transaction as such, Trachtman explained.

Where the merchant and the financial institution have a common interest, Trachtman said, is in providing convenient options for customers that ultimately make money for both parties.

“I make money off of bank card revenue and the merchant makes money off of selling goods and services.”

The credit card companies are responsible for setting interchange rates, the largest single component of what merchants pay to accept a Visa or MasterCard. But ultimately, it’s the financial institutions that are members of Visa or MasterCard that set pricing for merchants, Trachtman said.

The pricing for interchange is fundamentally risk based. Fountain said the interchange rate depends on how much information is presented at the point of sale. Visa and MasterCard set the interchange rates once or twice a year.

“The banks that issue the credit cards are controlling members of Visa and MasterCard, so they’re the ones that actually set the interchange fees that the merchants pay.”

The more information presented at the point of sale, the better.

“If the merchant captures a signature, that’s even more information,” Fountain said. “If they can capture that, it saves them money on interchange because if you have a copy of the signature electronically, then it save you a lot of time on the back office if you have a charge back as well. The debit model is not tied to risk as much as the credit model from a fraud standpoint.”

Different factors can influence the rate and other fees merchants pay to accept credit cards, including the type of business, number of years in business, the average dollar amount of sales transaction, total dollar amount of sales per month and percentage of sales made over the phone or Internet.

The “average ticket,” or sale, is a big factor because everything is a function of volume, Trachtman noted. There’s a big difference, for instance, between a gas station’s and an airline’s average sale transactions. Volume is another one: how big the merchant is, how much the merchant processes and the type of merchant processing environment. Non-face-to-face merchant transactions, such as direct mail, phone or Internet sales, are considered more risky.

“Merchants can promote PIN-based debit and that’s really what they want to do,” Fountain said.

But they have to keep in mind that in order to accept PIN-based debit, they have to have the hardware deployed, like the PIN pads, and all the technology in place to do that.

It’s not a huge investment, Fountain said, but it is an additional cost for the smaller business.

Merchants have to decide whether they have enough potential volume that can be converted to PIN-based debit to justify the cost. Most large merchants already have converted to PIN pads.

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