Bundled vs. pass-through pricing models

Bundled Discount Rates

Understanding merchant account pricing can be challenging. Unfortunately, there is no common standard for presenting the countless potential fees processors can charge merchants. In an effort to simplify fee structures, most processors advertise a “bundled rate,” whereby all of the applicable fees are rolled-up into a single, simple percentage rate called a discount. These pricing schemes may also include a fixed per item fee on each transaction.

Discounts are loosely based on interchange and assessment fees that processors are required to pay the Card Associations and the card-issuing banks for each transaction. The discount rate that the merchant pays their processor is somewhat arbitrary in the fact that it includes fees owed to others plus the processor’s own profit. The following simplified example demonstrates how the fees included in a bundled discount are distributed to all of the parties involved in the transaction.

In this example, a merchant agrees with its payment processor to pay a discount of 3%, for “Qualified” Visa and MasterCard transactions. This discount is actually shared between three distinct parties. The largest part of this percentage, let’s say 2%, goes to the card-issuing bank in the form of Interchange. In essence, your payment processor passes this portion of the discount to the bank that issued the consumer’s card. A very small percentage of the discount, the Assessment, let’s say 0.09%, gets passed to the Associations – Visa or MasterCard. The payment processor keeps the remaining percentage (0.91%) for itself. This represents the processor’s gross profit.

Downgrades

Bundled rate agreements seldom involve a single contracted rate. Merchants should be aware that these types of arrangements usually make provisions for downgrades, i.e., transactions that for one reason or another did not qualify for the optimal discount rate. Like the primary contracted rate, downgrades are bundled discount rates loosely based on Interchange rates; But, because downgrades are generally not reported in terms of actual Interchange, it is often impossible to determine why these transactions were downgraded in the first place.

Our example above illustrated a “Qualified” transaction, but merchants will likely also experience downgraded transactions. In many cases, merchants find that the quantity of downgraded transactions exceed those falling under the lower, primary rate. While most processors will report these downgrades, they are frequently described in proprietary terms, with little indication as to the cause of the downgrade. Downgrades are often reported using terms such as “Unqualified” and “Mid-qualified” as illustrated in the following table:

If you are fortunate, you may also receive a separate Interchange qualification report. This, however, is not always the case. When selecting a processor using a bundled rate, inquire as to whether they offer interchange qualification reports.

Pass-Through Arrangements

A less common, form of payment processor billing is known as the “pass-through” or “cost plus” method. Under the pass-through model, the processor reports on all of the constituent components including interchange, assessments and the processor’s own fees. There is no notion of a discount.

Interchange fees and Assessments are reported in the same format as the Associations’ published rates, so merchants can verify their fees. The Processor’s own fees will be billed and reported to the merchant in a separate accounting. These fees may be expressed in terms of a fixed per transaction fee, a percentage, or a combination of both. From a reporting standpoint, it is always more desirable to be billed under the pass-through model. In this way, it is perfectly clear what you are paying and to whom you are paying these fees.

Which is better?

Generally speaking, the larger the merchant the greater the benefit of pass-through pricing. This is simply a matter of the law of large numbers. Larger merchants will have a greater number of SKUs and transactions resulting in a larger number of interchange qualification categories. Like the bundled model, large merchants will experience downgrades. Instead of being lumped into three generic categories as with bundled models, pass-through merchants can use the raw downgrade reports to troubleshoot specific problems.

The major drawback to pass-through billing is that merchants are subject to increases in Interchange and Assessment fees. Larger merchants are better equipped to manage the complexities of pass-through arrangements, so the benefits of transparency usually outweigh the potential drawback of interchange and assessment increases.

For new or smaller merchants, choosing between these two pricing models is generally not of paramount concern. Assuming fair and reasonable pricing, the benefit of simplicity afforded by bundled pricing allows these merchants to concentrate on other things like growing their business. In the case of new merchants, there would be limited amounts of available interchange and assessment data anyway, obviating the benefits of pass-through pricing altogether. Merchants operating under bundled agreements should keep in mind, however, that some processors may include provisions for discount increases related to increases in interchange or assessments.