How and where do payments generate revenues?

In previous posts, we’ve looked at the four party model and how it works, but we skimmed over a key point. The system makes sure that funds are available, mitigates against fraud, and make their way from the consumer to the merchant. But how does everyone involved get paid? Is it possible for a business currently paying for payments, to start generating revenue from them?

When a payment is made using the four party system, the customer may pay £100, but the merchant will not see all of that money. Some of it will be taken by the acquirer, usually as a percentage and a flat fee. A provider may take, for example, 35p plus 2.9% of every transaction. Different providers will take a slightly different slice, and the rate will be different for offline and online transactions. The rate may even differ depending on the risk of the transaction—some merchants are happy to pay a little more for removing the friction of asking for the CVV code from stored card details. They can also differ depending on the type of card used to pay.

In our example, the merchant will receive around £97-98, depending on the agreement they have. As far as most merchants are concerned, this is the cost of doing business. But we’re going to go a little deeper into where this money goes.

Merchant Service Charge

The merchant service charge is probably the easiest slice to understand. Acquirers are providing a service that needs to be paid for, and as the acquirer’s customer, the merchant has to pay for this. Those services, such as creating and maintaining payment gateway, ensuring security is PCI-DSS compliant, and processing transactions, chargebacks and refunds, all cost money to run.

Interchange Fee

Interchange fees are paid to the customer’s issuer (usually a bank), but they are set by the card schemes and subject to regulation. When it comes to consumer interchange fees, in the US, there is no maximum on credit card transactions (although the average fee is 1.81%), but the cap is $0.22 plus .05% for debit cards. In Europe the limit is .3% for credit cards and .2% for debit cards. There is no cap for corporate cards.

The interchange fee is set by the card scheme, and it’s not one-size-fits all. It’s determined by the type of card (consumer or corporate), whether it’s an online or in-person transaction, where the payment is made, and what the business is—ecommerce marketplaces may have a different percentage to pay.

This variable price model can presents a cost challenge to providers. Because the fees are based on card types which while they can be forecast, can never be fully predicted, this may lead to higher charges than the provider is expecting.

This hasn’t been helped by opacity around card fees in the past, but regulation and transparency have helped.

The odd wrinkle is that even though the card schemes decide on these fees, they are collected by the issuer. Therefore anyone who is an issuer, and issues cards that are used to make payments, stands to earn interchange fees. But if interchange fees don’t go to the card schemes, how do the card schemes get paid?

Assessment Fee

Assessment fees are collected monthly by the card schemes, and as a percentage smaller than interchange fees. This cost, sometimes called a “brand fee” is charged monthly, and goes to the card scheme used to make the payment.

All of these fees are small, but all of these nickel and dimes add up. In the EU alone, card issuers make over $13bn every year from interchange fees.

Most merchants are unaware of how these charges break down. All they really know is there is a “merchant service discount” for payments and that credit cards take more of a fee than debit cards.

This model could be under threat thanks to real-time payments, Open Banking, and other alternative payment method—the topic of our next blog post.