The biggest opportunity for SaaS companies to reduce embedded payments cost usually isn’t negotiating a lower fee with the payment provider.
It’s optimizing interchange.
In this episode, payments supply chain expert Max Jewell explains how interchange fees are determined, where SaaS companies might be able to qualify for better rates, and what to look for in your processing statements to uncover potential savings.
Max shares:
- The most frequent causes of transaction downgrades and how to avoid them
- Common mistakes that prevent platforms from getting Level 2/3 data rates
- Little-known interchange optimization methods that almost no one is talking about
- 3 steps to size up your potential interchange optimization savings
- An easy way to spot hidden payment processor fees
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Brooke:
Welcome to another episode of the Payment Strategy Show. I’m Brooke Smith, the Content Manager at Rainforest. We are the embedded payments provider purpose built for vertical SaaS companies to help you drive more processing volume at higher margins and making your product stickier.
I’m here today with Max Jewell. He’s a platform success manager at Rainforest and a subject matter expert in interchange optimization. So Max, tell us about your background. How did you get into payments?
Max:
Well, actually, the first interaction I had with payments was just at the end of college, I was a branch manager for an outdoor services company who used a very large prominent vertical SaaS solution. And part of them, they used their Stripe integration. So a lot of my job was dealing with Stripe and interacting with Stripe. And while I didn’t know at the time, that would actually be very relevant to my future career.
But my first official job in payments was at a payments consulting firm called CMSPI, which was at the time based in Manchester, England, and just starting to open up their office in the United States.
My job there as an analyst and then consultant was to work with their clients, which were very large US retailers. So think of all the big brand names that sell in the US. My job was to look at their payment supply chain and look for areas of optimization. So that included things like looking at their approval rates and trying to reduce how many transactions were declined or helping them run a processor RFP. So helping them in their vendor selection. However, the majority of my time there was spent on interchange and passthrough fee optimization. What that was essentially was looking at, for these businesses processing billions of dollars every year, seeing how they can reduce their payments costs through reducing their interchange fees, their network fees. And ultimately that was very impactful for these businesses who operate on very slim margins in many cases.
After that, I spent some time in the banking world as well at Truist and their strategic payments team. And my time there was really focused on how small businesses are using fintech and specifically vertical SaaS to meet their financial needs. Both of those experiences really gave me a solid understanding of how money moves within payments and specifically where money is made and where optimization opportunities are.
Brooke:
Most business owners are accustomed to paying a percentage for card processing, but where does that money actually go? Like what drives payment processing costs?
Max:
I think it’s important to set up, definitionally, what is behind the payment processing costs. So as you mentioned, the 3% is what a lot of merchants roughly pay in the United States, especially small businesses, for payment processing. That 3% is going to be split up by a number of different parties in the backend. And you can go very deep with upwards of 10 players in certain instances. However, it’s easy to simplify this into really three main buckets.
The first is, the biggest bucket, which we’re to talk a lot about today, is interchange. And so what is interchange? Interchange is a fee that’s been around a very long time since really the introduction of credit cards. And it is the fee that the card issuers charge to cover the costs of their payment services. And this includes the card issuer being people like JP Morgan, Wells Fargo, who actually you as a consumer have a relationship with and have a credit card or debit card with.
And so they cover those costs with interchange fees. And one of the things that cover specifically is, is rewards. So your credit card rewards are often funded in part by those interchange fees that, that banks charge and, merchants pay. this interchange fee is the bulk of that 3% and is going to the issuing bank. And that the interchange fee is very wildly. They can be as low as, you know, five basis points and 22 cents for some debit cards or up to a 3% or more for certain card types.
As I mentioned earlier, these higher rewards cards in the United States, those do have higher interchange rates as well. So really very wildly based on a number of factors. And that is the biggest portion.
The second part of that 3% fee is your network fee or your card brand fee. And these are going to be fees charged by Visa and Mastercard. So this is their take or share of the pie.
And this is a combination of a number of fees, there’s a large fee table that Visa and Mastercard have, and they basically combine to form your network fee total. And there’s also monthly fees involved in the network fee. And roughly, this averages out to be somewhere between 20 and 30 basis points we typically see. However, it does vary by transaction, by platform, by merchant. And lastly, the remaining bit of that is your processor costs, or the kind of the remaining margin that split up among a number of vendors. It could be your PayFac, it could be the software platform, it could be backend processing costs in there as well. However, a number of different players can kind of make up that last, let’s call it 10%.
Brooke:
You mentioned that interchange can vary widely from like five bps and 22 cents all the way up to 3% or more. What are the main factors that determine the interchange fee?
Max:
Yeah, so I already mentioned credit versus debit, right? That’s the simplest one. Credit, higher interchange fees. Debit, lower interchange fees. Primarily due to rewards, like what we said earlier, and some regulation around debit.
However, there are so many other factors such as is it an e-commerce transaction or is it in person? Is it a commercial or business card or is it a consumer card? Is the transaction taking place? Is it from a bank in the United States? Is it outside the United States?
And one of the most important things is what industry are you in? There are certain interchange incentives for industries such as healthcare, charity, real estate, insurance. There’s a ton of different interchange categories that there are published rates for that your transaction based on your business type will get.
Brooke:
There seems to be a perception that interchange rates are immutable. They’re set in stone and there’s nothing you can do about them. So how does interchange optimization work?
Max:
I think one of the reasons why people think it’s so stagnant, and there’s really nothing much you can do about it is because based on the way the transaction is, what bank it’s at, or where the transaction is taking place, whether it’s debit or credit, what industry you’re in, people think, well, that’s just the interchange rates that’s assigned to me. And while that is true to a sense, there is also this aspect of data quality that’s being sent with the transaction. There’s some different things like off settlement timing, things of that nature that can impact the qualification that your interchange has. So even though your interchange is set in a certain category, let’s say, you can do things that cause it to qualify for a higher interchange rate typically, and that’s called a downgrade. And so that’s one of the first things that I see when kind of, hey, interchange is not set in stone because here’s downgrade, which is a great example. And this happens when, for example, zip code isn’t sent with the transaction, a transaction can downgrade to a lower rate. And this can have huge impacts such as this transaction was supposed to be 2%. And now it’s all the way up at 3.15%. So that’s just one way that hey, your interchange category, it is defined. But because you didn’t send certain types of data with the transaction, it downgrades to a lower interchange rate.
Another item is settlement timing, making sure you’re settling transactions in a timely manner. That can also cause a downgrade and cause higher interchange rates.
However, there are also areas to send even more data than normal where it can cause a transaction to qualify for a lower rate, which is called Level 2/3 processing. And so even though this is not technically a downgrade, it is the ability to send additional data to qualify for a lower rate. And these are fields that most businesses have on hand, such as tax amount, shipping amount, commodity product code, and there’s a number of different items. And if you send that data in a very structured format, Visa and Mastercard will use it and actually may allow you to be eligible for a lower interchange rate. And so that’s basically what it comes down to is there’s a lot of things you can do with the data you send with the transaction to ensure that you are not downgrading or in certain cases, qualifying for the lowest interchange rate.
And just to touch on Level 2/3, a little bit more, one of the easiest ways to see this is if you have a lot of commercial and business card transactions. That’s where Level 2 and 3 is applicable. You can look at your statements, identify those transactions and see areas of optimization.
Brooke:
It sounds like although the categories themselves are sort of set in stone, there are things that platforms can do where if they execute them well, they can qualify for lower interchange rates within those categories. Is that correct?
Max:
100%. And I think that’s a really good point because oftentimes people think they’re sending the correct data and doing the correct things because they implement it they kind of let it sit. However, rules change. Visa, Mastercard policies change.
In addition, you might not have done it right in the first place. so making sure that you are sending complete data with the transaction is absolutely essential to getting those lower rates in a number of different areas.
Brooke:
I feel like that’s something we hear from platforms quite a bit. They’ll say, we’re sending Level 2/3 data, but we’re not receiving those advantage rates. So what are the most likely things that the platform might be doing that’s causing them to not qualify for advantage rates when they are sending Level 2/3 data?
Max:
Yeah, I think one of the biggest shortfalls is not understanding that there are differences in requirements between Visa and Mastercard. While they mimic each other in a lot of ways, both Level 2 and 3 have different requirements that are for Visa and Mastercard. And oftentimes we see platforms who come to Rainforest who were getting maybe a Mastercard only. And then we do some changes and they’re able to add that Visa Level 3 qualification and increase the amount of savings they’re getting, and a lot of times the platforms are completely unaware that they were not receiving the rates in the first place because it is somewhat difficult to identify. That’s a great example of the differences there. I think, understanding those nuances, there’s a long list of data fields that you have to send and checking each one off and making sure they’re formatted and the data sent correctly is very important.
Brooke:
Yeah, I’ve heard a lot of examples of platforms not qualifying because of the formatting of the data, like sending EA instead of each, and really fussy things that I never would have imagined would matter, but they do.
Max:
Yeah, definitely. I think one of the things that’s upcoming is Visa CEDP, which is going to be changing some of the requirements around Level 2/3. And to your point, the way the data is coming through is going to have more scrutiny on it. So previously, these fields just had to be filled and format correctly. But now there’s going to be some additional tests on the data quality, including, do all my line items add up correctly to the authorization amount. So this is gonna become even a little bit more difficult starting in October of this year. To the point it was already platforms already were not entering the data in the correct format oftentimes now it’s gonna become even more difficult.
Brooke:
So beyond Level 2/3, what are some other examples where platforms can qualify for better interchange rates by sending more data?
Max:
Yeah. So this is going to be very industry specific. So for example, in the travel industry, you have to send folio data, which is essentially customer check-in data, with your transaction to qualify for travel or hotel specified rates. In addition, there’s the customer service phone number that has to be sent with the transaction to qualify for charity rates. If you are a 501c3 or charity merchant.
A little bit different vein, there’s things called Visa SMB rates, which are actually incentivized rates for small businesses that Visa offers. And these rates are 10 basis points up to 80 basis points, in some cases cheaper than standard rates. And oftentimes, your processor that you work with will have to send additional data with the transaction or with that merchant to ensure that they qualify for those Visa small business rates.
At Rainforest, we manage that on behalf of our platforms and the merchants to ensure all eligible merchants are getting those Visa small business rates. In addition, we actually see situations where less data is required to qualify for the rates. For example, government merchants, government entities don’t actually have to capture AVS, so they don’t have to ask for even a zip code or full AVS at checkout.
Just the other day I was paying for parking in my neighborhood for a street parking permit and I noticed that my zip code wasn’t required to process the transaction. So there’s nuance here and it’s, very industry specific.
Brooke:
So when platforms get it right and they really reap the full benefits of interchange optimization, can you give us some examples of the results that they achieve? What’s the financial impact?
Max:
Yeah, I think a great example is in the healthcare space is clients oftentimes receive these really large, and merchants specifically, often receive these really large payments from insurance companies and they’re often paid for with corporate purchasing cards, which are Level 3 eligible. And just to emphasize the scale of what we’re talking about, these transactions, which oftentimes are $50, 000 – $100,000 because their insurance company’s paying back practices. They are oftentimes, if they’re sent with Level 1 data, they’re all the way at 2.9%. So extremely high interchange rates with Level 3, can get those all the way down to 1.9%.
So when you’re talking about merchants who accept the majority of their payments from these insurance providers, you can look at, you know, uh, decreases by 30, 40, 50 basis points in their overall costs because of how impactful that interchange shift is. That’s just one example in the healthcare space.
I’ve seen others, we had a client actually that came over and was using a third party billing software. And they just asked us to take a look at their interchange for a different provider. They had some of the business at Rainforest and we saw that they were getting downgraded every single Visa transaction because they weren’t sending zip code and they made an easy change and they’re, they reached out to their provider and that’s, that’s was getting base basically a 1% increase on every Visa transaction. So when they corrected that, they were able to reduce their costs by nearly, overall, I think 60, 70 basis points.
So you can see some very significant swings. especially those who process a lot of B2B transactions, so business cards.
However, I do want to caveat that and say really anyone processing a lot of volume is going to be a good fit to have interchange looked at just because there are so many different areas that you can target for optimization. Even if they are small, one to two BIPs means a lot for a lot of our platforms.
Brooke:
What about charity rates and MCC optimization?
Max:
Of course. One of the things that we mentioned earlier was that your business type determines the interchange category you fall into. Visa and Mastercard have incentivized rates for charity merchants and not for profit. And many of our platforms service a handful or all their merchants are 501c3 registered.
entities. Some processors will not do the correct work and help you onboard those merchants under the correct charity MCC. And when that doesn’t happen, they oftentimes get potentially services or retail interchange rates, which are much, much, much higher than charity interchange rates. Visa and Mastercard have big incentives, nearly 1% in some cases, for these types of businesses.
So if you’re able to even get a handful of your eligible merchants flipped over, it can have a really big impact on your profitability as a platform as well. it’s a very impactful, kind of tool, to use.
Additionally, outside of charity rates, there are other industries that have MCC benefits. So looking at your entire portfolio and seeing if there are any areas to move MCCs to a MCC that fits the business better, then that would also potentially produce some interchange savings.
Brooke
it sounds like a lot of the levers that a platform can pull may be dependent on their specific vertical or the card mix. What types of platforms tend to have the biggest opportunity for interchange optimization?
Max:
Yeah, I think, accepting a large portion of business card transactions. We’ve already hit on that.
In addition, I want to say healthcare, I think, has a lot of opportunity. Like I mentioned earlier, because of those insurance payments that they often receive via card.
Charity, the 501c3 orgs. So clients serving different verticals that might have some portion of their business be 501c3. Youth sports organizations, I see this sometimes as a 501c3.
And lastly, I would say pretty much any, like I said this earlier, anyone with a significant volume who wants to see how much revenue they can pull out of their payments product. Even though you might not fall into one of these categories, there’s oftentimes areas of optimization to be found.
And I’ll even say just from my experience working with large merchants and working in the business, there’s oftentimes areas to find from an audit. There can be little things that pop up where, Hey, this fee is not being charged correctly here. Or, wow, this is a small area of optimization. I’ve seen things like the processor not refunding interchange in certain cases. For example, when you have a refund, Visa and Mastercard do pass back a portion of interchange there. And I’ve seen that as a practice that, from audits finding that, Hey, you guys should be receiving that interchange back and you’re not. While there are certain businesses that have great opportunities, I think it really does apply to the industry as a whole is, everyone can get a health check from that standpoint.
Brooke:
I love that idea of looking at it as a health check because there is possibility for everyone. If a platform is curious about the potential to optimize interchange costs, but they’re not quite ready to engage with a consultant or a third party or sort of a specialty payment provider, how should they size up the opportunity based on the information and data they already have?
Max:
Yeah, I think a lot of our platforms and merchants out there will receive a statement from their provider. My recommendation is to flip through that statement. Just get a high level, very, very quick look at your interchange and look for things like non-qualified or business commercial and or see try to find Level 2. If you’re finding Level 2, then you are getting some benefit there. Look for those indicators.
And see right from the bat, you can say, are my transactions downgrading, which is the non-qualified piece, or is there optimization around business commercial cards, which is the Level 2 piece. In addition, if you have questions about what certain types of fees are and what they mean, there’s great resources out there. I know CardFellow was something I used early on in my career. It’s a great resource. You can look at fees out there to get a better understanding of your statement.
But first I would really try to look at your statement with a little bit more scrutiny and try to understand exactly what is broken down. And then, high level, see if there’s any optimization opportunity there.
Brooke:
It sounds like the first step might be to look for downgrades since those are like open wounds that are just bleeding high interchange costs. And then the next step would be to look for those like business and commercial cards that could potentially qualify for Level 2/3. And then the third step might be to look for any industries or verticals within the portfolio where there might be opportunities to qualify for an advantage rate.
Max:
A hundred percent. And it could be as simple as you have, five or 10 merchants that could benefit from an MCC switch, and checking what their current MCC is would be a great place to start. and a lot of people don’t, don’t know that offhand. You’d have to maybe go to your processor and ask, but just getting a current list of MCCs and seeing where it up would also is a great step three, I think as part of that.
Brooke:
That’s a good recommendation. Another frequently asked question we hear from platforms and merchants a lot is, can payment processors negotiate interchange rates directly with the card network? Do some payment processors actually get different interchange rates than others?
Max:
The answer is generally no. There is no special deal that a processor can work with the card networks.
However, my answer to this is processors are also responsible, just like there’s things that platforms and merchants can do, processors are also responsible for helping you manage downgrades in a number of ways with the transactions they send. And they’re also responsible for helping you identify optimization opportunities, helping you send Level 2/3 data. So there are definitely processors out there and payment facilitators, that will help you more than others in terms of how do you achieve your optimization goals. And so I think that’s one thing to note as well.
If people are saying that, there’s 100% a possibility that one platform would receive lower interchange rates at one processor than versus the other. It’s not the fact that they have specialized interchange rates. It’s the fact that one processor is helping them, navigate, pass through fee optimization, more efficiently.
Brooke:
Yeah, that sounds very sane and rational. That all processors are fundamentally getting the same rates. No one is getting special treatment, but some are much better at optimization than others.
Max:
Definitely, definitely.
Brooke:
So is there anything we missed? Are there any other sort of frequently asked questions that you hear or best practices that platforms should be aware of?
Max:
Yeah, from a best practice standpoint is oftentimes both platforms, and I see this with merchants, are not 100% aware of what they’re paying in each category. And I think that one first step is to really try to break down your exact interchange costs, your network costs, and then your processor costs as well. So you can really have a good idea with what you’re paying in each category.
I think a lot of people look on the surface and think they pay, sometimes lower, sometimes higher fees, than what they are paying today. So I think doing a deep dive into your statement and understanding how each of those fees add up is something I hear from platforms and merchants a lot, that they just quite, quite don’t know what their exact paying today and rates.
One other thing is how do I manage interchange and network fee changes that, that are, that are coming up. I think one thing to do is, when you’re looking at your next 12 months, people can kind of predict, every year Visa and Mastercard release changes twice a year in April and October.
So people are always asking me, Hey, what’s going to change what’s coming up. And I think marking those down in your calendar is, Hey, this is potentially something to look out for that could impact my residual and my statement coming up for my payments business. So a couple of recommendations that pop up for me.
Brooke:
Those are really helpful. I know you mentioned understanding what are they actually paying for interchange? What are they actually paying in network costs? And then I think the third piece that’s sort of implied is what are they actually paying in processing fees to their payment processor? When someone starts to go through that exercise and bucket every fee into one of those, are there any red flags that would suggest this isn’t just an interchange optimization question, we also need to go looking for hidden processor fees.
Max:
Yes. So, a fun game processors like to play is bucketing processing fees into different categories such as their network fees, or they call them, they identify them as incorrect as, as passthrough costs. Passthrough fees should always be fees charged by the network, the card brands, and interchange fees. Everything else should be correctly identified as a processing costs.
Red flags, I’ve seen things like bank acquiring fees be put on statements, other, other small things that just don’t feel right. That feel like, they look different than the rest of the network fees or the interchange fees categories. And one thing processors sometimes do is lump those around the edge processor fees in with the rest of passthrough.
Brooke:
Yeah, I feel like that’s really good advice. Just the idea of one of these things is not like the other. Because in a whole list of valid interchange fees, the ones that are hidden processor costs will usually have a different format or they will look fundamentally different.
Max:
Yes, they definitely will look, look fundamentally different on the statement. Not to say those aren’t contracted fees that you have with your processor, but you should definitely look at your entire processor margin holistically to see if there’s any additional fees sneaking in.
Brooke:
I think that’s a really good exercise because although the goal is not necessarily to pay the least, platforms definitely have a right to know what they’re actually paying.
Max:
100%.
Brooke:
So if a platform is curious about interchange optimization or even just a better understanding their true costs, like what would you recommend for their next steps?
Max:
Yeah, I think the first step is to just do a simple, hey, this is what I paid as an effective rate for the last six months and try to identify, Hey, how consistent is it? Where are there spikes? And then from there, break down each of those categories. And, know, you aren’t going to be able to potentially answer all your own questions on your own, but at least we’ll give you a jumping off point and say, Hey, I’m curious about this. Why did this go up or why did this go down in this time period? So mapping out exactly what your fees are over a time period can really help set the stage for you to engage a consultant, or if you do want to take that next step and go talk to a different provider.
As you know, one of the things that we love to do at Rainforest is, if you’re willing to send us statements and processing history, we can pretty quickly go look at those statements and give a high level overview of what we’re seeing and if there’s any optimization opportunities. So I think the first step is understanding what you’re paying and then try to find any areas where you don’t feel like you have all the questions answered.
Brooke:
And if people want to get in touch with you or if they want to follow you and learn more about interchange optimization, where can they find you?
Max:
You’re always welcome to reach out on LinkedIn. I’m going to be posting more about interchange optimization. And this is one of the things that, if anyone were to come to Rainforest, that I lead up and help out here. I think those are the two best ways. And then, of course, if you’re a platform, come to Rainforest and see what you can potentially save in interchange.
Brooke:
Max, this was awesome. Thank you so much for joining us.
Max:
Awesome. Thank you, Brooke.
