As an industry, we tend to talk about interchange rates as though they’re out of our control because the rates are determined by the card networks.
It’s true that the rates are determined by the card networks, but that doesn’t mean it’s totally outside of our control. The card networks not only determine interchange rates, they also provide ways to qualify for lower interchange rates on certain transactions by providing additional data.
We frequently see platforms reduce passthrough rates by 20-30 basis points, and occasionally more than 50 basis points!
What is interchange passthrough?
Interchange is the largest contributor to credit card processing fees. Interchange rates are determined by the card networks, and the fees are paid to the issuing bank for every transaction.
Interchange rate vary based on a combination of:
- card network (Visa, Mastercard, Discover, American Express)
- card type (debit, credit, or pre-paid)
- transaction size
- merchant category code (MCC)
- card program (e.g. business, corporate, rewards)
- security measures and data (e.g. card present, address verification, Level 2 and Level 3 data, etc.)
- special programs (e.g. Visa SMB rates, American Express Opt-Blue)
Interchange rates can vary widely. At the low end, debit card transactions can carry an interchange rate as low as 0.05%. At the high end, a rewards card can be close to 3%. If the data provided with the transaction is incomplete, the transaction may be downgraded and the associated penalty can push the interchange rate to over 3%.
In addition to interchange fees paid to the issuing bank, the card networks also charge dues, fees, and assessments (DFA). These tend to be smaller fees.
The combination of interchange and DFA is called “interchange passthrough”.
In the wild, no platform processes just one type of card transaction, so average interchange rate will depend on the overall mix of the factors listed above. The average interchange passthrough for a platform usually falls between 1.3% and 2.8%, but there are certainly outliers.
When it comes to reducing interchange, the first five factors are mostly determined by the characteristics of the merchants and their end customers. But the last two factors – security/data and special programs – can be optimized to reduce overall interchange passthrough costs.
Why optimize interchange?
As the single biggest driver of card processing cost, interchange is also one of the biggest opportunities for platforms to improve payment processing margin.
There are always two ways to increase margin: increase price and reduce cost.
A lot of vertical SaaS platforms have room to increase price, particularly those offering a comprehensive end-to-end solution with fully embedded payments.
On the cost reduction side, most platforms only have two direct payment processing costs: interchange passthrough and payment provider fees. Interchange passthrough is usually 5x – 10x as much as payment provider fees. An “average” platform may pay 200 basis points in interchange passthrough and only 20 – 40 basis points to their payment provider. If you’re looking to add 20 basis points of margin, you can look for a 10% reduction in interchange fees or a 50% – 100% reduction in payment processing fees.
Payment providers can only reduce price to a certain point before quality and support suffer. In contrast, the 10% reduction in interchange fees might be attainable with a few low-code changes.
Optimizing security and data to reduce interchange fees
Card networks reward data because it generally reduces risk. The simplest example is card present rates, which tend to be lower than card not present rates. To make sure transactions qualify for card present rates whenever possible, the merchant just needs to use a POS device to capture payment card information rather than manually keying the card number.
Address verification can also reduce interchange rates. One platform was suffering from transactional downgrades on all their Visa volume. These downgrades carried “non-qualified” interchange rates that are often 1%+ higher than standard rates and come with additional network fees, such as the 10c Visa Integrity Fee. Overall, Visa downgrades drove up the platform’s Visa passthrough rates to >3.3%. Our Platform Success team determined that the downgrades were caused by the lack of zip code collection at checkout. The platform made a simple low-code change to enable zip code checks on all transactions, which reduced the number of non-qualified downgrades and lowered their overall passthrough rates by more than 20 basis points.
Further interchange reductions can be enabled by sending Level 2 and Level 3 data, particularly in B2B verticals where much of the payment volume is on commercial credit cards. Level 2 rates require tax amount, tax indicator, tax ID, customer code, and shipping information. Level 3 rates require all Level 2 data plus more granular information, including product numbers, item descriptions, quantities, and shipping information. Implementing Level 2 and Level 3 data can reduce interchange rates by 20-90 basis points. Overall impact is dependent on merchant codes and card mix. For example, one platform that has a mix of B2B and B2C transactions recently lowered their overall interchange rates by 15 basis points by sending Level 2 and Level 3 data. The savings can be even greater for a platform that is predominantly B2B.
When it comes to interchange optimization, most managed PayFac providers have the ability to send the Level 2 / Level 3 data that’s needed to qualify for lower rates. But, when it comes to interchange optimization, the devil really is in the details. We’ve seen platforms sending Level 2 / Level 3 data on all eligible transactions but less than half of the transactions are qualifying for lower rates. This usually means that the data isn’t being sent correctly.
In some cases, the values aren’t being properly populated by the platform. When this happens, we’re able to diagnose the issue and instruct the platform accordingly. In other cases, the platform correctly populates the values but their payment provider sends it incorrectly to the network. The only way to determine root cause is to audit interchange detail reports and, if necessary, data payloads. Rainforest does this proactively for platforms that migrate significant card processing volume from other providers.
In order to successfully optimize interchange rates, a payment provider needs to have the ability to send the data and the expertise to audit the data, diagnose non-qualified transactions, and identify the specific changes needed to qualify for lower rates.
Leveraging special programs to reduce interchange rates
Platforms can also reduce interchange rates by enrolling merchants in programs with preferred interchange rates, like Visa’s SMB program and American Express OptBlue.
Visa SMB rates are lower interchange rates for small businesses who process under ~250K in consumer credit volume annually. Many processors have not taken the correct steps to leverage this program. Rainforest has done the upfront work for the platform to ensure all eligible merchants receive these rates.
Similarly, American Express OptBlue offers lower interchange rates for merchants who process less than $1M/yr in American Express volume. Rainforest automatically enrolls eligible merchants.
Impact of interchange optimization
Interchange optimization can have a profound impact on platform margin. One Rainforest platform partner reduced overall interchange passthrough by 24 basis points. Since Rainforest doesn’t take a revenue share, the platform’s margin increased by a corresponding amount. For a platform processing $500M/yr, this is an additional $1.2M/yr for the platform.
Although interchange optimization tends to be most impactful in B2B payments, platforms with a high volume of B2C payments shouldn’t ignore it. For example, a healthcare billing platform that processes patient payments might still get a meaningful volume of corporate or purchase cards such as virtual single-use cards from insurance companies or businesses that are paying on behalf of employees.
One retail platform did a head-to-head comparison between Rainforest and another provider. The results? Interchange passthrough was 36 basis points less with Rainforest.
It’s normal for software companies to obsess about every basis point of payment provider fees – even pitting providers against each other to negotiate a discount of 5 basis points. But interchange passthrough is the more significant driver of overall processing costs, and the gains from interchange optimization can far outweigh payment provider fees. Choose a provider who has both the technology and the expertise to optimize it.
If your SaaS platform processes at least $1M per month in embedded payments, our experts will analyze your interchange detail reports to determine how much money you are leaving on the table due to interchange. Contact us to get started!