Credit Card Processing: A Primer

You know that you must accept Visa and MasterCard; most catalogers wouldn’t be in business without them. And you know that credit card processing can be expensive, typically costing more than 2 percent of sales. But you probably don’t know if your payment processor is doing a good job, or if you’re getting value for your money. And what you don’t know might be hurting your business.

But a little information goes a long way. This article will provide ways to evaluate a payment processor, and tips to help you understand your options and make sure you’re getting the biggest possible bang for your payment-processing buck.

Key Roles

Payment processors fill four crucial roles:

1. They sponsor merchants into the Visa and MasterCard networks.

2. They perform the mechanical functions of transmitting credit card data.

3. They make sure merchants comply with the Visa and MasterCard rules and regulations.

4. And they collect fees for themselves as well as for the Visa and MasterCard networks and the banks that issue the cards.

The first role — sponsoring merchants into the card-association networks — requires the payment processor to guarantee that a merchant will meet its financial obligations. If you, as a merchant, cannot pay for refunds, chargebacks or other obligations owed to the card networks or card-issuing banks, then your processor will. Effectively, this means the payment processor gives you a line of credit.

This also is the primary reason processors often require merchants to maintain reserve funds, which provide security in case the merchant fails to: issue refunds, pay for chargebacks, or honor consumers’ claims for goods not shipped or services not rendered.

How large the reserve fund should be, and whether it’s required at all, is determined by the processor. Some types of businesses are riskier than others and generally will incur larger reserves. But without concrete rules for this, the reserve fund turns out to be a good way to compare service bureaus to decide which one to select as your processor.

Some service bureaus are better at managing risk than others. Some are quite conservative, and some impose arbitrary reserves regardless of risk. In general, look for a service bureau that understands your business and can minimize the amount of funds sequestered specifically as a “security deposit.”

Real Value

The second role of payment processors — handling data — is something most catalogers take for granted. But they shouldn’t, because some processes do a better job than others, and because Visa and MasterCard have made the operational issues very complex. There’s plenty of scope for overcharges and other mishaps that cost you money.

Reports are a critical management tool; indeed, they’re your window into the underlying data flow that eventually turns your orders into cash. Expect your processor to provide a secure online reporting option that offers more than just HTML versions of paper reports. Data should be sortable, searchable and configurable. Ideally, you should be able to separate versions of reports by department or by user.

You also should be able to create reports at specified cycles that you select, and use transactional data to do an in-depth analysis of your credit card processing activity. While reports should be simple to use, they also should provide the depth of detail you need to manage effectively.

Operational Excellence

When you first start working with a payment processor, look for a reasonable array of options for interfacing your order-management system with the service bureau. This will help you select the service provider that’s least disruptive to your current infrastructure and most cost-effective to set up and maintain.

A reputable service bureau also will be certified by Visa’s Cardholder Information Security Program. And it should provide ways to identify and safeguard against credit card fraud.

Types of Processors

There are four types of players in this field:

• Banks. All credit card merchant accounts are issued by a sponsoring bank. This is where the funds from each bank card (Visa and MasterCard) transaction initially are deposited before being transferred to your bank account. Some credit card processors simply are a division of the sponsoring bank. As such, they’re part of the bureaucratic banking world and may operate in a slow and deliberate fashion.

• Independent Sales Organi-zations (ISOs) are at the other extreme. An ISO doesn’t actually do any transaction processing, but rather passes your transactions along to a silent partner, which often is a bank-related payment processor. While the ISO may be your processor of record and provide you with processing reports, the company is, in essence, an intermediary.

• Independent Sales Agents (ISAs) are even further removed. Often an ISA is a single sales agent representing an ISO. After a contract is secured, you’ll be passed along to an ISO for the ongoing transaction processing.

• Finally, there are the specialized service providers. “Specialized” refers to their in-depth knowledge of both the credit card processing business and the types of businesses in which their clients are engaged.

These companies, which manage their own processing systems, have a close relationship with a sponsoring bank but remain independent of the banking community. This independence may allow them to be more innovative. They’re often better able to develop creative services and systems for clients than a typical bank division processor.

Understanding Rates

The final payment processor role is that of collecting fees. For most catalogers, the biggest thing distinguishing one processor from another is the rate and fee schedule for processing credit card transactions. Look at your current processor’s billing statements and/or reports with the following factors in mind.

The base rate for processing bank-card transactions is set by the bank-card associations and is called the interchange rate. From that baseline each service bureau adds its own fees and charges.

Unfortunately, there are many ways these charges can be abused. The most common is through downgrading, which usually is blamed on a transaction with missing or insufficient data such as an order number, a reservation or a certificate number associated with the order.

The downgraded transaction is subject to a surcharge on the interchange fee, but this sometimes is supplemented by an additional charge from the service bureau. Worse yet, some service bureaus actually routinely downgrade all or most of a merchant’s transactions. If you don’t complain, the practice may continue.

More-reputable processors either will ask you for more information to avoid a downgrade or plug in a reference number to substitute for the missing data to help you avoid the downgrade charge.

Watch for Tricks

One processor quoted a merchant a rate of 1.43 percent for qualified charges, and 1.6 percent for downgraded charges. What the merchant didn’t realize, however, was that the fine print in the contract made the second charge a supplement to the first, not a replacement. Downgraded charges were being billed at 1.4 percent plus 1.6 percent, for a total of more than 3 percent each! And of course, the processor reported that every single charge was downgraded.

Finally, regarding fees, when you authorize a credit card charge at order entry and then submit a deposit transaction at time of shipment, there should be a reasonable correlation between authorizations and deposits. Allowing for cancellations, for every 900 orders there should be about 1,000 authorizations.

Some service bureaus, however, find ways to inflate the number of authorizations. If a batch transmission of authorization requests is interrupted and restarted, for instance, the service bureau may charge you twice — once each for before and after the interruption. That’s irresponsible, to say the least.

Payment-processing mistakes can happen to anyone, of course. But if they frequently happen in favor of your payment processor, you may be feeling more pain than is necessary. And that pain proves that what you don’t know can hurt you.

In conclusion, look for a service bureau that can help you simplify the credit card acceptance process, control your costs and manage transactions for your maximum benefit.

Tim Litle is president of Litle & Co., a Lowell, MA-based credit card processing service bureau. He is a widely recognized pioneer in the field of direct marketing transaction processing. Contact him at (800) 548-5326, or e-mail him at tim@litle.com.