A payment processor is a company that helps a business accept credit card payments. Small business payment processing if it were not for the facilitation of the transaction process through payment gateways, card readers, and POS systems. All made possible through payment processing merchant service companies.
These software and hardware tools collect card information and move it along the electronic processing network. This results in the transfer of money from a customer’s checking account or credit line to your own merchant account at your bank.
How Does Small Business Credit Card Processing Work?
There are multiple avenues to how small business credit card processing works. The first step in the process is the customer giving their credit card information to the merchant. Businesses can process payment in a number of ways in this regard. If the sale occurs at a cash register, there will be a point-of-sale terminal.
Customers make their payment by swiping the magnetic strip on their card, inserting the chip, or tapping the card over the POS terminal if it’s a contactless card. There are some other ways of processing payments as well that have developed in recent years. We will go into greater detail after outlining in broad strokes how credit card transactions work.
If your small business is online, you will need to accept online payments, of course. In this case, customers will enter the required information as prompted by the payment gateway. This might include things like the name on the card, the card number, the expiration date, the security code (CVV code), and the billing address. The right payment processor makes it easy for online credit card processing for small businesses with integrated virtual terminals connected to your website.
Card Networks, Issuers, and Acquirers
Either way, whether your small business payment processing is done online or in person, you will send the data to your gateway. The gateway sends it to their credit card processor (which may be the same company that services the gateway). In turn, the card processor sends the payment data to the card network that services the customer’s card: Visa, Mastercard, Discover, or American Express.
The card network then informs the merchant whether or not the transaction can be completed—e.g. does the customer have enough cash in their checking account or enough credit available from their credit line?
The merchant will then complete the transaction. The payment processor will then inform the card issuing bank (the one that issued the customer’s credit or debit card) that they must transfer funds to the acquiring bank (the merchant’s bank). The settlement of these funds may take a few days or a few hours, depending on all the parties involved.
How Much Does Credit Card Processing For Small Business Cost?
The cost of processing credit card payments is borne by the merchant, who issues a per-transaction payment to their merchant service provider or payment processor. The payment processor, in turn, pays off the other parties in the transaction.
The total sum of this transaction fee for the merchant is the Merchant Discount Rate. Generally speaking, this rate runs about 2% to 3% of the total transaction and includes the following components:
Interchange fees usually take up about 7% of the merchant discount rate. The card networks (Visa, Mastercard, Discover, Amex) set these fees. However, it is the issuing bank that receives the payment. In the case of Amex and Discover, the issuer and the card network are the same.
But in the case of Visa and Mastercard, their issuing banks will not necessarily be the same. While Visa and Mastercard do offer their own credit cards, most Visa and Mastercards are actually issued by a bank or credit union—like Chase, Bank of America, Wells Fargo, Citicorp, or any other local or regional financial institution.
The exact interchange fee actually depends on a number of factors, including the card used (network and card issuer), the location (card-present or card-not-present…more on that later), and the industry of the merchant. All these variables add up to around 700 different interchange rates.
Merchants pay assessment fees to the card network. They are often a percentage of the merchant’s total sales. The assessment fee for each network is leveraged against the total sum of transactions with cards bearing that logo.
The Visa assessment fee is 0.11%, Mastercard is 0.095%, and Discover is 0.0925%. These rates are also called basis points. For example, the Visa assessment fee is 11 basis points, while the Mastercard assessment fee is 9.25 basis points.
Assessment fees with American Express are a little bit more complicated and based in part on whether the merchant has a direct agreement with Amex or participates in their recently rolled-out OptBlue program. The complexity of the Amex fee landscape is one reason why merchants are not always enthusiastic about accepting payments with that particular card.
But in recent years, Amex has somewhat rectified this reputation through the OptBlue program. This program allows a small business to use their regular payment processor—as long as the business has sales volumes under $1 million. Businesses with more than that need to have a direct agreement with Amex.
Processor and Acquirer Fees
Then there are processor fees and acquirer fees to compensate the processor and the acquiring merchant bank for facilitating the small business payment processing transaction from start to finish. These fees will vary depending on the payment processor and the merchant bank. The merchant discount rate comprises these fees along with the interchange and assessment fee.
Accepting payments for small businesses through credit cards could include but may not have all of the following processor fees:
Every time a cardholder swipes, dips, taps, or keyes their information in a terminal or online gateway, the authorization fee applies. Regardless if the transaction is approved or declined, merchants must still pay a fee for facilitating the transaction and card authorization process to the financial institutions involved.
Return Transaction Fee
Not only do merchants have to pay for the original authorization fee for a transaction, but if a customer returns an item, there is an additional return fee to process the reversal.
Though rare, some payment processors may charge a small fee for settling a merchant’s daily batch to their acquiring bank.
PIN Debit Fee
Credit and debit networks have different rules and fees. Because of that, merchants who accept debit cards may need to pay a monthly debit network access fee with an additional transaction fee per every PIN verification.
Address Verification System Fee
For eCommerce transactions, payment gateways use security features such as address verification or AVS to reduce fraudulent transactions. This system may require a small fee per transaction verification.
Retrieval Request Fee
A retrieval request may occur when a customer does not recognize a charge on their account. They can inform their bank and request additional information. Their bank will then investigate the transaction and inform their cardholder what it was for. This process requires the cardholder’s bank to request additional information from the merchant. This process will then result in a retrieval fee.
In a more severe (yet common) scenario, rather than requesting more information on an unrecognized charge, a cardholder could, instead, dispute a transaction with their bank.
If the bank agrees to proceed with the dispute, they will issue a chargeback to the merchant’s account. Forcibly reversing the transaction. The merchant does, however, have the right to submit a rebuttal to prove the authenticity of the transaction.
However, the processor will charge the merchant a fee for the chargeback initiation and possibly an additional fee to facilitate a rebuttal.
Cancellation or Termination Fee
If a merchant signs a contract with a merchant service provider for a set amount of time, there may be a breach of contract should they decide to get out of that contract early. And if it is stated in your contract, a merchant may aquire a hefty early termination fee.
Voice Authorization Fee
Another rare instance that may occur during a transaction process is having to authorize a card via phone with the payment processor. This can happen if a terminal is experiencing an outage for any reason, such as a malfunction, a power outage, or internet connectivity issues. If you have to authorize a card via phone, the processor may charge an additional fee.
PCI Non-Compliance Fee
PCI compliance is a standard that the card networks have implemented with all merchants who accept credit cards to protect cardholder data. If a merchant fails to become or maintain PCI compliance, they may be subject to non-compliance fees.
Terminal Lease Fees
As far as hardware is concerned, a merchant can either buy their terminals outright or choose to lease their equipment. Should a merchant lease their equipment, there will be a monthly fee to cover their lease agreement.
Many merchants can take advantage of integrated POS business tools right from their Clover device or other POS systems. Should they utilize certain applications, there may be an additional monthly subscription fee.
Regardless if a merchant is processing transactions or not for the month, they may still have a monthly fee. Think of it like a phone bill. Whether or not you use your data that month, you will still have your monthly coverage bill each month as an active client on the company’s services.
Monthly Minimum Fee
In some cases, certain payment processors will require merchants to meet a set processing volume. Should a merchant fail to process enough to meet that threshold, the remaining volume of transaction fees would be added to a merchant account to cover the processor’s service fee.
If a merchant uses wireless terminals for their point-of-sale, there may be a setup fee, monthly fee, and per transaction fee.
How Are Interchange Fees Calculated For Small Business Credit Card Processing?
As you will see from the rates below, whenever a customer is physically holding their card, the interchange rate is lower. And the rate is even lower for debit card payments. However, the network makes up for that by a higher flat rate addition. The biggest reason for that is there is a direct relationship between risk and pricing.
A customer holding the card in their hand creates far fewer opportunities for credit card fraud, and payments coming out of a checking account instead of a credit line are more immediately tangible for all parties involved—the card issuer doesn’t have to carry any debt that the cardholder might not pay (which is always a risk when using credit).
Visa Interchange Rates
For payments where the customer is holding the credit card in their hand, Visa charges anywhere between 1.29% to 2.5% plus $0.10. For payments where the card is not present—like online or over-the-phone transactions—Visa charges 1.58% to 2.7% plus $0.10. And for debit cards, Visa charges 0.05% plus $0.21 or $0.22.
Mastercard Interchange Rates
Mastercard interchange fees for card present transactions range from 1.65% to 2.7% plus $0.10. For card-not-present transitions, they range from 1.95% to 2.7% plus $0.10. They charge the same rate as Visa for debit card transactions.
Discover Interchange Rates
Discover’s rate is 1.56% to 2.3% plus $0.10 for card present and 1.89% – 2.4% plus $0.10 for card not present. Their debit card rate is the same as the other networks, except that the flat fee addition will always be $0.22, never $0.21.
American Express Interchange Rates
As mentioned, things get a little more complex with Amex. But in broad strokes, retailers can expect to shell out 1.6% to 2.4% plus $0.10, depending on the size of the transaction. And restaurants can expect to pay 1.6% to 2.85% plus $0.04 to $0.10, depending on the tab size.
Are There Different Pricing Models For Small Business Payment Processing?
You should consider several factors when searching for the right payment processor and payment structure for working with one. A few of these factors are the type of small business you own, which will be associated with a specific merchant code, which in turn will impact your fees. Other considerations are your sales volume.
Interchange Plus Pricing
Interchange-plus-pricing is a percentage rate plus a set markup, such as all the interchange pricing listed above. For instance, the rate for using a Discover card has a flat markup of $0.10 per payment, but the percentage may range from 1.56% to 2.4%.
The benefit of this pricing model is that it is often less expensive than flat rate or tiered pricing for businesses with significant transaction volume. The disadvantage is that merchants can see some variability in the pricing models, even between transactions.
Then there is flat-rate pricing, which, as you can guess, involves a flat rate. For example, in-person (card present) transactions might be 2% plus ten cents, regardless of the merchant code, and 2.5% plus ten cents for online transactions. The upside to this pricing model is simplicity. The downside is that businesses with high sales volumes stand to lose money with this particular pricing model.
Tiered pricing combines both interchange-plus and flat-rate into a hybrid creature. Qualified rates are applied to debit cards and non-reward credit cards that are swiped or inserted. Mid-qualified rates are applied to rewards cards and keyed-in transactions. Non-qualified rates are applied to corporate cards, high-reward credit cards, international cards, and card not present transactions.
As you can see, a significant portion of tiered pricing is the type of transaction and the type of card plays a large part in determining which of the three categories a transaction falls into. Pros to this method are its simplicity, but cons are the potential for higher fees applied to business credit cards and rewards cards.
Merchant Category Codes For Your Small Business’s Payment Processing
Merchant category codes (MCCs) are numbers that apply to certain types of businesses. The credit card issuer actually supplies these four-digit numbers to categorize the transaction for all the parties involved behind the scenes. The intention of the MCC is to summarize the merchant’s primary business activity.
For example, Citibank has categorized grocery stores and supermarkets as 5411. That means even if Costco also sells gas, playgrounds, and washing machines, whenever a card is swiped, dipped, or chipped at Costco, the transaction will be categorized as such.
The implication of this for the merchant is a particular amount of pricing. But from the consumer end of things, it may have rewards implications. For instance, some credit cards offer 3% cash back at grocery stores.
If a cardholder swipes their card at Divine Fudge (confectionaries, or code 5441), Le Petit Croissant (bakeries, or code 5462), and The Ham Hock (butchers, or code 5422), spending $200 on their entire trip (half of that on fudge, of course), they might be expecting to get $6 back on their purchases. But none of these places fall into the grocery category, so they’ll actually just get back whatever the cash-back rate for general purchases.
There’s not much you can do to change your Merchant Category Code. They are set by the International Organization for Standardization (ISO), and applied to your small business at the time you apply for a payment processor.
While some card networks recognize the MCCs set by card issuers, others have their own set of codes. The one takeaway from this concern is to make sure that when you apply for a payment processor, you are adequately describing your primary business activity.
Debit and Credit Card Consumer Benefits
Debit and credit cards are the preferred way of making payments for customers. A study conducted by the Federal Reserve called Diary of Consumer Payment Choice found that 28% of consumers use debit cards, 27% use credit, and only 19% use cash. Other studies have placed an even wider gap between these numbers, and the disparity will likely grow as inflation drives more and more consumers to turn to credit to cover everyday expenses.
Popular Credit Cards
The most popular cards in terms of percentage of the total outstanding balances carried have been found to be Chase cards (16%), followed by Citi (11.6%), American Express (11.3%), Bank of America (10.7%), and Capital One (10.5%). Keep in mind these rankings were compiled based on outstanding debt, so they may not exclusively represent the number of actual cards floating around but also how much consumers spend on those cards.
Credit Card Rewards
Consumers who choose to use credit cards over debit cards or cash may be using them because they get points or cash back. They also appreciate the convenience of using a credit card instead of cash. If cash gets lost or stolen, it’s gone forever.
Credit Card Safety
By contrast, credit and debit cards can be locked or replaced if they are lost or stolen. They’re also much easier to carry than a roll of bills. Although, they make for much less interesting Instagram posts. Somehow, holding a credit card up to your ear does not create the same impression as a thick stack of Benjamins…
For all these reasons, you will want to accept credit cards at your small business. Yes, even if they come with rates and fees. eBay found that in almost every English-speaking country and some others, around 75% of consumers would love to leave their wallets at home for good and just use mobile payments. Which brings us to our next point.
Until the day when all consumers walk around with mobile wallets or a microchip in their hand (which may not be too far off), having a POS that accepts swipes, ship inserts, and contactless payments is a must-do for your small business.
Other Types of Small Business Payment Processing Aside From Cards and Cash
We won’t bother going into check payments since only 2% of polled consumers like using checks for purchases. At the same time, consumers do still use checks for bill payments. This scenario will most likely not apply to a small business considering how to handle an influx of daily transactions as opposed to a monthly payment.
As a side note, however, businesses built on a subscription model can also use a payment processor to collect recurring payments. They can also use ACH payments. ACH payments transfer money directly from the customer’s checking account to the merchant account via the ACH network instead of card networks. In many cases, a payment processor who facilitates credit card payments can also facilitate ACH payments.
Another type of payment method coming to the fore is mobile payments. These can include credit cards stored in a mobile wallet, whereby a phone is held up to a POS like a contactless card. But mobile payments can also include electronic payments sent using a processor like PayPal or Venmo. Side note: Zelle does not fit into this category because it involves bank-to-bank transfers.
Around 32% of polled consumers had used Venmo in the past month to make a purchase. The problem with these types of processors for businesses is that they can have an oversimplified fee structure. Ultimately costing the business more—along with a one-size-fits-all customer service approach with minimal effectiveness at resolving issues.
There is also the newly adopted QR code technology, which is an interesting development. The customer takes a picture of a sort of barcode, which directs them to a website to make a payment. The issue is that the payment will be run as a card-not-present transaction, which, as discussed, has higher fees.
How Should I Choose a Payment Processor For My Small Business Credit Card Processing?
In summary, the best thing a business can do in choosing a credit card processor, especially a small business, is to find a payment processor that is approachable, personalized, and available. Smaller credit card processing companies (unlike monoliths like PaPal, Stripe, and Square) can offer more nuanced payment structures that benefit the business. More importantly, they can offer more responsive customer service for resolving issues as they come up.