When ecommerce was first introduced as a new concept there was a common belief that it was expensive and difficult to implement. In truth, when ecommerce first came into existence it was often expensive and complicated to setup. This was true from both the Visa / MasterCard card acceptance perspective, and also from the technology / shopping cart perspective.
If we fast forward to today ecommerce is commonplace. Ecommerce solutions like Shopify exist to make selling online affordable and accessible to even the smallest of new and startup businesses.
Similarly, most banks and credit card processors no longer see ecommerce as high risk. It is much easier to get a merchant account for credit card acceptance today than it was at the advent of ecommerce.
Unfortunately, (and perhaps as a side effect of making ecommerce so accessible) some business owners tend to enter into a merchant processing agreement without understanding what they are getting into. This is a significant mistake. A business owner must research and do proper due diligence before selecting their processor.
Your credit card processor will provide you with a merchant account. This merchant account will be used to capture funds collected from credit card sales. You will pay fees to your credit card processor for this service, and you need to make sure you will get what you expected. This article will help you to avoid some of the most common and damaging mistakes that business owners make when choosing their credit card processor.
Before you read further
In this article I will shed light upon some of the deceptive practices employed by a small number of processors in the payments business.
I want to strongly point out that this is in no way reflective of the industry as a whole. There are a great number of honest and hard working professionals in the merchant services industry. Most established processors have achieved their success by being able to go the extra mile and support their clients. In short, there are many good options to choose from.
The purpose of this article is to arm you with knowledge so you can proceed with confidence when choosing your processor. In fact, much of what is discussed is as much common sense as it is inside information. Regardless, it’s advice that every business owner should keep in mind.
On that note I will ask the single most important question…
Did you actually read the terms of the Merchant Agreement?
While researching to find your credit card processor you will speak to many different sales people and receive numerous quotes. However, you can’t simply make your decision and start processing immediately.
In order to get a merchant account you must apply and be approved to use the service.
Part of the application paperwork will include the terms and conditions of the merchant agreement. The T&C will govern the usage of the service and the relationship between your business and the processor. It is a very important document.
It should be obvious that you should read the T&C of the merchant agreement before signing the contract and submitting your application. Why would anyone sign a contract without reading it? The reason is actually quite simple, and anyone who has seen a merchant agreement will know the answer: they are long legal documents filled with complicated legalese and confusing language.
Upon glancing at the paperwork, many people don’t bother reading. We’ve all been on websites or installed software that included long terms of usage that must be agreed to before proceeding. Few people (if any) actually read these documents. Your merchant account agreement should not fall under this category. It will have a major impact on your business and requires proper attention. Despite the fact that it may not be a thrilling read, as a business owner you must take the time to at the very least do a solid skim through the contract. The purpose of this is not to examine the language or try to review it like a lawyer would. What you are looking for is red flags. If anything comes up that causes questions or concerns you must raise them with your potential processor before proceeding. If you don’t do this you could be setting yourself up for frustration down the road.
The most common cause of that frustration has to do with fluctuating pricing that some processors do not properly explain during the sales process…
Watch out for interchange downgrades and rate fluctuations (AKA hidden fees)
Most merchants are understandably very concerned when it comes to establishing pricing for their payment processing. Cost is always one of the main decision making factors when it comes to choosing a processor.
The single most common frustration that merchants experience after signing the merchant agreement is that they do not end up receiving the pricing that they were promised by the sales person. This happens for two reasons:
- The merchant does not have an adequate understanding of merchant industry pricing.
- More importantly, the sales person may have been deceptive. The business owner accepted a verbal or email based quotation but did not read the contract to make sure they would receive what was promised.
The merchant industry is rife with confusing terms. In fact, merchant industry pricing is a topic worthy of an entire article on it’s own but here we will discuss it only enough to understand the basics of the issue. The most important thing to understand is that the rate that you pay fluctuates depending on the type of card used. This is because the “interchange” cost (the cost from Visa or MasterCard) varies depending on the type of card used. Cards that carry a benefit to the cardholder (like an airmiles card) and corporate cards are slightly more expensive to process. Some processors may offer flat pricing where the type of card does not influence the rate being charged, but in 2011 this is very uncommon. Fluctuating pricing is far more common because Visa and MasterCard have built interchange to vary depending on the type of card used.
With the understanding that the cost to the processor fluctuates depending on the card type, we can now understand why the cost to the merchant often fluctuates. Armed with this knowledge we can now discuss the worst pricing trick in the industry. The worst trick occurs when a sales person quotes an extremely low rate (often below interchange cost to the processor), but does not explain to the merchant that the pricing can fluctuate.
I will give an example. A shady salesperson quotes a discount rate of 1.49% (which for the record is far below cost on an ecommerce transaction). However, they don’t point out that this rate is only applied to swiped credit card transactions. How often do you swipe a credit card in an ecommerce transaction? Never. You will never pay the quoted rate.
How can you avoid this problem? With a bit of common sense and a basic understanding of the interchange table. This is a classic case where if you receive a pricing quote that sounds too good to be true then follow your common sense. (Consider it a huge warning bell if the rate sounds low and the sales person hasn’t at all discussed premium, corporate and foreign issued cards)
It is worth noting that when the interchange rate fluctuates the processor should pass that cost increase onto the merchant. Visa and MasterCard have modeled the pricing this way, and there is nothing wrong it – so long as it’s always clearly explained by the salesperson. Unfortunately, that is not always the case.
We now understand how misleading pricing tactics can be employed, but not the extent of the damage that it can cause. The damage happens when a processor adds an unexpected surcharge on top of the cost increase from Visa or MasterCard when a premium or corporate card is used. (When this is done it is most often referred to as a “non-qualified” transaction). If a Visa infinite card is used the cost to the processor increases by 0.2% in Canada. However, what if the processor added an additional surcharge of 1% whenever a Visa infinite card is used? For the sake of mentioning it, there is nothing wrong with a processor adding a surcharge for different card types. The processor has to generate some income for the service they are providing. The practice of surcharging for premium cards is fine - so long as it was explained to the merchant upfront. Unfortunately, some of the less scrupulous processors don’t do this, and this is why many business owners end up with pricing that is far higher than they had expected.
We can now create a simple example. A merchant receives a quote a rate of 1.5%. (Side note – this is a typical “too good to be true” rate, and is well below interchange cost for ecommerce transactions). The processor has a 2% surcharge buried in the pricing table of the merchant agreement to be applied whenever premium cards are used. Merchant processes a premium card and their 1.5% turns into 3.5% (or more).
If the merchant had taken the time to read through the agreement and had carefully examined the pricing table they would have seen some language related to downgrades and premium cards. They would have known to ask the sales person about it and could have avoided the problem.
As far as recommended best practices go, if discussing pricing and the sales person hasn’t mentioned premium cards or interchange it is a major warning sign. However, even if you ask about rates for different card types it isn’t good enough. This is because there two types of processors in the industry. Some processors operate a consultancy model with highly trained staff. These staff work on a managed account basis with a smaller number of merchants managed per consultant. This processor will (generally speaking) always be able to properly explain a quote that they are providing.
The other model is for a processor to run a volume driven business that utilizes call center staff to cold call thousands of businesses in an attempt to generate leads and interest. Call center staff work from a script and cannot deviate far from it. They are instructed with a clear goal of getting a merchant to submit an application. These staff are poorly trained and most often don’t even understand what interchange is. This type of sales person is not capable of properly educating the business owner on the pricing (even if asked about it) and is why you should always get to the bottom line by reading the merchant agreement. As a side note, processors that operate a call center model are always easy to spot by Googling for complaints.
If you want to put it to the test, your salesperson should be knowledgeable and transparent with all of the details of the quotation. They should be able to tell you how much margin is built into your processing rate. They should understand interchange. If you understand interchange better than the person trying to sell the account to you it should be a major warning sign!
Read the agreement and focus on clauses that deal with rates, assessments and downgrades from the card associations (Visa and MasterCard). Look for anything that might be a surcharge and make sure you understand the pricing before you sign the contract.
Be aware of the contract term and early cancellation penalties
Many business owners don’t seem to realize that the processing agreement forms a contract between a merchant and their processor. This contract has a duration called the contract term. Every major processor in Canada and the US has a contract term. (Paypal is the exception because they don’t actually supply a merchant account, but instead aggregate transactions through their own merchant account.)
There are many reasons why a contract must exist between the processor and the merchant. Without going beyond the intended scope of this article, one of those reasons is cost.
Opening a merchant account for a business involves a significant amount of work and expense to the processor. To oversimplify a somewhat complex process, the processor must complete a KYC check (know your customer) and other due diligence to make certain that the business does not have a history of fraud and will operate a stable and honest business. This involves costs at several points throughout the process including credit reporting, technology costs, and fees owed to the card associations and upstream providers involved in the transaction flow. The end result is there is significant cost and effort to the processor, but with today’s competitive environment many processors will operate at a loss when boarding the merchant even if a nominal setup fee is being charged. The merchant will have to stick around and process for a while before the processor generate positive revenue from the account. This is one of the reasons why merchant agreements have a set contract term. The term with almost every major processor in Canada is almost always the same: 3 years. In the USA it’s often 3 years or 5 years. In Europe it seems to commonly be set to 1 year.
With the understanding that every processing agreement has a contract term, there is almost always an early cancellation penalty. Most processors have an early cancellation fee based upon the monthly fee. For example, if you are on a standard 3 year (36 month) contract and cancel after the first year it means you have 24 months remaining on your agreement. If your monthly fee was $50 you would multiply the monthly fee by the number of unfulfilled months remaining on the contract term. ($50 x 24 months) = $1,200. Keep in mind that this is just an example.
The early cancellation fee should be of particular importance to a startup business. Despite a business owners best efforts and intentions, not every startup business becomes a runaway success. In some cases a business owner may have to shutter the doors if the business isn’t working out. There are few times when a person is as financially vulnerable as when an entrepreneur must shutter a business. That is why cancellation fees should be addressed before entering the agreement. Some processors are very good at working with startups and can be flexible with merchants who are in this situation. If operating a startup and considering a particular processor, you should ask them about the cancellation penalty. A good processor will understand your concerns and work with you to address them. Different processors will provide different remedies to this situation. It’s about finding the most workable solution to the problem. If you operate a startup and this problem isn’t adequately addressed move on to the next processor who will better understand and listen to your concerns.
Are you making volume commitments?
Some processing agreements have volume commitments that a merchant must satisfy. In other words, a merchant must process X amount of dollars per month. If the merchant doesn’t satisfy this volume commitment then the discount rate can be increased or other financial penalties can be applied. This practice is almost non-existent in Canada and Europe. It’s far more prevalent with US based credit card processors. A clause like this is unfair for most small and mid-sized businesses, and is absolutely outrageous for a startup. Be aware and make sure that there are no volume commitments in your processing agreement.
As a side note to the volume commitments discussion, in some cases it is a fair fee. For example, an established business that processes 10 million dollars in sales per month would be able to negotiate a very low rate. The processor may roll out the red carpet and give them a fantastic deal. But if the merchant doesn’t end up driving that high transaction volume the processor could end up taking a loss (or at least make no revenue) in which case there was no sense in boarding the account. Again, this is something that doesn’t apply to small and mid-sized businesses. The reason I’m mentioning it is because many of the “pricing tricks” that exist in the industry originated for very meaningful reasons. It’s when and how a rule is applied that matters. What you don’t want to happen is to find yourself in a situation where you signed into a merchant agreement with some type of clause that you weren’t aware of that will have an adverse impact on your business.
Also note that the volume commitments discussed in this section are not to be confused with a monthly minimum fee, which is a standard fee to help a processor cover costs on dormant or inactive accounts. A monthly minimum is standard and fair, so long as it’s reasonable and clearly disclosed.
Use the competition to your advantage
If you are shopping to negotiate an account and have an offer that sounds too good to be true you may be able to discuss what is being offered with your second-in-line choice provider. It has often been the case that clients have come to me with quotes that were below interchange. They had thought that it appeared to be too good to be true, and in some cases it was. With expertise in the industry it’s far easier to spot shady pricing techniques than it is for someone without an understanding of interchange. I have to be careful of my advice in this regard because some processors consider their application documents sensitive and you don’t want to be sharing them with other folks. However, nothing would stop you from discussing a rate you may have been quoted verbally. Try to leverage the expertise around you to get to the bottom line and walk away with the best arrangement and value possible.
This article is by no means meant to paint any particular processor in a negative light. As I’ve mentioned above, most processors are hard working and honest. The good guys by far and away outnumber the bad guys. So do not be scared or intimidated when choosing your processor.
Remember that your credit card processor will make a little bit of money every time you process a sale. They should want you to succeed and do everything possible to support you. Good processors do this very well. If you follow the advice in the article it will help you to setup your account with a good and honest processor. Watch out for the major red flags.
If you have questions or concerns about anything related to your agreement you must discuss them. The merchant payment business is a business in which where there are no silly questions. Every time you raise a concern you should receive a direct and knowledgeable response. Above all, trust your internal radar. If you have an offer, and warning bells are going off in your mind then trust your intuition and move on until you find the solution that is right for you.
If you are educated and informed, if you read your agreement, and if you discuss the issues herein with your chosen provider you will end up with a stable solution that can help you to build your business online for years to come.
This article was written by David Goodale who is the CEO at MerchantAccounts.ca. David has over 10 years of industry expertise in the international and multi-currency ecommerce payments sector.
Merchant Accounts.ca is a leader in credit card payment processing and specializes in multi-currency transaction processing and is able to help businesses implement credit card processing solutions that can transact in many different currencies such as CAD, USD, GBP, EUR, AUD and JPY. With a client focused business model, every merchant works one on one with the same account manager for the lifetime of their account. This managed consultancy model makes implementing ecommerce transaction processing easier to achieve for small online businesses that are new to ecommerce. More information can be found on the Merchant Accounts.ca website.