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Archive for December, 2008
Level III Data Requirements
Visa and Mastercard want to encourage merchants to capture extra data about each purchase because it is useful to some of their corporate and government customers. Thefore, they offer better interchange rates when more information about the purchase is captured by the merchant. Level III is the highest level of additional data capture and includes the following fields:
Merchant Name, Transaction Amount, Date – these are all also required for level I and are captured and reported automatically by all credit card terminals and point-of-sale systems.
Tax Amount, Customer Code (16 characters), Merchant Postal Code, Tax Identification, Merchant Minority Code, Merchant State Code – these are also required to meet Level II Data Requirements.
Item Product Code, Item Description, Item Quantity, Item Unit of Measure, Item Extended Amount, Item Net / Gross Indicator, Item Tax Amount, Item Tax Rate, Item Discount Indicator, Ship from Postal Code, Freight Amount, Duty Amount, Destination Postal Code, Destination Country Code, Alternate Tax Amount – it’s not really possible for businesses using those little black desktop terminals to capture this information, this is really only applicable to businesses that are using a computer system or point of sale system to capture the transaction.
Most online retailers collect all their revenue from credit and debit cards. They are also charged higher rates than their offline counterparts and bear the risk in the case of chargebacks, which offline stores do not.
I recently spent some time with the financial statements of Blue Nile, a large online retailer selling jewelry. BTW – I highly recommend Blue Nile, I bought my wife a pair of diamond earrings there about a year ago, got a great deal and was highly pleased with the quality of the product and customer service.
From Blue Nile’s 2007 10-K Annual Disclosure (P.28):
Credit card processing fees increased approximately $1.3 million in the year ended December 30, 2007 compared to the year ended December 31, 2006 due to the increase in sales volume.
On P.23 we can find that sales in 2007 were $319.2M compared to $251.6M in 2006, an increase of $203.2M. If credit card processing fees increased $1.3M when sales increased by $203.2M then we can reasonably conclude that Blue Nile paid an average rate of about 1.92% in 2007. That means that they paid about (319.2M x 1.92%) = $6.12M in credit card processing fees in 2007.
Since credit card processing fees have two components 1. a percentage of the sales volume and 2. a per-transaction fee, retailers that do larger transactions typically pay less (since they have fewer transaction fees) than a retailer with the same volume but small transactions. Blue Nile sells expensive stuff, with an average sale of about $1500, which keeps their processing costs lower than many other online retailers.
To examine the credit card processing fees of your own business, to see if they are reasonable, check out our free credit card processing calculator.
This summer and autumn, interchange fees and rising gas prices have drawn some attention. The majority of people pay for gas with a credit or debit card now and gas usually has pretty low margins for the retailer. The economics of gas station operators have been severely impacted by this combination.
The National Association of Convenience Stores (NACS) estimates that the 146,000 convenience stores in the U.S. paid a combined $7.6B in credit card fees, or $52,064 per store, in 2007. In contrast, those same 146,00 stores only generated $3.4B in profits (net income), or about $23,287 per store. Credit card fees are the 2nd-largest operating expense for convenience stores, behind only labor (i.e. more than rent, utilities, etc.).
Based on the NACS estimate that in 2007 the average gas station / convenience store collected $3.955M in revenue meaning that 1.32% of total revenue was paid in credit card fees. The 2008 Hitachi Consulting Study of Consumer Payment Preferences (P.6) found that 56% of purchases at gas stations and convenience stores were made with a credit card or debit card. Therefore, we can confidently estimate that the average credit card processing rate paid by convenience stores and gas stations is (1.32 / 0.56) = 2.36%.
Nearly all of an airline’s revenue comes from credit cards, particularly those focused on consumers, like Southwest Airlines. Since Southwest is publicly traded, we can garner some interesting information about credit card processing rates from their financial statements. From P.24 of the Southwest Airlines 2007 10-K Annual Disclosure :
In absolute dollars, Other operating expenses increased $122 million, of which $39 million related to credit card processing fees. The $39 million increase in credit card processing fees represented a 22.2 percent increase from 2005 compared to the Company’s 20.2 percent increase in Passenger revenues. In excess of 97 percent of Passenger revenues are booked via customer credit cards, resulting in a close correlation between these two measures
Doing the math on this, we can find out how much they paid in 2006 in credit card processing fees ($39M / 22.2%) = $177.27M and how much they paid in 2007 ($177.27 * 122.2%) = $216.27M. That’s enough to buy 54,000,000 gallons of jet fuel at current prices (around $4).
By the way, Southwest spent only $132M on its employees’ retirement plans (P.44). Southwest also only made a profit of $645M in 2007, so in other words, the credit card issuers, processors and Visa and Mastercard made 1/4 as much from Southwest’s business as Southwest did. Southwest also only paid $14M in dividends to shareholders, well less than the $216M that went to credit cards.
Southwest had $9,861M in revenue in 2007 (P.17), 97% of which was paid for with credit cards, so we can figure out the overall rate that Southwest is paying ( $216.72M / ($9,861M x 97%)) = 2.26%.
Smaller companies can often benefit from looking at the financial statements of their larger publicly-traded counterparts. If you are an SaaS business much of your revenue likely comes from customers that pay with a credit card. I looked through Rick Sherman’s On-Demand Index to find publicly-traded SaaS businesses and picked through the financial statements of those businesses, looking for those that 1. Get 100% of revenue from credit card payments and 2. Disclose those fees in their 10-K annual financial disclosure.
I am not done, but for the time being have found 1 company that meets that spec – Constant Contact. Constant Contact provides software that helps businesses manage email lists. From Constant Contacts 2007 10-K (P.37):
Cost of revenue for 2007 was $13.0 million, an increase of $5.2 million, or 67%, over cost of revenue of $7.8 million for 2006…Of the increase in cost of revenue…$700,000 related to increased credit card fees due to a higher volume of billing transactions.
So, credit card processing fees increased by $700k. We also can find on P. 31 of that same report that revenue in 2007 was $50.495M, an increase of $22.943M over the $27.552M the company earned in 2006. Let’s divide the increase in credit card processing costs into the increase in revenue (700,000 / 22,943,000) = 3.05%. We can conclude from this analysis that Constant Contact is paying about 3.05% of revenue to its credit card processor.
We can also calculate that Constant Contact paid somewhere around $1.54M in credit card processing fees in 2007 ($50.495M x 3.05%).
As your company grows, you will inevitably be faced with the prospect of credit cards: whether you should accept them, and if you do, how to go about it.
Making the move to accept credit cards can be a big step for your company, and one tacked with the disincentive of fees drawn from your revenue. However, it opens up new doors and provides a convenient and popular form of payment, so many small business owners ultimately decide to take the leap. (Services like PayPal make it possible for businesses to receive credit payments over the Internet without a credit check or any paperwork; however, these services charge higher fees and lump payments into scheduled deliveries that increase the time between a customer’s transaction and your receipt of the payment.)
Credit card processors can be found in many places. First, your bank probably has an arrangement with a credit card processor, or, if it is a large bank such as Chase or Bank of America, may itself be a credit card processor. Second, you could find a credit card processor with a local presence in the phone book. Third, most processors market themselves aggressively online. If you want help sorting through all the options, you can use our free credit card processing comparison-shopping service.
The fee for each transaction, called the discount rate, is divided into three parts: interchange, assessments, and the processor markup. Interchange, which goes to the bank that issued the credit card, is not negotiable and is composed of a flat rate for each transaction plus a percentage of the transaction. Assessments, which go to Visa and Mastercard, are also not negotiable. The processor markup, however, is negotiable and are based on a number of factors, including your business’ assessed risk, the type of transaction, and the size of a given transaction. Discount rates have been discussed on this blog here and here.
In negotiating fees with providers, the important things to consider are what sort of transactions your business will be doing and how many of them there will be. If you will have numerous transactions, getting the per-transaction fee down is crucial, whereas minimizing start-up costs like purchasing a terminal can be pivotal for lower-volume companies.
For those who have not yet checked it out, be sure to take a look at our free credit card processing calculator, which will tell you how much your business’s discount rate and its derivatives will come in at.
Visa and Mastercard take payment for their part in facilitating credit or debit card transactions. Mastercard charges 0.095% of each transaction while visa charges 0.0925%. These assessments are not Visa and Mastercard’s only source of revenue, but they are a significant part.
According to Mastercards 2007 Annual Report in 2007 Mastercard collected 1.1B in assessments. Visa does not report how much of its revenue comes from assessments, but I estimate (based on extrapolating from Mastercard’s results) that Visa collected about 1.4B in assessments in 2007. In total, that’s about $2.5B in assessments in 2007.
Assessments make up the smallest portion of most businesses’ credit card processing bill, with the larger parts going to credit card processors and to the banks that issue credit card (via interchange).
