One of the worst practices in the credit card processing industry is called Marking up the Downgrades.  A Downgrade occurs when the business owner has a tiered pricing agreement with his/her merchant account provider (credit card processor) and a transaction occurs that does not qualify for the lowest possible interchange rate.

For example, a rewards card might have been used (rewards cards are now more than half of all cards), or a business credit card might have been used, or the transaction might have been done over the phone or internet rather than in person.  What most business owners don’t know is that the processor usually makes additional profit from such downgraded transaction than on ordinary transactions.

Here’s a specific exmple:  The interchange rate for a non-rewards Visa card at a retailer  is 1.54% + 0.10.  The retailer may have negotiated a 1.64% + 0.20 rate for Qualified transactions, providing the processor with a reasonable markup of 0.10% + 0.10 (or $0.20 on a $100 transaction).  However, if the customer uses a rewards Visa card instead the interchange rate would be 1.65% + 0.10.  In a tiered pricing scheme, the processor might qualfy such a transaction as “Mid Qualified” and charge the merchant 2.19% + 0.20.  Notice that now, instead of 0.10% + 0.10 (or $0.20) the processor makes 0.54% + 0.10, or $0.64 on a $100 transaction, around 3x as much as on the Qualified transaction.

Many business owners, upon inspecting their bills, realize that a significant portion (sometimes more than half, even) of the transactions are being cleared at a higher Non Qualified or Mid Qualified rate and causing the actual rate he/she pays to the processor to be much higher than was originally agreed upon.

Most business owners also find such a situation, where the processor makes a much higher profit on the downgraded transactions, unfair, since the details of what causes such a downgrade, and how much additional profit is being made on the downgrade, are rarely disclosed.   In this article a Vice President at Global Payments, one of the biggest credit card processors, explains how extra money is made off the downgrades in a tiered pricing system.

We recommend that all merchants insist on interchange plus pricing, where the exact interchange rates charged by Visa and Mastercard are disclosed on every statement, along with the exact markup charged by the credit card processor.