Why Your Effective Processing Rate Matters More Than Your Quoted Rate (And How to Calculate It)

Credit card processing companies will often say that their rates are lower than those of other companies. For example, “Our rate is just 1.49%”, or “We can beat your current processor’s pricing.” Most people view these rates as the only important numbers.

This is not the case.

Typically, the quoted rate is just one factor determining the total processing cost over the time of your contract. To really understand how much your processing is going to cost you, you must consider all the costs (i.e. the percentages, fixed fees, monthly service fees, statement fees, PCI fees, batch fees, etc.). None of these costs are included in the rate you are quoted.

Business owners feel that a quote is the only important number, while the true rate is the smaller, irrelevant detail. In processing, the other number is often the one that controls how much money can be made.

Because your effective processing rate is the true cost of your processing, it is the number that directly gives you the ability to evaluate processing cost across your competitors. It is the number that gives you the ability to evaluate cost across competitors, see buried fees, and evaluate payments and pricing smarter.

This article will help you understand what an effective processing rate is, why it is more important than what is advertised, how to find it, and what to do in the number is excessive.

What Does Effective Processing Mean?

It means the processing fees you pay are divided by your total card sales volume, and is expressed as a percentage.

In simple terms, the processing fees charged by your payment processor are expressed as a percentage of your total sales.

This is important because your processor may break down the fees in your monthly statement.

As a result, your processor may choose to highlight a lower fee, when in reality, the fees tend to be much higher because of:

• Percentage transaction fees
• Per transaction fees
• Monthly fees
• PCI fees
• Gateway/platform fees
• Batch fees
• Assessment/Network fees
• Chargeback fees
• Non-qualified/mid-qualified surcharges
• Incidental/annual service fees

The quoted rate goes into less detail than what is actually the effective rate.

What is the Issue with the Quoted Rate?

Just because a quoted rate is often misleading does not mean that it is always false.

It is common for processors and sales representatives to highlight the most favorable number in the pricing model, and that number may be applicable to a single card type, only swiped transactions, or only applies to a qualified transaction rate that is a small fraction of your total sales.

Your total costs may increase significantly when processing multiple card types, keyed transactions, reward cards, online payments, or commercial cards, which is why the quoted rate does not accurately represent the reality.

This is why the quoted rate is misleading.

Only Qualified Transactions May Apply

Some pricing models showcase one low rate for a limited subset of transactions known as qualified transactions. However, many actual transactions do not meet this criterion. Payments made with reward cards, corporate cards, manual key entry, and online transactions may be considered higher tier.

This indicates that your starting at rate likely applies to only a fraction of what you actually process.

Exclusions of Fixed Costs is the Norm

Even when the percentage rate is true, a lot of quotes have the rationalizations of a fixed cost intact. Some of which include

• Account monthly fees
• Costs of a payment gateway
• Compliance fees for PCI
• Fees for statements
• Fees for batches
• Costs for renewal, annual

Each of these may not seem significant, but for a business with low average tickets or low monthly volume, the aggregate is easily one of the higher costs.

Pricing Complexity Can Be Hidden

Payment processing statements can be complicated. Fees can be categorized, abbreviated, and spread. A business owner may overlook assessments, markups, network fees, and pass-through costs and only focus on the primary discount rate.

This is one reason so many merchants think they are paying one rate when they are actually paying something much higher.

The Importance of Your Effective Processing Rate

Because your effective rate is true, that is, it is the most accurate representation of your costs.

This number is the clearest numerically for answering practical business questions such as:

• What % of my revenue is going to payment facilitation?
• Is my payment facilitator competitive?
• Are my costs being driven up due to obscure charges?
• How do I compare payment processors?
• Is changing my pricing structure a good way to lower my costs?

Quoted rates that are low give the impression that savings exist for sure. However, savings exist only with a lower effective rate.

It Assists in Evaluating Competitors on the Same Playing Field

Two different processors can have vastly different pricing schemes. One can have a low percentage but have multiple monthly, incidental, and other costs. The other can have a slightly higher rate for transactions but have fewer add-ons. Without knowing the effective rate, it is impossible to know which is better.

The effective rate is the only way to do a true comparison.

It Safeguards Your Profit

The revenue that is remaining after paying the processing fees diminishes with tighter margins. Effective rates that are lower have a significant cumulative effect.

The difference in effective rates of 2.65% and 3.35% seems insignificant. However, for a volume of card transactions that is \$500,000 annually, that difference amounts to \$3,500 annually.

That is money that can be used for marketing, payroll, equipment, or added to profits.

It Exposes Problems with Your Business

The cause of a higher effective rate can be attributed to your processor, but it can also be due to the way your business is structured.

To determine if your costs may go up, consider the following examples:

• Entering too many manual transactions instead of using card-present methods.
• Processing rewards cards or premium cards.
• Processing too many small ticket transactions, whereby there are fixed fees per item.
• Frequent chargeback or refund activity.
• Not providing the data that allows you to qualify for lower use of interchange categories.

Your effective rate reveals where pricing and operations require focus.

How To Determine Your Effective Rate

The calculation involves

In order to perform this calculation, you will need to obtain the total card sales and total processing fees for the defined statement period.

The calculation involves total fees divided by total sales, then multiplied by 100 to obtain a percentage.

Basic Example

To illustrate, last month your business processed \$40,000 in card sales, and the processing-related fees totaled $1,120.

This means your effective processing rate is 2.8\%.

You have processed 2.8 cents in total processing costs for every dollar that you accepted in card payments.

What are Counted As Total Processing Fees

The expectation is for you to include every single expense related to the processing of card payments that month if you want to arrive at an effective rate that has real meaning.

This may consist of:

• Discount or transaction fees
• Per-transaction authorization fees
• Processor markup
• Interchange fees
• Card brand assessments
• Monthly account fees
• Statement fees
• PCI fees
• Gateway fees
• Batch fees
  Depending on your target, you may also decide to add:
• Chargeback fees
• Retrieval fees
• Equipment leasing fees related to payment acceptance
• Monthly software fees are directly bundled with your payment stack

If you are trying to ascertain your true all-in payment cost, include everything related to processing. If you are trying to analyze core processor pricing, you might exclude one-time or odd fees. The crux of the matter is to be consistent when comparing one month, one provider, or one proposal to another.

Step-by-Step Guide to Calculating It From Your Statement

If your statement appears daunting, please follow the steps provided.

Search For Your Total Monthly Card Volume

Find the gross sum of transactions involving Visa, Mastercard, Discover, and American Express processed within the statement period. The total card sales amount is preferred since it is before fees are deducted.

Avoid the total of your bank deposit if the fees were deducted from the deposits.

Calculate Total Processing Fees

Go through every fee category on your merchant statement and write down the applicable amounts. This can include:

• Discount fees
• Transaction fees
• Authorization fees
• Network fees
• Monthly fees
• PCI fees
• Batch fees
• Gateway fees

You may need to take totals from your dashboard or monthly summary if fees are being deducted on a daily basis instead of on a monthly basis.

Fees \ Volume

Take the total fees and divide it by the monthly card total.

Multiply by 100

It is best to keep records of this for the long term because it can average out seasonal sales. For example, if multiple months had similar sales values it increases the chance of having less sales that have seasonal spikes that are not representative of the average.

Take a look at these fees from a statement, for example.

• Card sales volume:$75,000
• Processing fees that are percentage-based: $1,425
• Fees based on the number of transactions: $180
• PCI fee: $19.95
• Gateway fee: $15
• Account fee for the month: $10
• Batch fees: $22

It can be shown that:

Now, calculate the effective rate

2.23 percent is the effective rate of your processing.

If a provider had quoted you 1.79 percent plus 10 cents processing, that quote would have not accounted for the complete cost. The effective rate indicates the rate that was paid.

What Is a “Good” Effective Processing Rate?

No one figure can be determined to be ideal for every business.
A “good” effective rate takes into account multiple variables:

• Card-present or card-not-present
• Level of risk of your industry
• Average size of your transactions
• Volume of processing for that month
• The ratio of debit cards, basic credit cards, and rewards cards that you process
• Methods you’ve used to process (in-store, online, mobile, or a combination of all three)
• The model used for pricing

On average, most companies will find themselves in the low to mid 2% range, with the model and card mix resulting in a few going higher than this level. Traditional in-person retail typically has a lower effective rate than e-commerce businesses, those with lots of manual entry, and merchants with lots of small tickets.

It isn’t relevant whether your rate is consistent with your fellow merchants.

It is more important whether your effective rate is appropriate for your transaction profile; that your rate is not inflated because of poor pricing or other avoidable costs.

Common Reasons Your Effective Rate Is Higher Than Expected

If your number is higher than you expected, here are some answers.

Tiered Pricing

Tiered pricing is a form of pricing that moves many transactions into higher and more expensive buckets. This is one of the most frequent reasons merchants are surprised by their total costs.

Too Many Fixed Fees

As your business grows, the impact of monthly and per-batch fees hits you more severely. These costs represent a greater proportion of your revenue when your volume is lower.

High Card Not Present Volume

The risk associated with online, phone, and manually entered transactions is higher than for in-person chip transactions.

Small Average Ticket Size

The small payments result in higher effective costs when there is a fixed cost per transaction.

Premium Card Mix

Interchange costs for rewards, business, and some commercial cards are higher than for standard debit or basic credit cards.

Hidden Add-Ons

Merchant accounts sometimes have hidden extras such as service add-ons, memberships, compliance, and equipment that add cost without sufficient return.

How to Lower Your Effective Processing Rate

Reducing your effective rate is about more than just the lowest advertised percentage. Improving pricing transparency and reducing costs are the areas that will have the most impact.

Here are simple ways to do that.

Review Your Statements Regularly

Request a full breakdown of fees and a simple explanation for anything you don’t understand. Most of the time, there are substantial fees that are left unchallenged by the average consumer.

Pricing Model Changes

Interchange-plus pricing is normally more favorable than tiered pricing, so ask your merchant services provider about it.

Manual Entry

Encouraging chip, tap, or wallet payments may decrease risk and save money as compared to keyed transactions.

Monthly Fees

Account fees, statement fees, PCI fees, and gateway fees are just a few examples of fees that are open to negotiation.

Audit Additional Services

Examine charges associated with bundled services, compliance programs, or equipment. If you are paying for services you don’t use, removing those can reduce your all-in cost.

Evaluating Offers Using Effective Rate, Instead of Sales Hype

When comparing vendors, ask each one to provide your effective rate based on your specific processing profile, not just a generic quoted rate. Apply recent statements to actual cost models.

Why This Value Should Factor in Your Financial Review

Most business owners forget about payment processing while closely managing labor costs, rent, inventory, and advertising. They view payment processing as technical or something beyond their control. Payment processing is a variable expense.

Your effective processing rate has a direct impact on net revenue, which is why it should be factored into your financial reviews. Even a small increase is significant, especially as you increase your sales volume.

Knowing your true number empowers you to make confident decisions about:

• Which processor to choose
• Whether you are paying your current pricing a fair amount
• What payment acceptance actually costs the business
• What operational changes, if any, could reduce costs
• How to confidently evaluate future proposals

Conclusion

The processing rate you were quoted is a marketing number. Your effective processing rate is the business number.

Your effective processing rate tells you what you actually pay, after all the percentages, fixed fees, and additional charges are included. This makes it one of the key metrics that is most valuable in evaluating your processor, preserving your margins and clarifying the actual costs of card payment acceptance.

The great thing about calculating your effective processing rate is it is not difficult. With one statement and one simple calculation, you can clear the uncertainty.

If you haven’t calculated your effective processing rate before, you should do that now. This number could support the idea that your pricing is competitive or it could show that there are costs that have silently dropped your revenue. In either case you will be basing your decisions on information and not marketing rhetoric.

Frequently Asked Questions