A Piece of My Mind

Merchant Processing – A Piece of My Mind

I’m going to imagine that most of you are not intimately familiar with merchant processing and that’s OK. I wasn’t either before I owned a business and after two years of doing business I finally rolled up my sleeves and dug into this. It’s an eye opening topic.

You go out to eat. You most likely don’t pay with cash because 90% of all restaurant transactions are cashless. You use your card (swipe, dip, or tap) or your phone, watch, or other device to pay. You probably added a tip to the transaction and then you were done. A month or so later you get the bill and pay some or all of it. It’s the way things work.

From the restaurant perspective, things are a bit different. If someone pays cash, we are very happy. For that $50 tab we get to keep all $50. But, as noted, 90% of the transactions are not cash. If someone uses their card (shorthand for all of the ways people pay without cash) I, the restaurant owner, have to pay for letting people have the convenience of not carrying cash. When all is said and done, I have to pay about 3% of the bill. So for that $50 tab you rang up, I actually get $48.50. This doesn’t seem like a big deal at first glance, but we’re talking about restaurants here. A really well run restaurant has a 5% profit margin and we figure that on cash sales. So, if your math is a little rusty, 5% of $50 is $2.50 and the company (merchant processor) that processes the credit card transactions just took $1.50 of my $2.50 profit! Is it any wonder that restaurants go out of business?

So, what’s a business owner to do? There are options, of course.

  1. I can just take cash. Certainly attractive, but not feasible
  2. I can try to negotiate a better merchant processor rate (more on this later), but the bottom line is there isn’t much room for improvement
  3. I can pass the cost on to the customer by adding a surcharge for every transaction

So, why is this such a difficult problem? Isn’t the whole world going the way of China, with digital wallets and no cards at all? The Motley Fool ( certainly seems to think so. They have a whole report called “Leave Your Wallet At Home – 4 Stocks for the Digital Payment Revolution”. Copyright prevents me from sharing this article with you (or the stock recommendations they make), but the Motley Fool analysts seem to have missed a couple of critical details about China’s digital wallet system. First, it’s free for the merchants. Yes, in China, if a merchant accepts payment from your digital wallet, there is no fee associated with that transaction; it’s just like cash. Second, it’s a “digital wallet”, not a credit card. There is no credit in the system. If you don’t have enough money in your wallet, you can’t buy whatever it is you’re wanting. They’re really the digital equivalent of a debit card.

Back to the U.S. market. Taking a page from the tax code or health care billing playbook, if you want to make something as opaque as possible the first step is make it needlessly complicated. Let me introduce you to The Interchange Rate. Visa, for example, publishes a 22 page document that lists their current Interchange Rates. But merchants don’t deal with Visa directly, they have to go through intermediaries. As always, the middle man wants his cut. So merchant processors (the middle men) have two general ways to get that cut. The most common is “Interchange Plus” processing. So they figure out what the interchange rate is for a particular card and charge that fee, plus an additional percentage of the total plus an additional “swipe” fee (i.e. the cost to use the card for one transaction). Because this system is so complicated, trying to read a statement is on a par with trying to complete your taxes by yourself or trying to interpret a health care bill; basically if you don’t work in the system, you’re not going to figure it out. So another option that some companies use is “flat rate” or “flat rate +”. They figure out a rate that more or less encompasses all of the interchange fees and adds a bit of profit and present you with this rate. The most well known version of this is Square, which couples the flat rate with free software to make accepting cards easy, if you’re willing to give up 2.8% of each sale.

Like so many things we seem to love here in the United States, credit cards have all kinds of hidden costs. The Brookings Institute, perhaps the most influential “think tank” in the US has a nice December, 2019 report on How Credit Card Companies Reward the Rich and Punish the Rest of Us. The report notes

the Supreme Court upheld the card companies’ right to prohibit merchants from passing along the costs of high-reward cards to customers who chose to use them.

So if a wealthy patron comes to my place and charges a $100 meal for the family with their cash back/high miles credit card, the issuer (Visa or MasterCard) may charge me up to 5% to take that card, which completely nullifies any profit I may have made from that transaction. And I, as the merchant, cannot do anything about it. Even if I recognized that as an expensive card, I cannot adjust my fees to compensate for the extra it costs me to accept it. Thanks Supreme Court; good to know you’re on the side of the oligarchs.

The report also notes that merchants, those accepting cards for payment, bear the burden of the costs of the system.

The economics of modern credit cards are often misunderstood. The bulk of card-issuers’ profit, particularly from the luxury high-end cards, comes not from interest paid by those who carry a balance on their cards, but rather from the so-called swipe fees paid by merchants, which can range from 3% to 5% of everything you buy. American Express, for example, booked in excess of $24 billion in swipe fees in 2018, more than three times as much as their net interest income.

But surely, then, as the foundation of the vast economic engine that is credit, merchants must have some protection, right? Wrong. If you think that, you don’t know about chargebacks. Chargebacks were created as a consumer protection mechanism where a customer, if they received faulty goods, could ask the bank to reverse the charges. More recently, however, they have been the primary mechanism for merchant processors to recoup funds after identity theft. Finally there is the “friendly fraud” where a customer reverses the charges for no good reason other than they don’t want to pay for something they received.

According to consumer claims at the time of filing, nearly half of all chargebacks are supposedly in response to unauthorized transactions. A recent survey, however, found that over 80% of cardholders filed a chargeback simply because they didn’t have time to request a refund from the merchant.

Moreover, although most merchants fight chargebacks, very few win. The estimation is somewhere around 80% loss rate for chargebacks. As if that wasn’t painful enough, there is usually a fee associated with a chargeback.

A recent example: a customer placed an online order from our website for $20 worth of food. The credit card number was typed in by the customer, meaning I paid well over 3% in fees for that transaction. A month later, I got a notification that the customer had chargedback the transaction, meaning the processor took $20 from my account to cover the transaction (note I didn’t get the 3% back) AND a $15 fee for the chargeback. So, I sold $20 worth of food, then gave the $20 back to the customer plus $15 to the merchant processor (fee) and $0.60 for the original processing fee. And I have no real recourse. Why did the customer chargeback? Didn’t like the food, someone stole their card (and ordered one meal???), who knows?

About 8 months ago I realized that the fees I pay for credit card processing for 2019 are going to be about the same as the profit I make at my restaurant. So, in essence, I’ve given up 50% of my profit to give my customers the convenience of not using cash. I embarked on a journey to find better rates. I talked to everyone. Square, other flat rate processors, some flat rate + processors (lower flat rate + a monthly “subscription fee”), and a number of interchange plus processors. I had my favorites, to be sure, and a bit of a bidding war ensued. The bottom line; I saved about 0.2% on my merchant processing. That translates to about a $4,320 savings on my projected restaurant sales of $2,400,000. Good to save every penny, to be sure, but not worth 8 months of work.

I was given the option, by Elavon, one of the top ten merchant processors in the US, to add a 3.5% surcharge to each bill and keep the billed amount. This is what the State of Minnesota does when I went to get my new driver’s license. There’s a sign by the register that says you can pay by card, but they’ll add 3% to your bill. While I like the idea as it adds transparency to the process, it’s pretty clear that people don’t want to know that the system costs to use, they just want to use it. I, like most merchants, fear backlash from my customers.

Clearly the only way to win here is to just accept cash. If I was smart I’d add an ATM right next to the register and charge 3% for withdrawing funds and peck away at my customers the same way that merchant processors are getting me!



8 replies on “Merchant Processing – A Piece of My Mind”

I go to restaurant in Minneapolis that has an additional percentage fee for credit cards. I’m totally fine with it. I like the convenience of using the card and I don’t like carrying a lot of cash. I’d be happy to pay a similar fee at J. Selby’s.

Hey Dave, thanks for the comment! I appreciate the sentiment and I feel the same way, about some places that I visit. But it doens’t change the fact that this is a deeply flawed system. Fearing the piece was getting way too long, I skipped the part about how the big perk cards, typically available only to those with deep pockets and big spending limits, are able (thanks Congress) to pay out their rewards tax free. It’s a rich get richer, on the backs of the working people, and we are all unaware it’s happening at all.

I agree that this is broken.

What I’d _really_ like is a fee-free digital currency system (basically a debit card with no fees). But either this would be built by a for-profit company, who would need to make a profit doing something super creepy. Or it would need to be a government creation, and the existing CC processor surely have massive influence with legislators.

So it probably won’t happen any time soon.

Oh, I totally agree! Here’s a link to the executive summary of a longer Brookings Institute piece on China’s payment system . The key to their system is that banks are not involved. Person X buys food at my place and I accept payment from their digital wallet with AliPay. Now I have AliPay credit to use, which is kind of like having Amazon credit, if Amazon sold everything (it seems like they do, but they don’t). The Brookings piece concludes that entrenched money interests in the US are the biggest barrier to success, even though such a system would benefit 90%+ of the US population. Ugh.

Hey Matt, nice piece. I agree with Dave about adding the surcharge. You may not be able to change the system (rage against the machine), but at least you can make a living wage profit. I don’t balk at the charge when I see it at merchants.

The other option is simply to raise your prices by 3-5%. It’s a cost of doing business in a charge card world so adding that cost to your published prices is fair (or offer a discount to cash paying customers). With your reputation and demand for your goods, your loyal customer base likely wouldn’t be put off by the higher prices.

Hope you are well…


Boris! I am well, thanks. I pondered the surcharge, but I couldn’t bring myself to pull the trigger. Yes, it’s a fix for the restaurant, but it’s still a broken system. As you well know, if a patient asks “How much will this appendectomy cost?” the answer should never be “it depends on what your insurance is”. But that is the answer, every time. Similarly, how much does this burger cost shouldn’t be followed with “it depends on how you’re paying”. And while I may be able to get away it, where does that leave everyone else who struggling to make it work?

I remember trying to find the answer to this dilemma in the late 90’s with my first restaurant when credit transactions gained on and then surpassed cash sales.  When I dug into it as you have. I could not believe a corporate entity could essentially force a “tax”. ( that is what it is to me, a tax imposed by the oligarchs ) on my business to give their preferred customers cash /credit back “rewards”. I bargained too with various merchant providers, another story in itself of deceitful sales pitches that are nullified by the small print in the contracts. Ending up in the same position you find yourself in. I first put a notice by the register. .25 charge for CC transaction under $10.  I knew the contract forbid this, but did not think they would bother with me and they didn’t.  But still saw how it was eating up profits in all the other transactions. That is when I decided to raise prices.  When determining an items food cost I put the credit card fees in the food cost formula.  The merchant services still won here as they get more as well with the higher price. But at least I knew I was getting the margin needed on the menu item. I assume this is what most restaurants do now as your left with little choice if you want to survive. So actually the consumer ends up paying for this. Cash & credit customers pay for it. So once again the money funnels up from the majority, some with modest means to those who don’t need it.  To me its a tax Imposed on consumers by the corporate entities that process the transactions. Dispersing the funds not to a common good like schools and roads, but as “rewards” to a few.  It really has come in under the radar for most consumers. That brings me back to when I raised prices.  No one complained. Not about the .25 additional charge for transactions under $10 either. People seemed to understand the necessity  also notice  people with credit cards seem to pay less attention to prices. There were exceptions but overall that was the trait I was seeing as CC transactions grew.  For the few that asked I said “Cash is king!”  much preferred. But the convenience of the card was an unstoppable wave. Seemingly,  without much regulation protecting the small business or the consumer. Initially it was nearly impossible for a business owner to set up a merchant contract without penalties for changing services.  So without serious due diligence, and as you noted very time consuming to research . Many businesses found themselves locked into bad percentages in addition to hidden fees.
I always thought and still believe that there should be a digital US Currency that is separate from the banks. That would work just like cash “legal tender” does.  The option should be there, it should be a right – For the consumer,  It should not cost money to spend money and for the business, it should not cost money to receive money.  This should not be accomplished by the government contracting a bank to provide. It should be a government entity. The US Mint of digital transaction. the service funded the same way printing dollar bills is funded. I imagine that the banks/transaction services would lobby and fight tooth an nail to retain their hold on this extremely profitable business of profiting off both sides of virtually every transaction.

Hey Rick! Good to hear from you. I like the concept, it’s taxation without representation! I also like the idea of a digital currency, great thoughts!

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