The Nebulous Art of Merchant Discount Rate (MDR) Pricing

I recently helped a fellow consultant on a project to provide a US-based Acquirer with information on payment processing here in Canada. Basically, the company’s looking to enter the Canadian market and we were part of their due diligence process.

Normally when we work together, the exchange of information is fairly consistent; he gives me a list of what he’s looking for and I deliver. Sometimes yes, I may need to add perspective on the content submitted but for the most part, we both have a strong grasp of the payments sector and generally don’t need the added guidance. Except this time, things were different.

The issue at hand was pricing: how do Acquirers establish merchant discount rates (MDR) for businesses looking to accept credit and debit card transactions? We talked about it at length, but it wasn’t enough. After more discussions and getting additional validation from industry executives, he finally acquired a comfort level with the art.

So it is here where inspiration for this document emerged; if this industry vet, who I totally respect and who certainly knows this (payments) stuff found MDR pricing confusing, others must feel the same way. The following is what I told him.

Pricing Process

Establishing MDR pricing has always been a nebulous art wielded by finance folks who don’t really share how they come by their answers. As an example, every time I needed to set up a pricing model for a referral partner looking to resell our processing services, my Pricer always gave me the end result. Often these new VAR or Software partners would try to reverse engineer the numbers to better understand how much money they could earn referring business to us but it never quite worked. Whenever I asked for the calculations behind the numbers, it was never, ever provided.

Nevertheless, from my experience, Acquirers use either a distributed or centralized pricing program:

Distributed

Once a threshold rate is in place, everything moves forward. It is here where the biggest mystery to the art exists as a number of factors are involved in determing this number – finance guys ‘n gals know what these variables are. With a base rate now in place, a minimum margin on each deal (transaction) is set. This is then scaled to allow approval at the various authority levels within an organization without supervisor intervention. For example: assuming a spread above the threshold rate for both Visa and MasterCard interchange is agreed upon, staff can add margin at the minimum level as outlined below.

80+ Bp – First Line Support (i.e: call centre rep)

60+ Bp – Account Managers

40+ Bp – Managers/Directors

20+ Bp – Senior Management

10+ BP – President / CEO

Once the deal is made, it gets forwarded to Credit for approval. Credit performs a risk assessment focused on industry, business, technology and financial factors. Based on their assessment, Credit can add terms to the deal such as rolling reserves and delayed funding or security measures like Letters of Credit.

Centralized

Thresholds are established as noted above. This time though, sales reps are required to give the deal to a dedicated pricing resource whom then produces a number. No questions asked – unless the merchant pushes the issue and there’s a going back-and-forth on rates.

Some of the factors that go into establishing a threshold rate:

• industry risk standards – MCC and/or SIC Codes..
• business, industry & financial risk assessments
• minimum margins business mandated to earn on each deal
• competitive pricing

Some of the factors that go into establishing a merchant discount rate:

• average ticket size
• projected processing volumes
• chargeback ratios
• future delivery [i.e: furniture sales]

Some of the ways merchant discount rates get used:

• Fixed Rate – this is what PayPal offers – very profitable (for PayPal).
• Qualified and Non Qualified Rates – a qualified card is your basic classic Visa or MasterCard. The non-qual represents premium cards. Note: in some cases a Delta fee may get included; the Delta is the difference between the Classic and the Premium credit card used. Reconciliation for the merchant can be very difficult.
• Bill Back – similar to the Delta described above
• Interchange Plus – probably the most equitable from all those noted above for a merchant as they will know exactly how much they’ve spent on each transaction processed.

Believe it or not there’s more to it but for now, I trust the above provides sufficient insight into a very complicated process…  nothing like a little confusion to maintain the status quo.

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