Interchange

The term “interchange” refers to both a process and the fee for that process, which involves Visa or MasterCard taking a percentage of retail transactions where a credit or signature debit card is used for payment. The amount fluctuates depending on the type of card, merchant, and transaction, averaging close to 2 percent.

Since Visa and MasterCard do not refer to the charges on consumers’ monthly statements, and prohibit merchants from displaying it on receipts, most people do not even realize that they are paying the fee. In 2006, Visa and MasterCard collected interchange of some $36 billion. This represents a 17 percent increase from the previous year, and a dramatic increase of over 117 percent since 2001.

Recent controversies
Interchange is of particular concern to some merchants, as well as more than a few economists, because it is calculated after sales tax has been applied to purchases. Naturally, this results in a higher fee than if it were applied merely to merchandise. Since retailers are required to remit the entire sales tax amount separately to various state treasuries, their prices have to compensate for the portion of the interchange fee that is charged on the sales tax.

Nine state legislatures considered at least 15 different bills on interchange in 2007. Lawmakers in Florida, Kansas, Nevada, New York and Washington investigated ways to ban interchange fees on the sales tax portion of retail purchases. Kentucky, Nebraska and Texas introduced bills mandating greater transparency in disclosing fees and processing rules by the credit card companies.

Some states, like Tennessee, even contemplated bills that would place a defined “cap” on interchange rates (at 0.75 percent in one version). The subject is sufficiently controversial that some states are still, a year later, considering multiple bills addressing all the various aspects of interchange. With the rise of economic uncertainties, some “help the consumer” legislation at the national level will doubtless address some of these costs.

Finding the future balance
Interestingly, the 2 percent average interchange rate is roughly equal to the retail industry’s historic, average profit margin. Retailers cannot absorb these interchange costs, and are constrained to pass the along to consumers in the form of higher prices. Visa and MasterCard require advertised prices to be the “credit card price,” thus making cash discounts difficult, so the interchange fee keeps prices high even for consumers paying by cash or check.

Interchange is growing more complex every year, even as advances in technology make it ever easier to implement and maintain a broad range of interchange rates and fees by card types, industry classifications and merchant profiles. New capabilities built into more sophisticated systems will allow for not just industry segmentation, but merchant segmentation within the many industry classifications. This opens up many possibilities for progress. For example, “smart card” products may be assigned a reduced interchange rate to help offset the costs of upgrading terminal infrastructure.

Interchange fees and practices are the subject of much discussion, and quite a bit of legislation, too. As with any other business matter, merchants are advised to keep an eye on changes in this area, and have various contingency plans in place to accommodate any upcoming changes, from within the industry or from lawmakers at the state and national level.