Downgrades: The Silent Killers of Credit Card Transactions

By July 17, 2017Blog

“Downgrade Fees generally cost merchants an additional 1%-3% per transaction on top of the Qualified-processing rate…On average, more than 50% of a merchant’s credit card transactions experience Downgrade Fees when set up under the tier/bucket rate pricing model – which is the pricing model that most merchants receive.”

Downgrade is a term that is thrown around a lot when discussing credit card processing fees. But what does that term actually mean? In order to know what downgrades are you need to make sure you understand the basics of credit card processing and interchange rates. Each time a credit (or signature debit) card is processed it is assigned to an interchange category with a corresponding rate and fee that is used to calculate the cost of the transaction. Every transaction has a target interchange category, which is the category that has the lowest rate and fee for the given transaction type.

A downgrade occurs when a transaction is shifted to an interchange category that is priced higher than the target category. When this happens, the rate used to calculate the cost of a transaction is increased and the transaction is said to have “downgraded.” 

Here is an example of this in real-world terms. Let’s say you have a business that provides services to e-commerce merchants, you are automatically in the high-risk category of the payment processing industry. High-risk categories are not the reasons why downgrades occur. Everything in the VISA© and MASTERCARD© world is based on two criteria: type of card and type of acceptance. But in the processor world it is all about tiers. Tier-pricing is still by far the most widely used model by payment processors, well ahead of the interchange plus and flat rate merchant account models. The reason: It’s easiest to understand for merchants. You get one rate for all “qualified” transactions and a higher one for your “non-qualified” ones.

Downgrades based on pricing model

Tier-Pricing Basics

  • Qualified. These are all credit card payments that are processed in accordance with the rules and standards established in the merchant agreement and involve a regular consumer type of card.
  • Non-qualified. These are all credit card payments that involve a special type of card (reward, purchase, commercial, etc.) or Are not processed in compliance with the rules set out in the merchant agreement or Do not comply with some applicable security requirement.
  • Mid-qualified. These are all credit card payments that are key-entered, rather than swiped through a point-of-sale (POS) terminal or Involve a special type of card.

Spotting downgrades on a tier-pricing credit card processing statement can be extremely challenging. Downgrades will result in a large volume of transactions being billed at the non-qualified rate. There are processors that surcharge many non-downgrade categories. Aggressive pricing is not necessarily an indicator of excessive downgrades.

Interchange-Plus Basics

An Interchange-plus pricing model functions by passing the cost of interchange to a merchant business. Therefore, the increased cost associated with downgrades is also passed to a merchant business. The important distinction with downgrades and interchange-plus is that a processor doesn’t get any monetary benefit when a merchant’s transactions downgrade like the tier pricing.

Reasons for downgrades

The most common reasons for interchange downgrades are as follows (Source: Alt-35):

  • Failure to capture all of the required data at the point of sale (Common for key entered rather than swiped transactions).
    • Customer billing address information
    • Transaction ID
    • Lack of industry specific addendum information (e.g., check-in/out dates).
      • Failures or issues with the processing equipment may cause downgrades if not correctly set up to capture the static or industry specific data required to qualify the merchant for optimal interchange.
  • Failure to process the transaction within a timely manner (transactions must be settled within a specific timeframe following authorization, typically 2 to 3 days).
  • Failure to process within tolerance limits.
  • In e-commerce businesses the failing to use AVS (Address Verification Systems), which is a fraud deterrent tool that tells businesses whether the address provided by cardholder matches the cardholders address on file at the issuing bank. You must provide a billing with each transaction to prevent AVS downgrades from occurring.
  • If you are use a commercial entity or business credit card the interchange requirements are different. A customer code must be provided with the transaction. Supply a customer code when processing all transactions involving commercial credit card.

Alt-36 gives a great example: “the average merchant should pay approximately a 1.7% interchange fee on a qualified business-to-business (B2B), card-not-present transaction by including the required product data. One requirement to receive the optimal rate on b2b transactions is by including a P.O. (Purchase Order) or invoice number before the transaction settling. However, failure to include the data will cause the merchant to pay 2.3% or higher on the same transaction.”

How do you recognize downgrades?

There is two interchange categories that are associated with downgrades: EIRF, which stands for electronic interchange reimbursement fee and Standard, which is associated with several different possible downgrade categories. Basically, you have to look at your statement and you will see the words “EIRF” and STANDARD associated with a large number of transactions or sales volume.

Moving Forward

Merchants want predictability and proactivity. They want to be able to calculate exactly how much payment processing will cost them for any given transaction volume, so that they can forecast for their monthly expenses. Tiered pricing offers no predictability. Merchants are challenged with not knowing the ins and outs of these silent killers. Merchants can try to be proactive with manual cost analysis or find a form of automation through software that pulls in this data to report and monitor it actively in real-time.