Merchant Discount Rate (MDR) and interchange fees: A comprehensive guide

Understanding card processing fees is crucial for merchants looking to manage their finances effectively and improve their payment strategies. In the world of payments, there's a whole bunch of fees floating around, passing between different parties involved in transactions. For merchants who accept card payments, getting a handle on these fees isn't just useful – it's super important for making smart business choices and keeping the cash flowing.

This guide digs into one of the biggies when it comes to card processing fees: the Merchant Discount Rate (MDR). This little guy represents all the costs involved in processing card payments, including a mix of fees and charges from all corners of the payment world. Ready to uncover the secrets of the MDR? Let's dive in!

What is MDR?

Picture this: every time you swipe your card, a complex network of financial institutions springs into action, ensuring seamless transactions. At the heart of this process lies the MDR, a fee charged to merchants by acquirers for managing their merchant accounts and handling payment processing services for credit or debit card transactions.

The MDR represents a fee charged to merchants by acquirers to maintain their merchant accounts and use payment processing services for credit or debit card transactions. Typically, merchants engage in agreements with their acquirers to determine the MDR before embarking on card acceptance. This fee, typically calculated as a percentage of the transaction amount, serves as compensation for the invaluable services provided by acquirers, such as transaction processing and fraud prevention.

But here's the twist – MDR rates aren't set in stone; they can fluctuate depending on several factors. These factors encompass the size and nature of the business, the types of cards utilized by consumers, the value of the transaction, among others.

In essence, MDR acts as a pivotal component in the card payment ecosystem, shaping the financial dynamics between merchants and acquirers. As merchants navigate through the realm of card payments, a comprehensive understanding of the MDR enables them to make informed decisions, improve their payment strategies, and negotiate favourable terms with acquirers, thereby fostering financial sustainability and operational efficiency.

How MDR works

While MDR is often depicted as a single-digit percentage paid to the acquirer, it encompasses various fees, including:

1. Interchange fees, levied by the card issuer, typically comprising the largest proportion of the overall MDR.

2. Card scheme fees, established by credit card schemes like Visa and Mastercard, influenced by a merchant's monthly sales volume and industry.

3. Acquirer mark-up, remunerating the payment service provider for acquiring services, negotiable between the merchant and their acquirer or payment service provider.

Types of MDR

The calculation of MDR varies based on merchant preference and provider offerings, manifesting as either a breakdown (Interchange ++) or a blended rate.

• Blended MDR (or flat-rate MDR): Merchants levy a single rate for all transactions, regardless of the interchange rate associated with the transaction amount.

• Interchange ++ MDR: Providers utilizing this structure delineate MDR into mark-up and card scheme fees atop the interchange rate.

Having clarified MDR's definition and function, let's dive in interchange fees and their distinction from blended rates.

What are interchange fees and how are they set?

Interchange fees, established and received by the card issuer from the acquirer, occur with every card transaction processed through a card scheme. These fees remunerate the issuer for various expenses, including customer support, system upkeep, and fraud prevention. Card schemes regularly evaluate and adjust interchange fees.

As previously noted, interchange fees can vary based on several factors, including the nature of the business, the type of card utilized by the customer (e.g., credit or debit), the transaction venue (online, in-store, over the phone), and the geographical disparity between the cardholder and the business.

Geographical classification

Interchange fees fluctuate depending on the location of the transacting parties. For instance, a business operating in Germany incurs lower interchange fees for domestic transactions compared to international ones, with variations existing within each territory. Thus, interchange fee structures differ based on whether transactions are domestic, intra-regional, or interregional. Below is an overview of the various regional transaction classifications:

1. Domestic transactions occur when both the business and the cardholder's issuing bank operate within the same European country.

2. Intra-regional transactions arise when the business and the cardholder's issuing bank are situated in different EU countries.

3. Interregional transactions are transactions where the card is issued outside of the European Economic Area (EEA), and the business is located within the EU, or vice versa.

Transaction type

Card not present transactions carry higher interchange fees, as they are often deemed to bear a higher fraud risk. This is because the cardholder is not physically present during the transaction.

Put otherwise, card payments placed in-store via a POS terminal will normally have a lower interchange cost than online or over the phone transactions. Transactions which have gone through the 3DS2 authentication protocol also have lower interchange fees because of this additional security layer.

Card and business type

The interchange fee rate is impacted by the type of card used during the transaction process. Normally, credit cards incur higher fees compared to debit or prepaid cards. Additionally, there's a distinction in fees between corporate and consumer cards, with consumer cards generally carrying lower costs.

Regarding business classification, card schemes employ merchant category codes (MCCs) to categorise merchants and businesses based on the goods or services they offer.

Comparing Interchange ++ and blended rate

Now that we’ve delved into the concept of interchange fees, let’s take a look at the ways they integrate into different pricing structures. Merchants have the flexibility to select a pricing model based on their business size and preferences.

For businesses seeking transparency in processing costs, particularly interchange fees, card scheme fees, and acquirer mark-up, Interchange ++ provides a detailed breakdown. This means that businesses can understand their processing costs comprehensively, facilitating strategic decision-making for maximum revenue. Conversely, a blended rate provides simplicity and predictability for merchants prioritising ease of use.

Conclusion

Understanding interchange fees and their role in the overall cost of payment card processing is key for merchants looking to manage their finances efficiently. These fees, affected by factors such as transaction type, card type, and business classification, can significantly impact a merchant's bottom line. By grasping the complexities of interchange fees and picking an appropriate pricing structure, merchants can enhance their payment processing strategies to reduce costs and increase revenue.

Whether opting for the transparent breakdown of Interchange ++ or the simplicity of a blended rate, merchants have the flexibility to align their payment processing approach with their business needs. With this knowledge, merchants can make informed decisions that support financial sustainability and enable growth in an ever-evolving payment landscape.