Tiered Pricing Contracts: Three Reasons to Stay Away

Understanding Tiered Pricing in Payment Processing

Tiered pricing is a credit card processing model that categorizes transactions into different levels or tiers, each with its own fee structure. This model was once the standard in the payments industry, widely used by large processors like First Data, Worldpay, as well as smaller Independent Sales Organizations (ISOs) and agents. However, tiered pricing began to fall out of favor around 2012, when alternative models such as cost-plus (interchange-plus), flat-rate, and subscription-based pricing started gaining popularity. These newer models offered greater transparency and predictability, making them more appealing to merchants.

Despite its decline, tiered pricing is still in use today, particularly among processors who prefer the higher margins it can generate. However, it’s essential for merchants to understand the complexities and potential drawbacks of this pricing structure to avoid being overcharged for payment processing services.

What Is the Tiered Pricing Structure?

When it comes to credit card processing, there are typically four different pricing structures that you will encounter:

• Interchange-Plus Pricing:
  This is often considered the best and most transparent pricing structure. With interchange-plus pricing, processing companies charge merchants the universal interchange fees (set by the card networks like Visa and Mastercard) plus a small, fixed processing fee. This allows merchants to see exactly what they’re paying to the card networks and what they’re paying to the processor, making it easier to understand and predict costs.
• ‍Flat-Rate Pricing:
  In this structure, processors charge one flat percentage on every transaction, regardless of the card type or transaction method. While this model is straightforward and easy to understand, it can be more costly for low-risk transactions, as the same rate applies to all transactions, whether they are low or high risk.‍
• Subscription-Based Pricing:
  This model, used by companies like Sonder Payments, involves paying interchange fees plus a flat monthly fee based on your processing volume. This structure can be highly cost-effective for businesses with higher transaction volumes, as it eliminates the per-transaction markup seen in other models, offering a predictable cost structure.‍
• Tiered Pricing:
  This is the least transparent and often the most costly pricing structure. In tiered pricing, transactions are sorted into different levels or tiers (qualified, mid-qualified, and non-qualified), each of which incurs a different rate. While tiered pricing is marketed as simple and easy to understand, it is actually quite the opposite. The lack of transparency can lead to higher costs, as processors have the discretion to classify transactions in ways that maximize their profits.

Unfortunately, many business owners unknowingly sign up for tiered pricing because it’s deceptively marketed as a simple and cost-effective solution. However, understanding the pitfalls of tiered pricing can help you avoid these costly contracts.

Why You Should Avoid Tiered Pricing

1. It’s Entirely Opaque: Processors offering tiered pricing models are often intentionally vague about how their tiers are defined. This lack of transparency keeps merchants in the dark about their actual costs. For example, if your customers frequently use a specific type of card, the processor might place that card in the highest-cost tier, increasing your costs without your knowledge. In some cases, even the salespeople selling these contracts don’t fully understand which transactions fall into which tiers.

2. Rates Are Compounding: Another way tiered pricing can be misleading is through compounding rates. For instance, if a transaction falls into tier 2, you might be charged not only the rate for tier 2 but also for tier 1. This can lead to significantly higher costs than expected. For example, if your contract lists a rate of 0.5% and 15 cents per transaction for each tier, the highest tier could end up costing you 1.5% and 45 cents per transaction.

3. Tiered Pricing Leads to Higher Variability of Monthly Fees: Credit card processing is one of the highest operating expenses businesses face, second only to labor. The problem with tiered pricing is that much of this cost is variable, making it difficult to predict and budget for. With tiered pricing, the fees you pay can fluctuate significantly based on the types of cards your customers use and how transactions are categorized by the processor. This unpredictability makes it challenging to stick to a realistic budget, which is crucial for running a successful business.

At the end of the day, tiered pricing structures are designed to take advantage of business owners who are not familiar with the complexities of credit card processing. These companies exploit the fact that many merchants do not fully understand how processing fees work, leading them to pay much more than they should. The best way to protect yourself is to educate yourself about these pricing models and choose a more transparent and predictable option, like interchange-plus or subscription-based pricing.

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How Does Tiered Pricing Work?

Overview of Transaction Classification: In a tiered pricing model, processors classify each transaction into one of three tiers based on the type of card used and how the transaction is processed.

Detailed Explanation of Each Tier:

• Qualified Transactions: These usually involve card-present transactions made with standard debit or non-reward credit cards. Because they are low-risk, they incur the lowest fees.
• Mid-Qualified Transactions: This tier typically includes transactions made with rewards credit cards or those that are keyed in (card-not-present). These are higher risk, leading to higher fees.
• Non-Qualified Transactions: This includes high-risk transactions like those made with corporate or international cards or those processed without sufficient data. These attract the highest fees.

However, tiered pricing structures are intentionally vague about how their tiers are defined. If your customers frequently use a specific type of card, the processor might place that card in the highest-cost tier, costing you more money. This lack of transparency makes it difficult for merchants to predict costs accurately.

How Much Does Tiered Pricing Cost?

Cost Variability Based on Processors: Before founding Swipesum, CEO Michael Seaman worked for the largest payment processor in the U.S., where tiered pricing was a standard sales tactic. It was common practice for salespeople to have complete discretion over how they priced the tiers, often setting them as high as they thought they could get away with, based on the merchant's lack of knowledge about interchange fees. During training sessions, there was a significant focus on teaching sales teams how to maximize revenue from each merchant by bumping up the rates on qualified and mid-qualified tiers, knowing that most merchants wouldn't recognize the inflated costs they were being charged. This experience was a driving factor in Michael's decision to start Swipesum, with a mission to bring transparency and fairness to the payment processing industry. One of the many ways that companies offering tiered pricing trick merchants into paying more is by compounding their rates. For example, if you complete a transaction that falls under tier 2, you will not only pay the rate assigned to tier 2 but also the rate assigned to tier 1. This compounded rate structure often leads to significantly higher costs than expected.

Interchange Fees Influence: Interchange fees, set by card networks like Visa and Mastercard, form the baseline cost for processing transactions. In a tiered pricing model, processors add their markup on top of these fees, but the way these fees are structured can vary greatly between processors, making the true cost of tiered pricing opaque.

Pros and Cons of Tiered Processing Pricing

Pros:

• Ignorant bliss: The state of unawareness or lack of knowledge that leads to a sense of contentment or satisfaction, even when the reality may be unfavorable. In the context of tiered pricing, merchants often experience this because they do not fully understand the complexities or hidden costs associated with the pricing structure. This lack of understanding can make them feel comfortable with their pricing plan, not realizing that they might be overpaying for services.

Cons:

• Opaque Pricing: To keep you in the dark about how much of your money they are taking, processors offering tiered pricing models are intentionally vague about how their tiers are defined.
• Higher Costs for Non-Qualified Transactions: These transactions often end up in the most expensive tier, leading to higher overall processing costs.
• Inconsistent Pricing: Because processors can change how transactions are classified, your costs can vary from month to month, making budgeting difficult.

Why Processors and Banks Use Tiered Pricing

High Margins for Salespeople: Tiered pricing often benefits processors and salespeople by allowing them to earn higher margins. The complexity of the pricing model can mask the true costs, making it easier to sell based on the lower qualified rates, while the real costs to the merchant are hidden.

Influence on Banks and Partners: Banks and partners who send business to payment processors often lack deep expertise in payments and are themselves convinced by processors to offer tiered pricing. This is driven by the potential for higher revenue shares, despite the higher costs imposed on merchants.

Alternatives to Tiered Processing Pricing

Overview of Alternative Pricing Models:

• Interchange-Plus Pricing: This model is more transparent and consistent, allowing merchants to see exactly what they’re paying to the card networks and what they’re paying to their processor
• Flat-Rate Pricing: While offering simplicity, this model can be more costly for certain transactions but allows for easier budgeting.
• Membership-Based Pricing: This model is beneficial for high-volume businesses, offering predictable costs through a monthly fee in addition to interchange fees.

Is Tiered Pricing Right for Your Business?

tiered pricing is rarely the best option for your business. While it might seem straightforward at first glance, the lack of transparency and the potential for hidden costs make it a risky choice. My experience in the industry, especially working for one of the largest payment processors in the U.S., has shown me firsthand how tiered pricing is often manipulated to maximize revenue at the expense of merchants. Salespeople are trained to set tiers as high as possible, knowing that most merchants aren't experts in interchange fees and won't catch on to the inflated costs.

At Swipesum, we believe in transparency and fairness, which is why we advocate for more predictable and clear pricing models like interchange-plus or subscription-based pricing. These models allow you to see exactly what you're paying and help you avoid the pitfalls of tiered pricing. So, in short, tiered pricing is not right for your business, and Swipesum is here to help you find a better solution.