Understanding Basis Points and the Cost Structure of Payment ProcessingPayments 101

Understanding Basis Points and the Cost Structure of Payment Processing

Last Updated on April 17, 2024

To optimize payment operations, manage costs effectively, and maximize your bottom line, it’s crucial to understand the cost of payment processing. One important concept in understanding how fees are charged by card issuers and financial institutions is basis points.

This blog post takes an in-depth look at what basis points are and how they factor into the overall cost structure related to payment processing. We’ll discuss how basis points are calculated, evaluate their impact on expenses, assess scalability, and determine the overall value and quality of service provided by payment processors. By understanding these important nuances, you can streamline your payment operations, enhance customer experiences, and drive business growth.

What are basis points and why do they matter?

Basis points — often abbreviated as bps — are a standardized unit of measurement that represents a percentage change in financial transactions. One basis point equals 0.01%.

Payment processors utilize basis points to offer flexible pricing structures. While each basis point represents a minuscule fraction of a percent, a difference of even a few basis points can add up to significant savings or costs over time. As such, understanding how basis points play into payment processing is a key factor in maximizing profitability and minimizing expenses.

How are payment processing fees calculated?

Rates for processing credit card payments are actually determined by card networks (i.e. Visa, Mastercard, American Express, and Discover). Payment processors add fees for the equipment and additional services they provide. This results in a combination of fixed fees and basis points to calculate transaction fees. Fixed fees are a flat rate applied to each transaction, while basis points represent a percentage-based component.

For example, your payment processor may charge you 200 basis points (2%) plus a fixed fee of $0.30 per transaction. In this case, the fee for each transaction is determined by adding the basis points fee (based on the transaction value) to the fixed fee. Therefore, the higher the transaction value, the higher the basis point fee.

Because the card networks contribute to the cost of processing credit cards, pricing is fairly standard across the industry. Fluctuations in price are typically due to extra services payment processors provide, including the following:

Payment acceptance methods and industry risk considerations

In addition to understanding basis points, it’s important to recognize that other factors can influence the costs associated with payment processing. Here are a few examples:

  • Card Present vs. Card Not Present — Accepting payments in a physical store (card present transactions) typically have lower processing costs compared to accepting payments online or over the phone (card not present transactions). Card present transactions usually involve lower risk and lower processing fees due to the reduced likelihood of fraud.
  • High-Risk Industries — Certain industries are considered high-risk due to factors such as increased chargeback rates, regulatory complexities, or reputational risks. Payment processors often categorize businesses in these industries as high-risk, resulting in higher fees and stricter underwriting requirements. Examples of high-risk industries include travel, subscription-based services, and nutraceuticals.
  • International Payments — Accepting international payments can involve additional costs such as currency conversion fees, cross-border transaction fees, and potential compliance requirements. Payment processors may charge higher fees for international transactions due to the increased complexity and associated risks.

Understanding the cost differences across payment acceptance methods and the impact of industry risk is crucial when selecting a payment processing partner. If you work in a high-risk industry, you should be prepared for the possibility of higher fees due to the unique challenges you face.

Consider the net cost of your payment processing

The total cost of your payment processing solution depends on multiple factors such as transaction rates and fees, processing volume, payment terminals, etc.

Many businesses mistakenly believe that rates and fees are the most expensive aspect of payment processing and assume cheaper rates will automatically equate to more revenue. This isn’t true. Businesses lose substantially more money dealing with:

  • Fraud — Every dollar lost in a fraudulent transaction actually cost your business $3.75.
  • Chargebacks — Each chargeback typically costs $20-$50.
  • Declined Payments — Visa reports that 24% of subscription credit card payments are declined.

Lower rates and fees don’t always save you money. You should assess the total cost of payment processing, including all additional services your payment processor provides. Additional features can help you streamline your payment operations, enhance customer experiences, and grow your business.

Costs will change as your business scales

Payment processors charge fees based on the number of transactions processed, meaning that the cost of payment processing can rise significantly as a business grows. Consider selecting payment processing partners that offer volume-based pricing, which provides discounts as transaction volume increases. By selecting the right payment processing partner, you can support your business growth without experiencing significant spikes in payment processing costs.

Final Thoughts

Understanding the importance of basis points is critical for you to make sound business decisions around payment processing. Understanding how basis points are calculated, assessing their impact on costs, and considering scalability requirements, will help you select a processor that facilitates your payment operations in the best way possible. Don’t forget to consider the overall value and quality of service when making your decision.

At Nexio, we have years of experience in specializing in payment processing and are dedicated to helping you understand the role basis points play in payments, so you can discover a solution that fits your business processes and budget for maximum performance. Contact us today for tailored assistance on your journey towards perfecting your payment operations!

FAQs On Basis Points And Payment Processing Cost Structure

What Are Basis Points in Payment Processing?

Basis points, often abbreviated as bps and pronounced as “bips,” play a crucial role in the world of finance, particularly in payment processing. They are a unit of measure used to describe the percentage change in value or rate of financial instruments. Understanding the concept of basis points is essential for those involved in payment processing, as it directly impacts the calculation of transaction fees and interest rates.

Definition and Calculation: A single basis point is equal to 0.01% or one-hundredth of a percent. This means that 100 basis points would equal 1%. For example, if a transaction fee is said to be 50 basis points, it is equivalent to 0.50% (50 x 0.01%).

Use in Payment Processing Fees: In payment processing, basis points are commonly used to determine the fees charged by payment processors, banks, or PayFacs. These fees are a small percentage of the total transaction amount. For instance, if a processor charges 30 basis points per transaction, and a transaction is $100, the fee would be 30 basis points of $100, or $0.30.

How Are Payment Processing Fees Calculated?

The calculation of payment processing fees is a critical aspect for businesses to understand, as it directly impacts their revenue and profitability. These fees are typically composed of two main components: fixed fees and basis points. Here’s a more detailed explanation of how these fees are calculated:

Fixed Fees: This is a flat rate charged on each transaction, regardless of the transaction’s size. For example, a payment processor might charge a fixed fee of $0.30 for every transaction. This means that whether a customer spends $5 or $500, the business will pay this set fee for each transaction processed.

Basis Points: As previously explained, basis points are a unit of measurement equaling 0.01%. In payment processing, they are used to calculate a percentage-based fee on the total transaction value. For instance, if a processor charges 50 basis points on a transaction, and the transaction amount is $100, the fee would be 0.50% of $100, which equals $0.50.

Combining Fixed Fees and Basis Points: Typically, payment processors combine these two types of fees. Continuing with the above example, if a transaction is $100, and the processor charges a fixed fee of $0.30 plus 50 basis points, the total fee would be $0.30 (fixed fee) + $0.50 (basis points), amounting to $0.80.
Additional Fee Types: Apart from fixed fees and basis points, payment processors might also include other types of fees, such as monthly account fees, terminal rental fees, chargeback fees, and cross-border transaction fees. These additional fees can vary widely depending on the processor and the specific terms of service.

Tiered vs. Interchange-Plus Pricing: Payment processors often use different pricing models. In tiered pricing, transactions are categorized into tiers, with each tier having a set rate. In interchange-plus pricing, the fee is based on the interchange rate set by card networks plus a fixed markup from the processor.

Impact of Card Types and Transaction Methods: The type of card used (credit, debit, rewards, corporate, etc.) and the transaction method (swiped, keyed-in, online) can also affect the fee amount. For example, credit card transactions often have higher fees than debit card transactions.

What Factors Influence Payment Processing Costs?

The cost of payment processing is influenced by a variety of factors, each contributing to the overall fees a business incurs for each transaction. Understanding these factors can help businesses anticipate costs and make informed decisions when selecting a payment processor. Here’s an expanded view of the key factors that influence payment processing costs:

Type of Transactions (Card Present vs. Card Not Present): The mode in which transactions are processed significantly affects the cost. Card-present transactions, where the card is physically swiped, inserted, or tapped, typically have lower fees due to a reduced risk of fraud. Conversely, card-not-present transactions, such as those made online or over the phone, usually incur higher fees due to the increased risk of fraud.

Risk Level of the Industry: Different industries have varying levels of risk associated with their transactions. Industries considered high-risk due to higher rates of chargebacks or fraud (like gaming, travel, or certain types of retail) often face higher processing fees. Payment processors assess the risk level based on industry standards and historical data.

International Payment Processing: Transactions involving foreign currencies or cross-border payments generally have higher processing costs. These additional costs are due to factors like currency conversion, higher risk of fraud, and the involvement of multiple banking systems.

Type of Payment Methods Accepted: The variety of payment methods a business accepts (e.g., credit cards, debit cards, e-wallets, ACH transfers) can impact processing costs. Different payment methods come with varying fee structures.

Volume and Average Size of Transactions: Payment processors often offer volume discounts. Businesses with a high volume of transactions or high average transaction values might negotiate lower per-transaction fees.

Credit Card Types Used: Fees can vary depending on the type of credit card used for the transaction. For example, premium credit cards or cards that offer rewards often have higher processing fees.

Payment Processor’s Pricing Model: The specific pricing model adopted by the payment processor (such as flat-rate, tiered, or interchange-plus pricing) can significantly affect overall costs.

Contract Terms and Agreements: The terms of the contract with the payment processor, including any minimum transaction requirements, monthly fees, or penalty clauses for early termination, can also influence total processing costs.

Compliance and Security Requirements: Adhering to industry standards like PCI DSS compliance can involve additional costs, either in the form of direct charges from the payment processor or through investments in necessary security measures.

What Additional Costs Should Businesses Consider in Payment Processing?

When evaluating the true cost of payment processing, businesses must look beyond the basic transaction fees. Several additional costs can significantly impact the net cost of processing payments. Understanding these costs is crucial for businesses to effectively manage their finances and pricing strategies. Here’s an expanded view of such costs:

Fraud Prevention and Security Costs: To safeguard against fraudulent transactions, businesses often need to invest in advanced security measures and fraud detection systems. This includes expenses for encryption, secure payment gateways, PCI DSS compliance, and other cybersecurity measures. While these costs are essential for protecting both the business and its customers, they can add up and impact the overall cost of payment processing.

Chargeback Fees: Chargebacks occur when customers dispute a charge and request a refund from their bank or credit card company. Not only do businesses lose the revenue from the sale, but they also typically incur chargeback fees imposed by the payment processor. These fees can be substantial, especially for businesses with high rates of chargebacks.

Declined Payment Fees: Some payment processors charge fees for declined transactions. If a business experiences a high volume of declined payments, this can add to the cost of processing payments.

Account Fees: Many payment processors charge monthly or annual account fees for using their services. These fees are often fixed and are charged regardless of the number of transactions processed.

Terminal and Hardware Costs: For businesses that require physical equipment to process payments, such as credit card terminals or POS systems, there are costs associated with purchasing or leasing this hardware.

Payment Gateway Fees: If a business uses a payment gateway to process online transactions, there may be additional fees associated with this service. These can include setup fees, monthly gateway fees, and transaction fees.

Integration and Maintenance Costs: Integrating a payment processing system with existing business software (like accounting software, CRM systems, etc.) can involve additional costs. Moreover, ongoing maintenance and updates to these systems can also incur expenses.

Cross-Border and Currency Conversion Fees: For businesses that accept international payments, there can be additional costs for currency conversion and cross-border transactions. These fees are typically higher than domestic transaction fees.

Non-Compliance Penalties: Failing to adhere to industry standards like PCI DSS can result in non-compliance fees or penalties, adding to the cost of payment processing.

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