How To Reverse Engineering U.S. Interchange Logic To Create Qualified and Interchange+ Pricing
How To Reverse Engineering U.S. Interchange Logic To Create Qualified and Interchange+ Pricing
So you don't have to buy expensive Interchange Reports.
In the previous newsletter, I introduced the Interchange & Scheme Fee Capability Maturity Model to provide a visual overview of how Payment companies gradually go through stages where the logic for determining their fees becomes more complex.
In this newsletter, I will share where most payments companies start when they try to move from the Initial Awareness Stage (buy-rate/sell-rate type or blended pricing) to the Basic Implementation Stage, in which they use Qualified or Interchange+ Pricing.
There is no better example than using the Interchange rates used for Cards Acquiring in the United States of America.
Solving the Hardest Problems First
To give you an idea of how complex U.S. Cards Acquiring is, let me give you an overview.
Visa has:
Approximately 50 - 60 different interchange categories/programs.
There are over 100 unique rate combinations when you consider different card types within each program.
There are around 10-15 main criteria types (e.g. entry mode, authorization, settlement timing, transaction amount, etc.), but many programs have specific additional requirements.
Mastercard has:
Approximately 40 - 50 different interchange categories/programs.
Over 100 unique rate combinations
Similar to Visa, about 10 - 15 main criteria types, with program-specific requirements.
Then there are Discover and American Express, with 30 - 40 and 15 - 20 different interchange programs, between 60 to 100 unique rate combinations, and 8 to 12 main criteria types.
To keep this newsletter simple, we will only focus on Visa and Mastercard.
Critical Components in Assessing which Interchange Rates need to be Applied
Unlike the previous Awareness Stage, where we only had to determine the Transaction Amount, Issuer Country Code, and Acquirer Country Code to assess Regionality, in the Basic Implementation Stage, we have to assess multiple things first to determine which Qualified rate or Interchange+ rate a transaction belongs to.
So when we break down the Interchange logic, we essentially get to the following components we need to determine.
Card Type: Different interchange rates apply to different card types, such as:
Consumer Credit
Consumer Debit (Regulated and Non-Regulated)
Commercial/Business Cards
Prepaid Cards
Rewards Cards
Premium Cards (e.g. World, World Elite, Signature, Infinite)
Merchant Category Code (MCC): Specific interchange programs are often tied to particular merchant categories or industries.
Transaction Entry Mode:
Card-present (swiped, contactless, or chip)
Card-not-present (manually keyed, e-commerce)
Transaction Amount: Many interchange programs have tiered rates based on transaction size.
Authorization and Settlement:
Where a valid electronic authorization needs to be obtained
Requiring a transaction to be settled within a specified timeframe (often 1-3 days)
Where authorization and settlement data needs to match
Data Submission:
Level II and Level III data for commercial transactions
Address Verification Service (AVS) for card-not-present transactions
Cardholder Authentication for e-commerce (e.g. 3D Secure)
Processing Method:
Standard retail
Recurring billing
Large ticket
Small ticket
Industry-Specific Requirements:
Travel & Entertainment data for airlines, hotels, car rentals
Fuel data for petroleum transactions
Healthcare, education, and government-specific programs
Tokenization: Some programs offer better rates for tokenized transactions.
Geography: Different rates may apply for domestic vs. international transactions.
Merchant Size/Volume: Some programs offer better rates for small merchants or those with high transaction volumes.
Technology Compliance: Meeting technical specifications to avoid non-compliance fees.
To assess if a transaction actually meets those criteria, we have to turn that into input fields that we can process.
Below I have provided an example of what that could look like.
Pre-Processing Data
While building logic to assess the Interchange criteria on this data is pretty straightforward, when getting to this level, there is also some additional pre-processing that needs to take place before we actually get to these values.
For example, for interchange programs that are based on the size of the transaction, such as Visa’s CPS/Small Ticket Consumer Credit, one of the criteria is that the transaction amount is less than or equal to $15.00, or for Mastercard’s T&E Large Ticket where one of the criteria is that the transaction amount is equal to or greater than $2,500.00.
Other pre-processing could include determining the Entry Mode, MCC Groupings, Settled On Time, AVS Matching, etc.
The outcome of this pre-processing can then be added to the input-file to apply the logic.
Interchange Program Selection Algorithm
While the current Artificial Intelligence hype, might have you believe that an Algorithm is very complex, it is actually nothing more than a step-by-step procedure or set of instructions designed to perform a specific task or solve a problem.
To determine the right Interchange, we have to execute the Interchange Program Selection Algorithm.
Data Preprocessing: Apply all necessary preprocessing to standardize and categorize input data.
Eligibility Determination: For each interchange program:
Check if the transaction meets all mandatory criteria
Flag the program as potentially eligible if all criteria are met
Rate Calculation: For each eligible program:
Calculate the total cost (percentage + fixed fee) based on the transaction amount
Store this information along with the program details
Sorting and Selection:
Sort the eligible programs by total cost in ascending order
Select the program with the lowest total cost
Fallback Logic: If no programs are eligible, apply the standard rate
Output Generation: Return the selected program details, including the rate, fees, and any relevant metadata
Qualified or Interchange Plus
Now that we have taken the data for a transaction and run it into our algorithm, the output becomes the selected program.
However, that doesn’t necessarily mean that it becomes the Interchange rate that the merchant sees.
As this process used to be (or still is) quite intensive to process, processors have developed a middle ground where they are still able to build in their margin while giving a merchant who is producing high volumes of transactions a “clearer” overview of the types of transactions they are processing.
With Qualified Pricing, Payments Service Providers create three tiers:
Qualified
Mid-Qualified
Non-Qualified
Based on the agreement, this could mean that transactions such as standard, non-reward, or in-person get the Qualified rate, which is a lower but flat percentage rate. The Mid-Qualified would be applied to reward cards or keyed-in transactions, and the Non-Qualified would be applied to corporate, business, and interregional cards.
But for the Payments Service Providers, who trust in their ability to calculate the accurate Interchange Program (or, like many, get it through a feed from the Card Scheme), the Interchange Plus pricing is applied. This passes through the exact interchange rate and adds a blended markup that covers the scheme fees and the processor markup.
The Problem with Reverse Engineering
While Reverse Engineering the logic that is applied to determine Interchange in U.S. Card Acquiring, the problem is that it is never perfect.
There is a reason why the manuals of the card schemes are thousands of pages long.
Similar to how the complexity of interchange and scheme fees has been simplified into blended pricing, so is qualified or interchange plus pricing often the result of reverse engineering logic, without fully understanding what goes down underneath.
That is where in the next-stage, which is the Rule-Based Processing Stage, logic is only a smaller part of how interchange and scheme fees are determined.
Something I will explore in the next newsletter.
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