Understanding merchant discount rate (MDR) and interchange fees

To run a successful business, you need a thorough understanding of all the costs involved. Once these insights are gained, it’s possible to either streamline the company’s operations or price products appropriately, while still remaining competitive. 

For any company that accepts credit and debit card payments, two major costs that impact every transaction are the merchant discount rate (MDR) and interchange fees. These are closely connected charges relating to the financial institutions that facilitate card payment processing. This article will go into detail about how and why merchants are charged these fees, how your business can reduce them, and how a modern payment processor can help. 

What is the merchant discount rate (MDR)?

The merchant discount rate is the fee charged by the merchant acquirer for facilitating a merchant’s card transactions. It is deducted from the total transaction amount and is typically expressed as a percentage of that amount. The MDR includes various costs associated with processing card transactions, including infrastructure, security and operational expenses, as well as the payment processor’s own profit margin.

There are several components to the merchant discount rate, because of the different services that several institutions need to carry out in order to make card payments happen. Here’s what happens when a customer makes a payment using their credit or debit card:

1. The acquirer relays the transaction to the customer’s card network, which passes on this information to the card issuer (that’s the customer’s bank or credit card company).

2. The card issuer carries out checks to ensure the customer can pay for the item, and tells the card network whether the transaction is approved or declined.

3. This information is then submitted back to the acquirer, which processes the transaction.

4. Funds are deposited from the card issuing bank into the merchant’s account, minus a small percentage that is withheld by the acquirer. This is the MDR.

The acquirer only keeps a fraction of the MDR to cover its own fees and infrastructure. The rest is sent back to the card issuer and card network to compensate them for their roles in the electronic transaction.

Interchange fees are sent to the card issuer to cover the cost and risk they take on while facilitating the transaction. We’ll go into greater depth about these in the following section. Assessment fees are sent to the card network to support its infrastructure and maintenance. These are usually fixed charges per transaction, and consistent across different types of cards and transactions.

What are Interchange Fees?

Interchange fees are a component of the MDR paid by the acquirer to the card issuer to compensate them for the risk and cost of the services they offer to the cardholder.

Interchange fees are set by payment card networks (e.g. Visa, Mastercard, JCB) and are variable. Different factors, such as the type of card used, the nature of the transaction, and the risk involved, influence the interchange fee. In some cases, for instance with American Express and Discover cards, the card issuer and card network are the same.

There are several factors that affect interchange fees. They are mostly concerned with the amount of risk that different types of transaction present to the card issuer. They include:

Transaction type

If the payment is made online, it’s known as a Card Not Present (CNP) transaction, which poses a higher risk of fraud. In-store transactions (Card Present or CP) are less risky, and generally come with lower interchange fees as a result. 

Business size

Bigger businesses – those with greater volume and value of transactions – may be able to negotiate better interchange rates, especially if they also use technology that enables advanced fraud detection techniques.

Industry type

Some industries are considered higher risk than others. For example, customer payments to airline and hotel businesses pose a greater risk because people tend to book so far in advance. Other industries, like online gaming, may be considered more vulnerable to fraudulent activity. In contrast, government agencies, grocery stores, healthcare providers, educators and petrol stations are seen as low-risk merchants where chargebacks and fraud occur less frequently. This means that they can be offered lower interchange rates. 

How your business can reduce the MDR

There are two main pricing models that acquirers use to charge merchants a merchant discount rate. Choosing the right one for your business can help reduce your costs or the resources you need to manage your finances. They are:

Interchange Plus

This is a more transparent, variable pricing model that is based on the specific interchange rate for each transaction. It’s good for larger businesses who may want to keep a close eye on their transactions, and can tolerate different rates from month to month. 

Flat-rate pricing

Flat-rate pricing (sometimes known as ‘blended pricing’) involves a predictable fee that rolls the merchant discount rate and other processing fees into one figure, usually a percentage of the transaction plus a small per-transaction fee.

There is a small amount of variability – for example international card transactions will still be charged at a higher rate – but there is less variability than merchants get by using Interchange Plus. Flat-rate pricing is designed to offer merchants a fair average rate per transaction, so the amount you pay should balance out. 

There are other ways that your business can reduce the merchant discount rate and other costs associated with electronic card transactions:

• Using certain security features, such as 3D Secure (3DS) and tokenization, can reduce your interchange rate in certain circumstances.

• You can cut the cost of processing cross-border transactions if your payment processor allows like-for-like settlement in multiple currencies. This involves settling transactions in the same currency in which the sale was made, thereby avoiding unnecessary currency conversions. 

• Pre-chargeback programmes can help you reduce the cost of payment disputes. 

How Airwallex can help

By being proactive in assessing your business needs and choosing the right payment processor, it’s possible to reduce the MDR and other fees associated with electronic transactions. 

Airwallex offers secure and cost-effective payment processing and acquiring services to help your business grow internationally. With Airwallex as your payment provider, you can collect and settle payments in multiple currencies, avoiding unnecessary currency conversion fees. Airwallex also helps you reduce the costs associated with fraud and chargebacks whilst boosting checkout acceptance rate, thanks to Smart 3DS2 authentication, pre-chargeback programs, and our machine-learing powered optimisation engine.

Chat with Airwallex’s team of experts today for customised advice on reducing your transaction costs and which pricing model is best for your business. Just click here to get in touch.