Lessons From the Line, July 2022

What I love most about my job is when my team and I can provide guidance that directly helps our clients’ grow and thrive in this crazy restaurant business.  Our unique understanding comes from working with hundreds of great restaurants, seeing thousands of transactions and digging in to solve problems.  Leveraging that deep focused experience is why I created this firm to work with independent restaurants and provide resources to allow independent operators to compete in an ever-consolidating world.

But, working with independent operators can make you angry.

Angry because you see passionate, hard-working operators with businesses rooted in their community get targeted by large corporations trying to bamboozle them for the bottom line.  And as the environment gets tougher heading into a possible recession the maxim “you can’t directly control revenue but you can directly control costs” should be recited between every episode of The Bear you’re binge-watching.

That’s why we did our first Lessons From the Line article about predatory merchant cash advances and now we’re turning our attention to explaining credit card processing fees.  Credit card fees are intentionally hard to understand and are becoming a bigger profit center for revenue-hungry companies that service restaurants meaning your costs could be going up or not competitive.  Understanding how you’re being charged for credit card processing and what’s negotiable can boost your profits in a meaningful way. 

It's not the sexiest stuff but it’s where we can add direct value by passing our knowledge on to you.  We have tools to evaluate exact credit card processing fee scenarios so remember to reach out if seeing your P&L is making you a bit angry.

Matt Hetrick, CPA
President and founder of Harmony Group Inc.

Demystifying Credit Card Processing Fees

The restaurant industry once had a reputation for being a notoriously “cash business”, collecting cash from customers at the time of sale. Today, in most markets, the notion of a cash business is a relic of a bygone era.

This month we’re discussing credit card fees because the vast majority of customers pay with a credit card and we field many questions from clients about the intentionally inscrutable nature of credit-card processing fees. So let’s start at the beginning, the difference between a credit and debit card.

A debit card is a card linked to a bank account you currently have, and each transaction decreases (debits) the linked bank balance in the amount of the transaction. Conversely, a credit card is linked to an unsecured loan made by a bank and every transaction increases (credits) the loan balance until it’s paid by a corresponding payment from another account. Underlying each card is either the deposit account or the loan account. The institution where the account connected to the card resides, almost always a bank, is referred to as the card issuer.

Card networks exist to facilitate the secure and orderly credit card transactions for issuers, customers and businesses by setting fee rates and functioning as intermediaries. Visa, Mastercard, American Express and Discover are the major card networks; American Express and Discover are also card issuers. Most debit cards have the card network logo because they can be settled via Electronic Funds Transfer or use the card networks, depending on if the customer chooses debit or credit at the time of sale.

A customer with a Chase (issuer) Visa (card network) enters the restaurant and wants to pay with the card. The credit card information is swiped/tapped/keyed-in where it’s transmitted to the issuer and accepted or declined. If authorized by the issuer, the information is stored in the restaurant’s payment data network with all the other authorized credit card payments (a batch) until a payments processor facilitates the payments from the issuer to the restaurant through the card network.

Now that you can see the various players in the system, you’ll understand who gets paid by your credit card fees: the card issuer, card network and payment processor. The payment processor is the only entity in this ecosystem whose fees are negotiable and deals directly with the restaurant. In fact, most point-of-sales systems also serve as payment processors.

There are essentially two varieties of pricing plans offered by payment processors: interchange plus (IC+) pricing or a flat rate.

The interchange rate is the percentage fee and transaction fee that is charged to a business by the card issuers for accepting their card. For issuers using the Visa/Mastercard card networks, the interchange rate percentage fee varies between 1.0% - 2.5% depending on card type and the transaction fee ranges from 5 to 15 cents. There are also additional assessment fees paid to the card network but they are significantly less than interchange fees.

An example will illustrate this difference, which payment processor offer is better for Example & Fictitious Restaurant (E&F)? In our example the interchange rate for a Harmony Rewards Visa is 1.85% + .10 cents. The payment processor then adds their own percentage and fee to the interchange rate in an IC+ pricing arrangement. In this example the processor adds .35% + .15 cents to the interchange rate for a total Harmony Rewards Visa processing rate of 2.20% + .25. Alternatively, the processor offers a flat rate (sometimes called a blended rate) of 2.50% + 15 cents for all Visa/Mastercard credit cards regardless of the interchange and assessments that are being charged by the card issues and networks.

That entirely depends on E&F’s check average. For the sake of simplicity let’s assume E&F is located somewhere where people only use the Harmony Rewards Visa (there are dozens of interchange rates associated with various cards).

First assume E&F is a fast casual restaurant with a check average of $15.00. Under the IC+ pricing their credit card processing fees percentage would be 3.87% and under flat rate pricing it would be 3.50%, over 5 cents cheaper per transaction. If E&F was a fine dining restaurant with a check average of $100.00, IC+ pricing is beneficial. Under IC+ their credit card fee percentage would be 2.45% and under flat rate it would be 2.65%, making IC+ 20 cents cheaper per transaction. At any check average over $34, IC+ becomes advantageous to E&F.

Two takeaways from this example: (1) the lower your check average the more significant impact credit card fees will have on your bottom line and (2) your check average determines the relative importance of weighing the percentage-based fees versus the dollar-denominated transaction fees. You should also scrutinize and ask for an explanation for every additional fee listed by your payment processor as there can be hidden fees piled on.

The most important metric to review and understand is your effective rate (credit card volume / costs associated with accepting cards). If that rate is between 2.0% - 3.0% you are probably falling into the band that most restaurants occupy. Remember if you’re evaluating this cost center, you need to calculate the effective rate because if you only look at the P&L statement the fee percentage will be higher due to credit card fees on tips that aren’t reflected in revenue and any cash transactions. In most states it is legal to deduct credit card fees from employees’ credit card tips.

A final wrinkle is that both flat and IC+ pricing can be different for card present transactions and card not present (“CNP”) transactions such as phone/mobile/online orders where the card number is keyed in or supplied digitally but not physically presented by the customer. Interchange rates consider costs from fraud and most credit card fraud occurs in CNP situations where thieves have obtained the credit card number so CNP transactions will cost more to process. A good cost evaluation process needs to understand how many transactions arise from CNP situations and how many are made at physical points of sale.

In addition to negotiating directly with your payment processor for the best rate, a merchant may elect to defray credit card fees by requiring a $10 minimum purchase for credit card purchases or charging a credit card surcharge as long as it’s registered with the card network, clearly displayed and doesn’t exceed the fees charged (although this isn’t legal in all states).

At CPA Eats we specialize in restaurants and part of that expertise comes in our seeing hundreds of different credit card processing rates and arrangements. We urge our clients to reach out to their CPA Eats advisor to investigate possible cost savings coming from understanding the complicated and intricate world of credit card fees.

Last Bites

Labor Issues Continue
The pandemic push-pull of how people relate to work continues. With all the talk of a looming recession, some employees are looking for stability and feel less secure than they did even months ago. This feeling could foreshadow more office occupancy – important for restaurants located in business districts. The push-pull of labor relations is acute in restaurants with tremendous labor problems impacting service and a wave of unionization rippling through parts of the industry.

Inflation Squeezes Consumers
While the timing or existence of a future recession is unpredictable, what's abundantly clear is that small businesses are grappling with record inflation with food and gasoline prices leading the way. As restaurants are forced to raise prices to keep up with cost increases it’s impacting the frequency of customer visits. More than 80% of customers say they are eating out less frequently. Sit down dining is most affected including casual sit down restaurants  while quick serve visits are growing.

Sure, We Deliver
If you’ve ever pined for food from your favorite online influencer that dream could become  a reality. While we offer no opinion on any particular company or the desirability of eating influencer branded content, being nimble in the ever increasing digital sales channel is something every business needs to explore. Uber had more food delivery revenue than ride hailing revenue last year and Amazon taking an equity stake in Grubhub shows the third party delivery sector is just getting more crowded.