By Bob Schoenbauer
Capitol Payment Systems Inc.
Question: Can you please explain ERR in plain terms? I've seen it thrown around so many times, and when I've tried to explain it to merchants, they seem to get a glossy look in there eyes, indicating that the program is way too complicated. In layman's language, please tell us what it's all about and how it's calculated.
"Coach" Bob's answer: First, let me explain that ERR is an acronym for Enhanced Recover Reduced, which is a merchant pricing model. ERR has been a hot topic lately.
Everyone seems to want to understand the mechanics of the model, along with how to explain it to merchants. Some also question the ethics of this model in the name of disclosure and see it only as a short-term means for overcharging small merchants.
We, at Capitol Payment Systems Inc., currently board a percentage of our merchants on ERR and have found it to be a great retention tool for small and medium-size merchants alike. As with tiered and interchange-plus pricing, if properly priced and disclosed, ERR can be an effective alternative to have in your toolbox for any size merchant.
We first boarded merchants using ERR about three years ago. Mike, one of our new agents, had been using it elsewhere and wanted us to look at it. Mike explained that it is a great merchant-retention tool and that he does fully disclose to merchants what they are paying.
He was also quick to remind me that what merchants really remember after you leave is, "I am going to pay x amount per month and gain a local rep who will meet with me face to face."
Mike assured me merchants would be priced competitively. He pointed out that, in his eyes, merchants get the savings they want, while at the same time, the next agent that comes in the door will not be able to interpret the pricing and may just walk out the door.
In his first three months as a member of our sales team, Mike boarded approximately 40 merchants, including a small chain. We reached out to some of those merchants to see just what they did and didn't understand. All were satisfied. Most honestly only cared about savings and not how it was achieved. Today, over three years later, nearly every one of those merchants is still on board.
Due to turnover in our industry, most of our competitors are new to the business at any given time and are virtually helpless when trying to obtain business from merchants whose processing costs are based on an ERR model. Only seasoned veterans selling on effective rates will have a chance; in fact, even they will have to battle against merchants who want to talk only about their qualified rate.
Before I explain the mechanics of ERR, let me be clear that I believe in full disclosure to agents and merchants alike.
The ERR model was designed for retail and restaurant swipe merchants as a blend of tiered pricing and interchange-plus with an enhancement. With ERR, three rates are written on the merchant agreement: qualified debit, qualified credit and a non-qualified surcharge rate.
The non-qualified surcharge may also be referred to as the ERR rate. The non-qualified rate is where interchange comes in.
So, here we go. (Remember, these are card swipe merchants.) For the qualified debit and credit, the rate is very simple. What you write in is what the merchant pays. For ease of use, if you enter 1.69% in both the credit and debit boxes, that is what the merchant pays on all transactions that qualify.
This is the only time the qualified rates that you write in are used. So we are done with qualified transactions and the rates you wrote in. These are not used on non-qualified transactions.
Transactions that do not qualify will revert to the true interchange rate the transaction qualifies at or downgrade to such rates as key entered, rewards or electronic interchange reimbursement fee (EIRF). You then add the non-qualified surcharge rate that you entered on the application.
In addition, merchants will pay a difference factor, which is the tricky part. It is the difference between where the transaction actually qualifies, in this case EIRF, and the card brand's swipe interchange rate, which is the same as saying the merchant's qualified rate at true interchange.
For example, let's picture doing a swiped Visa Rewards Card transaction at a retail store. We know that interchange on a Visa Rewards card is 1.65%, eleven basis points more than the merchant's base rate of CPS Retail at 1.54%. We also know that you wrote in a non-qualified surcharge of 1%.
So for that transaction, the rate would be 1.65% for the rewards card plus the 1% non-qualified surcharge you wrote in on the application, plus the difference of 11 basis points between rewards and CPS retail. Here's how it looks:
| Interchange | 1.65% |
| Non-qualified surcharge | 1.00% |
| 11 basis-point difference from CPS retail | .11% |
| Total | 2.76% |
Keep in mind that the only thing used from the application on a non-qualifying transaction is the non-qualified surcharge you wrote in. Everything else is straight interchange. The base rate used for finding the difference is the merchant's qualified rate at true interchange, and the rate that the transaction downgrades to is always true interchange.
Let's do one more: We begin with a card at 1.69% interchange and a non-qualified surcharge rate of 1%. However, the transaction downgrades to EIRF, which is 2.30% at interchange. So you have 2.30% plus the non-qualified surcharge of 1% plus the difference in EIRF at 2.30% and CPS retail at 1.54%, which is 0.76% (76 basis points). Here's how it breaks down:
| EIRF interchange | 2.30% |
| Non-qualified surcharge | 1.00% |
| 76 basis-point difference from CPS retail | .76% |
| Total | 4.06% |
I hope this sheds a little light on the mechanics of ERR.
The merchant statement shows only the qualified rate the agent wrote in. No other rates are disclosed. If you filled in 1.69% with a non-qualified surcharge of 1%, the merchant statement details only the 1.69% qualified rate.
For example, if the merchant processed $10,000, the merchant would see the following:
| $10,000 at 1.69% | $169 |
| Non-qualified transactions | $87 |
| Total | $256 |
No rate or volume is shown for non-qualified transactions - just the charge. If you think it is impossible for merchants to break down the charges when they receive their statements, you are right.
But if ERR is sold properly and fully disclosed, what the merchants really care about after the fact is that they are paying what they were told they would pay, that is to say, the effective rate or savings.
What sticks in a merchant's mind is the low qualified rate. We have all visited merchants who only want to talk about the qualified rate: You try to explain interchange plus, and they won't stop coming back to, "My rate is 1.59%; what is yours?"
As with tiered or interchange-plus pricing, How many merchants truly understand all aspects of these models when you leave them? What about a week later? Do they remember which tier each card or transaction type falls into? Do you? Do they understand the ever-growing novel of interchange?
The only ones negatively affected by ERR are your newly trained competitors who stumble in the door, possibly prepared to twist the numbers. The problem for them is all they have to work with is a qualified rate. The merchant is happy, you are happy, but the new guys have to retreat to their cars.
We all need to do our best to help merchants understand the model we choose. Used properly, ERR offers the opportunity to do this and raise your retention rate in a fair and equitable way - not discount rate, retention rate.
Regarding "ERR, a merchant retention tool," by Bob Schoenbauer, The Green Sheet, Sept. 28, 2009, issue 09:09:02, we received the following note:
Bob Schoenbauer recently wrote a nice article about ERR [Enhanced Recover Reduced], but there was a slight math error. Using ERR, you have the option to assess a surcharge to the merchant's downgraded sales volume. The surcharge is an ISO-defined percentage that is applied to the downgraded sales volume of participating merchants. Bob did a great job of explaining that.
In the ERR article, the rate for the transaction came in at 4.06%, but that is incorrect. The proper formula for ERR, according to the FDR ERR Sell Sheet available to FDR clients is:
Qualified discount rate charged, i.e. 1.69% - (minus) Nonqual-ified interchange rate, i.e. 2.30% + $0.10 + (plus) Difference between nonqualified interchange rate and "base" qualified rate (i.e. 2.30% + $0.10 - 1.54% + $0.10 for CPS Retail) + (plus) ERR surcharge %, i.e. 1.00% = (1.69% x sale amount) minus (2.30% + $0.10 cents x sale amount) plus (0.76% x sale amount) plus (1.00% x sale amount) = 1.15% profit on the individual sale.
(By the way, the $0.10 transaction fee of the interchange was dropped off for ease of math in the example below.)
The "rate" of that sale would ultimately be 3.45%, which is 1.15% plus the nonqualified interchange of 2.30% (interchange for the EIRF credit sale).
The calculation that was done appeared to be the actual interchange rate (2.30%) plus the ERR rate (1.00%) plus the difference in the two interchange categories (2.30% - 1.54% = 0.76%) which came to 4.06%.
Instead, it should be the qualified discount rate (1.69%) plus the difference between the two interchange categories (0.76%) plus the ERR rate (1.00%), or 3.45%.
Basically, an easy way to think about ERR is as follows:
On a $300 sale, that would look like this:
The profit actually comes to around 1.12%. You have to take into account you billed 1.69% plus 0.76% plus 1% (3.45%) and still had an expense of 2.30% + $0.10 for the interchange, or an effective rate of 2.33%.
3.45% - 2.33% = your 1.12% profit
Otherwise, it was a nice article. Well done, Bob!
Michael Nardy
Electronic Payments Inc.
"Coach" Bob Schoenbauer is the President and founder of Annapolis, Md.-based Capitol Payment Systems Inc., which was established in 1997. CPS is a debt-free ISO/MSP built on clarity, respect and an open door for MLS partners. Bob is always available for advice, drawing on his experience in both face to face and phone sales. You can reach him at bob@capitolpaymentsystems.com, coachbobs@verizon.net or 410-897-4960. For more info on CPS, please visit www.capitolpaymentsystems.com.
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