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Restaurant Economics: Caveat Venditor (Let the Merchant Beware)

As you likely know, POS sytem providers bundle payment processing with their service agreements. Also called a "merchant services processor", the service charges a fee to facilitate the transactions.

Credit card processing bundled with your POS system services agreement has upsides, including reduced upfront hardware costs. But you need to know what you're getting into when you sign on the line that is dotted.

The upside for operators is lower upfront hardware and installation costs. The POS system provider can afford it because credit card processing "is an easy way to make additional revenue," says Jeff King, founder of Payment Authorities, which audits credit card processing statements as a service to its merchant clients. In some cases, the provider will offer the hardware at a deeply discounted price, if not giving it to the operator at no charge. The money is in the credit card processing. Unfortunately, many merchants don't always understand what they are getting into when signing their POS system service agreements, King adds. "They just sign it."

Payment Authorities, a $9/month service, steps in on its clients' behalf even before they sign the agreements to ferret out conditions and terms not in the best interest of the merchant. Even something as simple as "the POS system provider charging $700 for a tablet terminal they could buy for $300," says King.

They also help clients avoid false economy when changing POS providers. King shared a story about an operator who considered changing to a newer popular provider even though the business's current system was paid in full. With the added expense of new providers upfront costs and credit card processing fees, King challenged the operator's emotional decision by explaining that the change was not going to save the business money.

Operators can also be caught off guard by credit card processing fee rate increases if they are not vigilant of rate change notices. And while the processors are required by law to provide notice of these changes, operators might not have the choice to switch processors if they are locked into the POS system provider's service.

Perhaps the good news worth noting is 51% of respondents to the 2022 RestaurantOwner.com Member POS Survey indicated they had contracts that allow them to use any credit card processor they wish. But that is not universal.

And early termination of the POS system service contract could bring significant penalties, particularly if the provider's contract includes a "liquidated damages" clause. Onerous contract terms appear to be waning among POS system and credit card processing providers. Still, a POS system provider is counting on a certain stream of revenue from merchant credit card transactions, it will incur a big loss if the merchant walks away from the deal.

With liquidated damages, you'll be charged the amount that your processor determines it will lose in revenue due to you closing your account. For example, if you have a three-year processing contract, and cancel after one year, you will pay a cancellation fee equal to two years' worth of processing costs. In other cases, the provider might just indicate that early termination will result in a flat fee. Among the contract provisions of which the operator should be aware are any language that explain how it can avoid termination fees, such as providing notice.

An example of a liquidated damages clause (borrowed from merchantmaverick.com) might read as follows:

In the event that Client terminates this Agreement within three (3) years from the date of approval or this Agreement is terminated by us prior to the expiration of the initial term due to an Event of Default, we will suffer substantial injury for which it is impractical or extremely difficult to fix actual damages. In an effort to liquidate in advance the sum that should represent such damages, you agree to pay us an "Early Cancellation Fee" of the greater of: (a) the average monthly processing fees charged to the merchant for the previous 12 months (or such shorter time if the merchant has processed for less than 12 months, multiplied by the remaining months, multiplied by the remaining months of the Agreement or (b) $350, whichever is greater.

These penalties can even be more painful if the provider required a personal guarantee from the owners. This is often required by companies entering into contracts with small and startup businesses when they are concerned that the new enterprise might fail or have insufficient funds to cover its debts. The personal guarantee shifts the payment obligations to the owners. In their enthusiasm to get the business started, independent operators are known to sign agreements without reading or fully understanding the terms and conditions.

This is why it is valuable to have an attorney review significant long-term contacts, such as POS system provider service agreements and leases. As King notes, however, if the attorney is not familiar with POS system provider and credit card processor practices and agreements, they might overlook critical language that could backfire on the operator during the life of the agreement.

Of course, POS system providers and credit card processors are in the business to make money, and there are legitimate reasons to increase fees. That said, when operators are locked into processors and cannot negotiate more-favorable fees, it can erode already slim margins.

Among the possible strategies to avoid cancellation penalties when switching systems is to keep the existing system through the end of the contract period and use it only to process one or two credit card sales a month, says King. But you should be aware of any language in the agreement that would prohibit such workarounds and invite an action for breach.

Some providers will recommend that the operator include processing fee surcharges to checks – paid via credit card, of course. But given increasing menu prices due to supply chain interruptions and inflation, that is risky business, when dining out often comes with sticker shock. A service such as Payment Authorities audits the statements and steps in to negotiate with providers as necessary. And as suggested, can ferret out provisions in the initial contract that could create problems later.

Just the Tip of the Iceberg

Credit card processing is a much more complex subject than can be covered within the scope of this article when you address not only merchant processing, but chargebacks and per-use "swipe fees" charged by banks to merchants using credit or debit cards, which average around 2-2.5% of the cost of the transaction. In addition, there are federal and state laws that govern this area of commerce.

Credit card transactions are a boon to all businesses, but they come with a cost. If there is any takeaway here, you should enter into agreements with your POS system and credit card processor service providers (who are of- ten joined at the proverbial hip) with eyes wide open, and enlist the help of experts before your sign on the line that is dotted.

Says King, "Try to look at the overall picture. Don't get emotionally attached to any system."