Lesson 1: The Processing Ecosystem

Every credit card transaction makes several stops before settling into your bank account.  This module will explain the entire process from swipe to settlement.  This knowledge is crucial to your success as a lifetime fee fighter!

When you accept payment from your customers in the form of a plastic card, it seems like an extremely simple process.  Within a few seconds, you learn if the transaction was approved or declined and you receive a deposit into your bank account within 24 – 48 hours.  On the surface it seems very simple, but there are many moving parts and entities involved in processing electronic transactions.  This lesson will provide an overview on each phase and participant of the processing ecosystem.  The image below displays the steps involved in the transaction process:

The Flow of a Transaction

Card Issuers

Today most folks have a few different credit and debit cards in their wallets.  The cards your customers present for payment are issued to them by a bank or a credit card company.  American Express and Discover are direct card issuers, but Visa and Mastercard are not.  Visa and Mastercard branded cards are all issued by banks, credit unions, and other financial service companies to consumers.

All cards have processing fees associated with acceptance.  These processing fees are predetermined based on the type of card your customer uses, what type of business you are, and how you processed the card.  These processing fees are called Interchange, and the money processors withhold from your transactions are paid to the issuing banks or the credit card companies.  Interchange Fees are a large part of a bank’s income and have recently been under scrutiny and regulated by the government.


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Example:  A restaurant accepts a Chase Southwest Visa Rewards Card for an $85 check.  The customer then leaves a $15 tip, so the total sale amount is $100.  The Interchange rate for a Visa Rewards Card accepted by a restaurant is 1.65% and $.10.  Your processor pays $1.75 to Chase bank for the transaction.  In the case of rewards cards, Chase will then share a part of the revenue they receive from the interchange charges with Southwest Airlines.

Card Brands

The primary card brands in the United States are Visa, Mastercard, American Express, Discover, Diners Club, and JCB.  Visa, Mastercard, and Discover to an extent are considered to be “Bankcards”.  Visa and Matercard do not issue card or extent credit to customers, all cards with their logos are issued by banks or credit unions.  Discover is now being issued by banks as well, but they also issue cards directly to customers.  The interchange rates for bankcards are set by the card brands, and are all public knowledge since Visa, Mastercard, and Discover are all publicly traded companies.

American Express, Diner’s Club, and JCB(Japanese Credit Bureau) issue cards directly to their customers, so they are considered Credit Cards.  All three companies set their own rates and provide their own authorization and settlement systems to handle processing of their cardholders’ transactions.  American Express has recently been experimenting with systems similar to Visa, Mastercard, and Discover.  They are doing this to try to acquire market share with small to medium size businesses who have declined to accept American Express due to their fees and funding timeframe.  Diner’s Club has been acquired by Discover, and their transactions are handled by Discover’s Processing Networks.  Outside of the United States, Diner’s Club is a very popular credit card, but it has not been able to acquire much market share domestically competing with the rewards cards provided by the banks or American Express.  Japanese Credit Bureau is essentially the equivalent of American Express in Japan.  They are able to be accepted in the US, but they are not very common outside of the West Coast or Major Cities.

There are many alternative payment methods gaining traction in the payment processing arena as well.  PayPal is by far the most well-known alternative payment method in today’s market.  PayPal originally facilitated payments for eBay transactions, but then extended into online transaction processing outside of eBay.  PayPal is now becoming another method of payment in the retail environment.  There are other companies that have attempted to challenge the conventional payment providers and systems, but have either failed or were acquired ultimately disappearing.  The only current alternative payment option that may have a chance to challenge the conventional giants centers around a new currency, rather than a company’s new or innovative issuing or processing system.  The new currency is digital or “cryptocurrency,” with the most well-known being Bitcoin.  There are other currencies in addition to Bitcoin, and it will be interesting to see how the currency becomes adopted and integrated into the commerce system.  The most interesting thing about cryptocurrency is that unlike any other currency, it is not created or backed by any country’s government or central bank.

Authorization Networks

An authorization is the first step of the transaction processing system.  When you facilitate the transaction through your device or system, it is transmitted through a telecom provider to the authorization network your Merchant Service Provider is using.  The authorization network then routes the transaction to the bankcard or credit card companies’ network where the transaction is then verified against the card holder’s account.  If the funds are available, an authorization code is issued for the transaction, and that information is transmitted back to Merchant Service Provider’s Authorization Network, which then transmits the result back to your processing device or system.  The second step, where the information is transmitted back with an approval code is when the transaction is “captured.”  After the transaction is captured, the authorization will exist for a period of time and can be settled immediately or at another time in the future.  The lifespan of an authorization is predetermined based on the type of card accepted, how it was processed, and the type of business accepting the card.  It is actually quite amazing how quickly the entire authorization process can happen anywhere in the world.  The authorization network is commonly referred to as the “front end” of the processing system.

Settlement Networks

Settlement is the part of the process that makes the money move from the banks or credit card companies to the business that provided the product or service.  Settlement is initiated when a batch of transactions, which are all the prior authorizations, is processed.  The settlement network goes through all of the authorizations in the batch, transmitting each one individually to the bank or credit card company with the authorization code, amount, and other required information.  When the transaction is presented with an approval, the money is then transferred from each customer’s account to the settlement network, where it will then be routed to the business’ bank account via the Acquiring Bank.  The settlement network also generates the monthly statement that is provided showing all the transactions processed as well as the associated processing fees.  The settlement network is commonly referred to as the “back end” of the processing system.

Acquirer

An acquirer is a bank or other financial institution that handles the movement of money from the card issuers to the merchants who accepted the cards for payment.  All merchant account agreements will have the acquirer as a party to the agreement.  There are currently less than 50 financial institutions registered with the card brands as Acquirers

The acquirer, either entirely or in conjunction with the Merchant Service Providers they have a relationship with, assumes all the risk involved with electronic payment processing.  In the event a business receives a chargeback from a consumer or accepts a fraudulent transaction, the acquirer is responsible for providing those funds to the issuer while working out repayment or rectifying the situation with the merchant they are contracted with.  A common misconception a lot of business owners have is that their bank is a “processor” because they can get their merchant account from a representative.  This is true in some cases, but most of the time, the merchant’s bank is an agent or reseller of a Merchant Service Provider.  The merchant’s bank would not be involved in the processing ecosystem other than to issue cards to their account holders.

Merchant Service Provider

A Merchant Service Provider (MSP) is essentially your processor.  There are different levels of MSPs, but regardless of the level, they are all composed of the three components of the processing ecosystem.  They utilize an authorization network, a settlement network, and an acquiring bank.  Some MSPs own their own authorization or settlement networks and some MSPs contract with different network providers to handle certain aspects of their transaction processing services.

Your Merchant Service Provider is the entity that sets the fees you pay for the transactions you process.  They are also responsible for providing you with technical support, customer service, and assistance with maintaining compliance.  Some MSPs also provide additional services in addition to credit card processing like Gift Cards, Customer Loyalty Programs, Check Processing, and ATM Machines.

Your Merchant Service Provider may very well be your most important vendor, as they handle the majority of the money that business takes in.  Your MSP will also try to make as much money off of your business as possible by sometimes charging exorbitant fees, by raising rates with a statement message that you may never see, or by adding one time fees for one reason or another.  As a business owner, it is your job to keep your MSP honest by educating yourself as much as possible about the service your most important vendor provides to your business.

Lot’s of Hands in the Pot!

As you can see there are more than a couple of hands reaching out to take a piece of our money as we transact!  Don’t worry, we’ve got your back and by the time you are finished with these training modules you’ll be a pro.  Below is another very good example of the credit processing flow.