In the simplest of terms, a transaction flow is the journey a payment takes from start to approval to settlement. Any time a person buys something using a credit card, it follows a stream or transaction flow, passing through many players before the payment is settled.
Step 1: The customer purchases goods or services from the merchant with a credit card; the clerk at the point of sale swipes the credit card through a point-of-sale (POS) terminal or device to obtain the information stored on the customer’s card and then inputs the amount of the transaction.
Step 2: This information is transmitted to the merchant bank (acquiring bank). The information is transmitted in one of the following ways:
- Standard terminal – The sales authorization request is submitted through a standard phone line connection to the acquiring bank.
- IP terminal – The sales authorization request is submitted through an Internet connection to the acquiring bank with a specially designed terminal.
- Processing software – The sales authorization request is submitted through an Internet connection to the acquiring bank using computer software (such as PCCharge Pro) and a small magnetic stripe reader. No traditional terminal is needed.
- Payment processing gateway – The sales authorization request is submitted through an automated Internet website, which communicates with the acquiring bank.
- Step 3: The merchant bank captures the transaction and forwards the information to the customer’s card-issuing bank through the bank card association network.
- Step 4: The association system then routes the transaction to the issuing bank and requests an approval. The transaction is approved or declined depending on the status of the cardholder’s account.
- Step 5: The issuing bank sends back the response. If the transaction is approved, the issuing bank assigns and transmits the authorization code back to the card association.
- Step 6: The authorization code is sent from the card association to the acquiring bank.
- Step 7: The acquiring bank routes the approval code or response to the merchant’s terminal. Depending on the merchant or transaction type, the merchant’s terminal may print a receipt for the customer to sign (or the customer signs electronically), which obligates the customer to pay the amount approved.
- Step 8: The issuing bank bills the customer.
- Step 9: The customer pays the bill to the issuing bank.
Settlement of Funds
The actual transfer of funds to the merchant is known as “settlement.” At the end of each day, the merchant generally reviews the days sales, credits and voids. After verifying this, the merchant will close his batch on the POS terminal. This entails closing out the day’s sales and transmitting the information for deposit into the merchant’s bank account (on some terminals and gateways, this might be programmed to happen automatically). The acquiring bank then routes the transaction through the appropriate settlement system against the appropriate card-issuing bank.
The card-issuing bank sends the money back through the settlement system for the amount of the sales draft, less the appropriate “interchange fee,” to the acquiring bank’s account. The acquiring bank then deposits the amount, less the “discount fee,” to the merchant’s bank account. Generally, within 24 to 72 hours, the merchants will have their money. Cutting-edge merchant service providers such as Fidelity offer next-day and same-day funding options.
Important note: Even though a merchant has been funded, the transaction can always be reversed—such as when a customer initiates and wins a chargeback. Therefore, the funds released to a merchant can be theoretically considered by the acquiring banks as a “loan,” which is one of the biggest reasons why the underwriting procedures for setting up a merchant account are so strict.
The settlement procedure differs depending on the merchant’s front-end platform (e.g., Nashville, Omaha, etc.). For example, a restaurant may want to be able to track servers to easily settle tips at the end of the shift. A hotel or car rental agency may want to get a pre-approval before the customer checks in or uses the service. A bar may want to open a tab for its customers. At Fidelity Payment Services, we have many pre-built programs that any merchant can request based upon their type of business.
Interchange (Discount) Fees
Each time a cardholder uses a credit card, the merchant is charged a percentage of each transaction, usually called a discount fee. This fee is charged to a merchant because the issuing and acquiring banks assume all the risks on every transaction (late or no payment, fraud, etc.), yet fund the merchant within 48 hours of the sale. The discount rate is largely comprised of the interchange fee and assessments. Interchange rates are determined by Visa, Mastercard, and Discover. In order for the merchant to receive their funds, the acquiring bank must pay this fee to the issuing bank which is then responsible for releasing the funds from the cardholder’s account. Interchange is the “wholesale cost price.”
All other cards, such as American Express, Diners Club, and JCB (Japan Credit Bureau) set their own discount rates.
The discount fee that a merchant is charged depends on several factors including the following:
Type of business (i.e. industry, brick-and-mortar or e-commerce, etc.)
The merchant’s industry type—such as fast food, colleges, warehouses, gas stations, and more—affects rates. Each transaction must meet one or many factors to qualify for a specific category. Some factors determine if the transaction will be completed, while others determine the rate and transaction fee that will be assessed.
A handful of industries have been assigned a special rate category. In some cases, preferred rates were established to attract merchants to accept credit cards. These include warehouse clubs and supermarkets. In other cases, categorization rules reflect the unique transaction flow for a particular industry; for example, lodging and car rental businesses require authorization at check-in days before a transaction is settled. This means that additional data points like arrival and checkout dates, folio numbers, and length of rental are required to be sent to Visa or Mastercard along with the credit card data. To qualify for these categories, merchants must use industry-specific software or terminal applications, which prompt for the extra information. They must also properly transmit it to Visa or Mastercard.
As a result of new technologies, such as Mobil Speed passes, rates have been created for gas stations, fast food restaurants and convenience stores. Fast food and gas station transactions are normally completed without a signature and are considered more secure than MOTO (mail order telephone order) or Internet transactions, mainly due to the limit set on the amount of each transaction.
Type of card processed (i.e., traditional credit cards, corporate, rewards based, purchasing or check cards)
Visa and Mastercard have created an endless list of names for virtually the same product. The difference between the various commercial cards is defined by the reporting features available to the cardholder.
Commercial cards are designed to help companies maintain control of purchases while reducing the administrative costs associated with authorizing, tracking, paying and reconciling those purchases. The interchange rate for commercial cards is different than the per transaction rate for the average consumer card. In most cases, the interchange cost is higher than the consumers’ rate.
Check cards, offline debit or signature-based debit transactions are routed through the Visa/Mastercard authorization and settlement system. Transactions are settled nightly and authorized by the cardholder’s signature. Due to the decreased risk factor, these transactions are at a lower rate structure. Keep in mind that the money is not loaned; it is money that is already in one’s checking account.
Check card transactions fall into a number of categories. Visa and Mastercard established check card rates that are priced significantly lower than all other consumer credit cards. These new categories provide yet another way for processors to create unique rate offerings.
How a card is processed (i.e., card present or card not present, swiped, dipped, etc.)
Determining what a merchant will be charged is based on the method of card entry and what data is entered. The first and most obvious factor is whether the card is physically present at the POS. Whenever a card is swiped (magnetic stripe) or dipped (EMV chip) through an electronic terminal or card reader, an indicator is transmitted to Visa or Mastercard, along with the rest of the data. It records the fact that the information was received directly from the card’s magnetic stripe. Without this indicator, the transaction is not eligible for any swiped interchange category.
Magnetic stripe and EMV chip technology has been incorporated into more and more products. Readers can be found in computer keyboards, cell phones attachments, and more. Whereas it is relatively easy to capture the information from a magnetic stripe or chip, it is entirely different to properly transmit the information to Visa and Mastercard in a way that will allow the transaction to qualify for a certain rate.
It is possible and, in fact, common for merchants to believe they are qualifying for the best swiped/dipped rates, when in fact their transactions are downgrading, which means higher transaction fees for them. Merchants should be encouraged to test transactions and have their processor verify their qualification levels instead of assuming that a swipe/dip will always qualify for a certain rate.
Note that Visa and Mastercard both make a distinction between a card that was key entered due to a bad magnetic stripe as opposed to a transaction where the cardholder is not present, such as in MOTO or Internet orders. To avoid confusion, merchants should follow one simple rule to ensure that they qualify for either the key entered or the card-not-present rate: Whenever a card is not swiped, enter the information required for Address Verification Service (AVS) as well as an “order number” for every transaction. The order number can be any length.
Additionally, certain categories have strict qualifications, such as merchant category, merchant actions and transaction size. For most categories, the interchange cost is a combination of a percentage rate and a transaction fee.
- Risk presented
- Merchant credit
- Other Factors
Transaction qualification is influenced by many factors. In many cases, the only way to truly know how merchants can minimize interchange costs is to critically examine their bankcard statements.