Merchant service providers (or payment processors) facilitate the processing of consumer electronic payments. It generally involves the use of credit cards but can also apply to debit cards and direct debits to a payer's bank account.
Merchant service providers process transactions where the card is physically present or on line. The differences between the two occur in the beginning of the sales transactions. The back end processes for physical and on-line credit card sales are the same.
The merchant service process involves several steps and transaction parties. It begins when a consumer presents a card for payment.
Brick and Mortar Stores
- The purchaser presents the physical card to the merchant;
- The card is swiped at the register;
- If a debit card is used, a purchaser inputs the pin number;
- If a credit card is used, the purchaser signs the receipt;
- Data from the magnetic strip on the card (along with the pin number, if applicable) are transmitted to a merchant service provider for validation.
On-line Stores
- The purchaser inputs the required verification information into an on-line shopping cart and then through to a gateway;
- Because no card is present, the purchaser needs to input the data found on the magnetic strip (account number, name, address, etc.);
- The gateway transmits the data to a merchant service provider's validation system.
Merchant Services Provider
- The merchant services provider verifies that the card is not on a lost, stolen or cancelled list; and that the amount of the transaction does not put the card over the credit limit.
- Merchant service providers maintain extensive databases of fraudulent cards.
- They also maintain an intricate system for identifying risky transactions.
- Merchant service providers first "authorize" a transaction and then "settle" the transaction. The authorization process determines that the card is valid and has enough credit available. The settlement process actually charges the card holder's account.
Approval Process
For a credit or debit card, validation data is included in the magnetic strip. This includes card number, country code, name, and telephone number and expiration date. The address may be included on the strip as well.
For on-line or phone transactions, the merchant uses a gateway to process the transactions. The gateway allows consumers to input enough data to validate card ownership, i.e. it effectively takes the place of the magnetic strip and card reader. In both types of transactions, the payment processor needs to check that the purchaser has a right to use the card.
"Chargebacks" is the industry term for reversing a prior payment if there is evidence that the card was used fraudulently or if the merchant failed to deliver the agreed-upon goods or services. There are certain validation rules that prevent merchants from accepting fraudulent cards; and merchants may choose to enhance security and further limit fraudulent activity.
Once the card is approved by the payment processor, the transaction is approved.
Merchant Acquiring Bank
A merchant service provider works with a merchant acquiring bank to facilitate the transfer of funds to and from the various issuing banks. The acquiring bank will collect charges from all of their merchants and send those charges to the issuing banks. Funds collected from issuing banks are sent back to the merchant's banks. This exchange of funds happens daily.
Processing Fees and Deposits
Determining fees can be complex. Fees are assessed by the merchant service providers, the merchant acquiring banks and the banks that issue cards. Fees include a fixed amount per transaction; plus a discount %; plus a monthly fixed amount for gateway and statement charges. Fees can increase based on other factors, such as risk inherent in certain types of cards (e.g., corporate cards); or if the card is part of a points program. Fees generally run between 2 ½% and 3 ½%.
Visa, MasterCard and Discover receipts are usually deposited together. Fees are normally collected and billed to a merchant once a month. Fees may also be deducted before the transaction amount is deposited into the merchant's bank account, but this is less common.
Deposits are made to a merchant's bank account 1 to business 3 days following the transaction. Merchant acquiring banks may also hold back a reserve from the deposit to the merchant's bank account. If a merchant is paid in advance and goes out of business before providing a service; or if they go out of business and cannot make good on a return, the bank is liable to the consumer. The reserve protects the bank from this possibility.
American Express
With respect to American Express, they operate are their own closed system. American Express functions as issuing bank, payment processor and merchant acquiring bank. American Express has had the reputation of providing the best service and protection to users and merchants; but they also charge the highest fees.
Visa, MasterCard and Discover all use the same clearing process run by third party banks and service providers.
Direct Debits
Payment processors can also process "direct debits" charging the purchaser's bank account and depositing the funds into the seller's bank account. This transaction method is less common. Direct debits are used primarily for subscription based services; and are usually done when the purchaser is unlikely to cancel the service, e.g., a utility bill. Fees to the merchant are usually lower, often running at 1% or less.
As mentioned earlier, direct debits are not very common in the U.S. These types of transactions, i.e. direct deductions from a purchasers bank account, are more commonly done with debit cards or recurring ACH payments. This somewhat obviates the need for a direct debit process.
Chargebacks
As mentioned earlier, the bank issuing the card will reverse a prior charge if there is evidence that the card was used fraudulently or if the merchant failed to deliver the agreed-upon goods or services. The chargeback will be sent to the merchant acquiring bank and then to the merchant. The merchant will have a certain amount of time to challenge the chargeback by proving that the purchaser did, in fact, order and receive the goods or services. The merchant acquiring bank will determine if the merchant has proven their case.
The chargeback rate that is considered acceptable is less than 1%. Over 1% and the merchant will risk a reserve holdback by the merchant acquiring bank and / or cancellation by MasterCard or Visa.