How Credit Card Transactions are Processed
Thus far we've looked at credit cards from the viewpoint of the consumer, the user of credit cards. We'll now turn our attention to the viewpoint of the vendor. The truth is that credit cards are an essential component of the current consumer economy. Any merchant accepting credit cards will make more income overall than a merchant who does not; especially if the marketing power of the internet is taken into account.
In general credit card payments can either be processed by a card issuer, a bank or a payment service provider. These are all referred to as Processing Companies. Of these a ayment Service Provider (PSP) may be advantageous in that they can connect to multiple acquiring banks and card networks, thereby making the merchant less dependent on any single financial institution. Furthermore, a PSP can offer reconciliation services, risk management and multi-currency functionality which can be invaluable if you plan to ooperate in multiple locales.
The Mechanism of Processing Credit Card Transactions
Obviously any credit card transacton starts with a customer chosing some goods or services and deciding to pay for them with a credit card. The merchant then accepts this card from the customer which is swiped or entered into a machine that is linked to the PSP (often via a telephone line). The card details are transmitted to the PSP which makes some basic checks to ensure that the card hasn't been reported stolen, that the card hasn't been cancelled and that the customer is still within their credit limit. This step is generally known as the 'initiating' process.
Depending on your equipment and whether you are an on-line business or not (and it is best to ensure that you have equipment that will allow real-time authorization of a transaction) the machine's software will send the card details and the amount to be debited to the PSP if all is well the transaction will immediately be approved (a process knwon as 'authorization') otherwise the transaction will be denied. This is critical for cutting back on charge-backs and card errors, all of which cost you money. Despite this a credit card transaction is often more secure than other forms of payment, such as checks, because the issuing bank commits to pay the merchant the moment the transaction is verified.
Though the purchase has been completed from the coustmer's viewpoint at this point the merchant still has one further task to perform. At the end of the business day all the outstanding credit card charges need to be processed. This process is generally known as 'batching' and used to be done by hand; though these days it is either performed by a central computer or on the credit card terminal itself. At this point the credit card processing company will send each credit card company involved in the day's transactions a copy of the transaction involved; at which point the individual credit card companies will debit the users' accounts. All that remains is for the monies owed to be credited into the merchant's account (which usually occurs within four days).
Payment Issues
Of course, the payment lag of four days may well be a matter of concern for a merchant. It is important to be certain that the money owed is actually on its way to your account. This should not really be a concern as long as you are registered with a reputable PSP. As always thoroughly check the record of any company you are going to sign up with. What is of more concern is your liability if a card has been fraudulently used to purchase something from you. Again, this is a matter of chosing the right Payment Service Provider as many credit card processing companies have protection policies in place that will absolve you of any responsibility should you be a victim of credit card fraud as long as you followed their authorization procedures 100%. Before you decide on which processing company to go with, check out their safety policies, particularly if you are an Internet company. You will want as much protection as you can get.
Drawbacks of Credit Cards for Merchants
The credit card companies generally charge merchants about 2 to 3% of each transaction to accept credit card payments (this, however, is negotiated by the merchant). These are generally known as Interchange Fees and are charged by the merchant's acquirer to a card-accepting merchant as component of the so-called merchant discount fee. The merchant pays a merchant discount fee that is typically 2 to 3 percent (this is negotiated), which is why some merchants prefer cash, debit cards, or even checks. The majority of this fee, called the interchange fee, goes to the issuing bank, but parts of it go to the processing network, the card brand (American Express, Visa, MasterCard, etc.), and the merchant's acquirer. For a typical credit card issuer, interchange fee revenues may represent about fifteen percent of total revenues.
Obviously, credit card companies do not want merchants to charge credit card users more than they charge other customers, even though the merchant pays a fee of 2 to 3% on every transaction to process credit payments. If this fee were transferred to consumers then the price of goods would jump which would significantly discourage credit card usage. In many places, governments have passed laws (at the urging of the credit card industry) to make the transfer of this 2–3% fee to the customer illegal. Some critics have observed that this results in what is effectively a hidden tax on all transactions conducted by merchants who accept credit cards since they must build the cost of transaction fees into their overall business expense. The end result is that cash consumers are essentially subsidizing credit card holder purchases.