From a customer’s standpoint, there is nothing easier than swiping their card at a point of sale (POS), and they’re ready to move on with their lives. On the other hand, businesses know that it’s not quite as simple as it seems. Whenever a credit card is accepted in person, over the phone, online, or even by mail order, it’ll require a payment provider to securely process every single transaction.
For most businesses, all they know is that they need a credit card processing system, but they don’t usually pay attention to how the process works. That’s unfortunate because if businesses have a thorough understanding of how credit card processing works, they’ll be able to receive the benefits of the process with the lowest costs possible.
Keep on reading for our full breakdown of how credit card processing works and the parties involved throughout the process. In addition, we’ll take a look at the different types of pricing structures available on the market today.
Credit Card Processing 101: How It All Works
Let’s divide the process into three main phases.
The first phase is when a customer provides their payment details which they can do so in a variety of ways. For example, they can use their card in person via a card reader at a POS, online, over the phone, over email, or by mail.
The second phase begins when the credit card information is captured by the payment processer. Then, it’ll be encrypted and routed to the front-end authorization network.
The third phase commences when the authorization network requests approval from the card-issuing bank. This is the step where things can go either one of both ways.
Case One: Approval
Case one would be the customer’s account has sufficient funds and the sale appears to be legitimate. That’s when the card-issuing bank approves the transaction. Afterward, the confirmation is sent to the payment processor, which—in turn—sends back an approval message to the device used to initiate the transaction.
Case Two: Transaction Declined
Case two would go into effect if the customer’s account has insufficient funds to cover the cost of the sale. They will also decline the transaction if it seems fraudulent in any shape or form. If either of these conditions is met, then the card-issuing bank rejects the sale and returns a “decline” to the device the transaction originated from.
The Parties Involved in Credit Card Processing
After having a close look at the inner workings of a single transaction process, you might be confused at the sheer number of parties involved. In addition, how does it all take mere seconds to conclude a transaction with the high number of messages sent back and forth?
The reason behind the seamless way credit card processing works is due to the smooth and streamlined cooperation of all the involved parties. Let’s take a look at what they bring to the table.
It all starts with the card-issuing banks. They’re responsible for providing their customers with secure forms of “plastic money” that follow the latest PCI-compliant data security guidelines. At the moment, this entails providing chip-enabled EMV credit cards instead of the traditional magnetic stripe plastic.
The customers’ part of the process is limited to providing their payment information at the time of sale. As we previously discussed, this can take a variety of forms. If a customer is shopping online, they’ll be providing their payment information into a checkout form.
The same protocol applies regardless of how they’re conducting the sale. For instance, customers can now store their payment information in smartphone apps or wearable devices that can leverage near field communication (NFC) technology.
Your business is the main player for all of these transactions. If you’re operating as a brick-and-mortar retailer, then the majority of your sales will be going through your POS terminal. On the other hand, if you’re an e-commerce business, then your online payment platform will be getting all of your customers’ payment information.
Regardless of your business type, industry, or style of operations, it’ll need to have a payment gateway of one sort or another. However, you won’t have the capability to securely process credit card payments. That brings us to the payment processor.
The Payment Processor
Once a business has captured a customer’s credit card details via their POS, it’s the payment processor’s responsibility to securely encrypt their information. Then, they’ll route the transaction’s details across the card network until it reaches the customer’s bank.
The Customer’s Bank
When we talk about the customer’s bank, we refer to the bank that holds the customer’s money, not necessarily the card-issuing bank. For example, a customer’s card-issuing bank can be Mastercard, while their actual bank is Capital One Bank.
Now, after receiving the transaction’s details from the payment processor, the card-issuing bank will either approve or reject the transaction. Afterward, if the sale is approved, then the card-issuing bank will acquire the funds from the customer’s bank and deposit them into your merchant/business account.
Processing Fees for Credit Card Transactions
After building a solid foundation on how credit card processing works, it’s time to explore the different types of transaction fees. As it stands, these fees will vary depending on your merchant services provider.
Therefore, it’s key to take a look at your monthly bill to guarantee that you aren’t overpaying for your processing. For now, here are the main types of fees associated with credit card processing.
Transactional Credit Card Processing Fees
This type of fee is rather common, and most businesses are rather familiar with its terms. This fee is tagged on every transaction you run, and they can be broken down into interchange and cents per transaction.
Both interchange and cents per transaction are the only mandatory fees in the whole process, as they’re charged by the credit card companies themselves. You can see it as paying Visa, Mastercard, and others for having the ability to accept their cards, and getting access to their customers.
Recurring Credit Card Processing Fees
Similar to interchange fees, many providers will try their best to charge merchant fees for almost anything at all. These fees tend to show up on your statements as monthly minimum fees, statement fees, batch fees, and many more. They share one thing in common, which is that they occur on a regular basis.
One-Off Credit Card Processing Fees
One-off fees are exactly what they sound like. They’re fees that are mainly triggered by specific actions and aren’t recurring in nature. For example, they include terminal fees, setup fees, reprogramming fees, and other fees that just happen once or twice.
What Pricing Structures Are Available for Credit Card Processing?
In this day and age, running a business without the ability to accept credit cards would be similar to crippling your business. It might seem like they all follow a single price structure and all businesses have to pay up or lose their customers.
Yet, if you knew what pricing structures are available, you can be a savvy business and pay the bare minimum, which can cut down on your costs.
Unfortunately, you’ll find that regular pricing models don’t tend to disclose the interchange rate. Only the rate at which your business is assessed. This tends to give leeway to overcharging businesses.
To recap, the interchange rate is the preset rate that a merchant service provider (MSP) will be paying to the issuing bank. The issue is that you don’t get to see how much the MSP will be paying the issuing bank for allowing you to use their services.
Therefore, you won’t be able to compare and contrast between the fees you’re paying the MSP, and how much they’re paying the issuing banks in turn and their margin of profit. Thankfully, when it comes to the interchange-plus structure, we see the most transparent and cost-effective pricing structure for merchant account pricing.
Fundamentally, it forces the merchant service provider to fairly price their accounts. For the merchants, that process at higher volumes will be paying a bit more in fees. However, that will only be proportionate to other smaller merchants and their volumes. This way the smaller merchants won’t be actively penalized for processing fewer transactions.
In the case of tiered rate models, they organize cards into different tiers and charge processing fees based on which tiers they’re in. The issue here is that the tiering system is arbitrary and at the discretion of the provider.
Therefore, if the merchant services provider decides to place all the common card types in the costly tier, then you’ll have no wriggle room to negotiate.
Credit Card Processing: Choose Wisely
We know how confusing the whole process can get. However, for the health of your business, understanding how credit card processing works and the pricing structure you’re currently paying for is critical.
Thankfully, now you have the full picture of the process and all the involved parties. Yet, there is still so much more to learn. Make sure to check out our blog for more analysis and advice on payment solutions, in addition to a host of topics on how to run a healthy e-commerce platform.