Published December 17th, 2015
If you aren't taking payments for credit cards then it is quite likely you are missing out on a lot of custom. According to a 2014 survey
, 37 percent said that they make at least half of their purchases on a credit card. In the UK, around two thirds of retail spending is done on card.
Whether you are a small brick-and mortar business owner with a cafe or shop to run, or an online company looking to make their mark, credit card processing is a crucial part of any operation.
This guide covers the basics of credit card processing.
What Is Credit Card Processing?
Credit card processing includes any transaction that is made on a card, rather than with cash. There are three main situations in which this can occur:
- Online card payments
- In-store (POS) transactions
- Mail, telephone, or fax
Each of these situations has methods available by which you can process a payment made by a customer, such as a terminal or mobile credit card processor. As a merchant, you should choose your service provider and method according to your needs.
In any case, there are always four parties involved in any credit card processing transaction:
- The merchant who is selling the service or product.
- The acquiring bank; the bank used by the merchant to provide the processing.
- The issuing bank; the bank who issued your customer's credit card.
- The customer.
The acquiring bank is who you will deal with if you want to integrate credit card processing into your business. The bank will likely have two separate branches. First, there is the merchant service provider who will be your point of contact. Then, there is the processing company, who pass on information of the transaction between merchant, issuing bank and acquiring bank.
On the surface, the customer simply gives their credit card details to the merchant, manually or electronically, the payment is processed, and if accepted the transaction is complete. The merchant will receive the payment in their bank, minus the fees from the processing service.
Types Of Credit Card Processing
There are many methods in which a merchant can equip their business with the means to process credit card transactions.
Some are easier to use for others, and some more suited to larger volumes of transactions. The choice will depend largely on whether you can take a physical credit card, or whether you need to handle the transaction online or over the phone.
The Credit Card Processing Transaction
- Terminals: Terminals are a popular and convenient choice for both merchant and customer. The point of sales terminal allows the card to be swiped, or a pin entered, or even touch payment in some cases. This is the common choice for retailers on the shop floor.
- Mobile Terminal: Ideal for smaller businesses, and those who are on the move or sale outdoors, a mobile terminal uses a smartphone, along with hardware that allows the credit card to be swiped. The transaction is handled via the phone's internet. In some cases, only an app is required, and the credit card details can by typed in rather than swiped on hardware.
- Manual: It's a bit old, but it still works and could be useful for for small businesses who don't handle a lot of transactions. An imprinter takes a copy of the credit card details, and these are typed up and sent for transaction later. It's a lot of responsibility to be handling credit card details, so beware!
- Virtual Terminal: A virtual terminal allows you to connect to a secure online website, enter the credit card details manually into a form, and process the payment online for a percentage fee. They might not be the best for handling larger volumes.
- Online Payment Processing: If your an online store or business, then you will want to be able to handle credit card transactions in the non-physical world. The merchant service will often provide you with a shopping cart for customer's ease, and the the payments are then processed online.
- Third-Party Payment: Smaller businesses may prefer to deal with a third-party payment company, if for instance they struggle to get a merchant account. Sites like Paypal allow you to handle and process all payments for a percentage fee.
To understand more about what Credit Card Processing really is, let's take a look at the transaction process in a bit more depth.
A credit card transaction involves two main stages; the settlement stage, and the authorization stage. There is also a period of clearing in between.
- The customer hands their credit card account to the merchant, by swiping their card for example, or typing a pin.
- The acquiring bank (merchant's bank) finds the customer's bank via the credit card company.
- The card security is checked with the customer's bank.
- If everything is fine, the approval will be sent back to the credit card company, then to the acquiring bank, and then to the merchant, who can approve the purchase and issue a receipt. All of this can take seconds.
- Purchase information is sent by the acquiring bank to the credit card network.
- The payment is cleared, and the customer's bank prepares the information on the credit card statement.
- The customer's bank (issuing bank) sends payment to the credit card network.
- The customer's bank then sends payment to the merchant's bank, so that they receive the money for the transaction.
- The customer is billed, and can pay this balance off within 30 days, or have it added to their balance and pay interest.
And that's the basics of a credit card transaction...
The Lending & The Fees
What is effectively happening is that the issuing bank is lending money to the cardholder, in the form of credit, but the acquiring bank is also effectively lending money to the merchant.
The issuing bank will add a service fee onto the transaction, known as the interchange fee. Usually, they will take this amount, expressed as a small percentage, off what they pay the acquiring bank.
The acquiring bank will, in turn, take this off the amount that they pay the merchant. They will also take their own processing fee, known as the discount rate, or markup. This is the profit of the acquiring bank or merchant service provider.
The interchange fee ends up in the pockets of the customer's card-issuing bank. It is therefore non-negotiable with merchant service providers, and is considered a base cost, or a raw material if you like. The credit card processing company does not see any profit from this charge.
The main credit card companies such as Visa and MasterCard (aka the banks) set these charges based on the card type, merchant type, processing method, and more. This is because they are taking a small risk on chargebacks, and want to be compensated. Chargebacks are where the customer disputes the charge, and gets a refund. They must be refunded in full and the transaction costs are lost.
The interchange fee is expressed as a percentage, usually combined with a set fee. For example, you might see an interchange fee of 1.52%, and a set charge of $0.11.
You will not be able to negotiate on interchange costs, and they will be fixed between merchant providers. They are what they are, and the banks decide.
I think it's safe to call the discount rate the merchant provider and credit card processing company's markup. This rate represents the fee that your acquiring bank adds on to the cost of the transaction, for handling the information, and providing the service. You could call it their service charge.
The markup is not all profit for the provider. It is balanced against the costs of the service, and the costs of running the business as a whole. After costs, the markup represents profit. There is usually room for negotiation on this part of the charge, and it should already be considerably less than the interchange fee.
There are a number of ways that credit card processing companies can pass the interchange fees to you. In a pass-through payment the processor adds a set markup fee to the actual price of the interchange. Tiered pricing on the other hand relies on more complex qualification systems for transactions.
Markup fees may also be charged in a number of different ways. For example, volume fees depend on the volume of sales in your business. Transaction fees are charged every time you process a transaction, regardless of size. Flat fees may be charged and are independent of volumes or sales, such as monthly or yearly.
When you search for the best credit card processing company, you should consider all of the factors and fees. Interchange fees should be transparent, and remain the same regardless of the company. Markup fees should be calculated according to what gives you the best deal.