If you want to understand how credit card networks work (and you should if you are interested in B2B platforms), the First Data S-1 contains a primer. Because First Data is the largest merchant acquirer in the US (processing $1.7 trillion in payment volume last year) as well as a major issuer processor and an ATM network provider, they understand this business from both sides and in between.
The first chart is one you have probably seen before. It is simply the description of how a credit card transaction works.
A Typical Credit Card Transaction
First Data’s accompanying description of the process is very helpful:
The processing of a traditional card transaction includes two sub-processes: (1) capture and authorization and (2) clearing and settlement.
Capture and Authorization
In the capture and authorization process, the business obtains approval for payment from the card issuing bank. This process includes the following steps:
1. Once the consumer is ready to make a purchase, he or she presents their card for payment;
2. The card is swiped in the POS device at the business location, which captures the account information contained on the card’s magnetic stripe or EMV-compliant chip;
• In a mobile commerce transaction facilitated by a mobile wallet, such as Apple Pay, the appropriate card details are stored virtually on an application on the phone and transmitted to the POS device through a chip equipped with near-field communication (NFC) technology;
• In an eCommerce transaction, the POS device is replaced by a virtual terminal application and the consumer types the card number into the check-out page of the online storefront. In some circumstances, an online wallet, such as PayPal, may be used to transmit the appropriate payment credentials;
3. The customer’s card details are transmitted from the POS to the merchant acquirer, or the merchant acquirer’s processor, via an internet connection or a phone line;
• In an eCommerce transaction, the information is encrypted and then transmitted to the merchant acquirer, or merchant acquirer’s processor, via an online gateway;
4. The merchant acquirer, or the merchant acquirer’s processor, identifies the appropriate payment network affiliated with the card, such as Visa, MasterCard, or STAR, and forwards the card details to the appropriate network;
5. The payment network receives the request for payment authorization, identifies the appropriate card issuing bank, and routes the transaction to the bank or its issuer processor;
6. The card issuing bank, or its issuer processor, receives the request and then executes a series of inquiries into its account systems to assess the potential risk of fraud for the transaction, establish that the account is in good standing, and verify that the cardholder has sufficient credit or adequate funds to cover the amount of the transaction;
7. The card issuing bank, or its issuer processor, approves or declines the transaction and sends back the response to the payment network. In this example the transaction is approved;
8. The payment network receives the approval and forwards the authorization to the merchant acquirer, or merchant acquirer’s processor; and
9. The merchant acquirer, or merchant acquirer’s processor, sends the authorization back to the POS device at the business location, which provides an approval confirmation and prints a receipt;
• In a mobile commerce transaction, the approval confirmation and receipt may also be transmitted to the consumer’s mobile wallet application or to the consumer via email;
• In an eCommerce transaction, the authorization is sent to the online storefront, which communicates the approval to the consumer on the screen, and may provide the receipt for printing online or via email.
Clearing and Settlement
In the clearing and settlement process, a request for payment is initiated, funds are transferred and the transaction is posted to the business owner’s and the consumer’s account statements. The clearing and settlement process includes the following steps:
10. Typically at the end of the day, the business submits a batch of all of its approved authorizations to the merchant acquirer, or the merchant acquirer’s processor, through a function on its POS device;
• In the case of an eCommerce business, the online storefront’s gateway sends the batch to the merchant acquirer, or to the merchant acquirer’s processor;
11. The merchant acquirer, or the merchant acquirer’s processor, receives the batch, notes the final amounts due for settlement and routes the batch of approved authorizations to each applicable payment network;
12. Each payment network sends the batch of approved authorizations to the applicable card issuing bank, or its issuer processor, which posts the transaction to the consumer’s statement;
13. Typically within 48 hours, the payment network calculates net settlement positions for the merchant acquirer and the card issuing bank, sends advisements to the merchant acquirer and card issuing bank and submits a fund transfer order to a settlement bank; and
14. The settlement bank facilitates the exchange of funds between the merchant acquirer and the card issuing bank; and the merchant acquirer transfers the funds to the business owner’s account.
Adding Value to the Payment
On top of the basic payment transaction, companies like First Data (and many others) are trying to add value beyond traditional merchant acquiring and issuer processor activities:
First Data describes each portion of this Value Chain as follows:
The Value-Chain of Commerce-Enabling Solutions Providers
The providers in our industry that sell solutions to businesses and financial institutions include:
1. Point-of-Sale Technology – Providers of hardware and software systems that enable businesses to perform a range of front and back office functions. Basic POS technologies, such as card terminals, help read credit and debit card information to initiate payment transactions, while more advanced systems, such as integrated POS (IPOS), enable business owners to operate more sophisticated software applications to perform functions that help them manage their enterprise from a PC, tablet, or mobile device that is integrated with transaction processing capabilities.
2. Business Loyalty Programs – Program managers that offer businesses the ability to run discrete retention campaigns, membership agreements and reward programs designed to encourage specific customer behaviors such as increased visit frequency, longer customer life, and higher spending.
3. Business Management Software – Software developers that create applications to help businesses manage front and back-office operations, allowing users to engage with customers more effectively, manage employees, monitor key operational metrics, and perform accounting and finance functions.
4. Compliance Solutions – Providers of services and solutions that help business owners ensure their enterprise practices and processes adhere to and remain compliant with various industry standards, such as payment card industry (PCI) compliance, government standards, such as 1099 reporting, and technical requirements, such as EMV acceptance.
5. Merchant Acquiring – Providers of services and solutions that help businesses accept, process, and settle electronic payment transactions across retail POS, online and mobile POS environments. The merchant acquirer sells payment acceptance services to the business client and underwrites the risk associated with each transaction. A few merchant acquirers, with proprietary technology platforms, provide processing in-house, but most outsource these functions to a merchant processor.
6. Merchant Processing – Providers of proprietary technology platforms that facilitate the processing of electronic transactions and other related functions on behalf of merchant acquirers that do not have in-house capabilities. For example, there are 76 merchant acquirers in the United States according to The Nilson Report, but we believe fewer than 20 own end-to-end processing platforms.
7. Encryption / Tokenization Technology – Providers of security solutions that protect payment and other sensitive data at-rest and in-transit from theft and misuse. These solutions encrypt and decrypt commercial transaction data or replace it with an electronic token. These vendors may also provide solutions to protect businesses and financial institutions from external data breaches.
8. Network Services – Payment networks such as Visa and MasterCard and EFT networks, such as STAR, NYCE and Pulse that connect, secure and transmit transactions between merchant acquirers and issuers to facilitate payment authorization, clearing and settlement.
9. Fraud / Security Technology – Providers of solutions that help businesses and financial institutions effectively manage risk and protect themselves from external data breaches, maintain control over internal access to data, and defend against fraudulent transactions.
10. Information / Core Bank Services – Providers of proprietary software applications and technology platforms that help financial institutions open and manage deposit accounts, process deposits and withdrawals, facilitate the origination, processing and servicing of consumer loans, and provide online access to financial accounts, at bank teller stations, ATMs and through online and mobile banking solutions.
11. Issuer Processing – Providers of proprietary technology platforms that facilitate the management and processing of electronic transactions and other related functions on behalf of card issuers, such as banks and retailers, which do not have in-house capabilities. These providers can sell their solutions as a complete suite of processing and related functions, discrete applications on a customized basis or as a hosted or licensed software solution.
12. Output Services – Providers of outsourcing services that help card issuers procure, produce, design and emboss their credit, debit, prepaid, EMV-enabled, contactless and private-label plastic cards, and deliver cards to account holders. These providers also help design, print and mail statements and letters on behalf of clients and send customer communications through other channels, such as electronic.
13. FI Account Management Software – Software developers that create applications to help financial institutions optimize their card portfolios, such as specialized administration portals, data mining and analytical tools, and strategy evaluation software, and manage certain front and back-office operations, such as customer relationship management and dispute resolution functions.
14. FI Loyalty Programs – Solutions that enable financial institutions to run discrete rewards programs to help drive customer acquisition, engagement and retention, through loyalty processing platforms, rewards portals, the design and marketing of offers and incentives, campaign management and analytical tools, and communication services.
15. FI Products and Services – Providers of services and solutions that help smaller banks cost-effectively offer a full suite of consumer-facing products and services to their account holders, such as revolving credit lines, credit and commercial cards, and access to ATM services.
With Paypal now spun-off of Ebay, Square filing to go public, Stripe having raised $200 million, it is important to understand for each of these companies, which pieces of the value chain they are trying to disrupt and how. First Data had $11.2 billion and $1.4 billion in operating profit in 2014. Many of these upstarts are looking to steal a piece of that pie, while First Data hopes to protect it!