Electronic Payments Industry Overview: The History of Credit Card Processing
Often one of the hardest and most frustrating things that a business owner must encounter when starting and running a business is choosing the right merchant service provider. Since the vast majority of consumers nowadays use alternate payment methods rather than cash to purchase their goods and services, both online and in person, such as checks, credit and debit transactions, accepting such enables a business to remain competitive. Since electronic payments is such an integral part of our financial structure today, having a clear understanding of the payment processing industry will help you in selecting a merchant service provider that will best suit the needs of your business.
History of Credit Cards
Payment processing is very confusing for most merchants as the involvement of so many different players makes it a somewhat complex industry to understand. Many think the industry is fairly new beginning in the 1950’s when credit cards were first issued. It actually began in the early 1800’s with merchants extending credit to their customers for the goods and services they needed immediately but couldn’t pay for at the time. Following is a brief overview of the timeline:
- Early 1900’s department stores and hotels began issuing paper credit cards to valued customers.
- In 1949 Diners Club issued the first merchandise credit card for travel and entertainment expenses for wealthy consumers. They soon after expanded across the nation, charging merchants a 7% per transaction fee, rather large for that time period.
- In the 1950’s, Bank of America (now known as Visa) issued the first general credit card. As banking regulations limited nationwide reach of individual banks, Bank of America began licensing the card to other banks in order to compete with Diners Club nationwide reach.
- In 1958, American Express entered the market and began issuing credit cards.
- In 1966, a network of banks formed together to get in on this successful money maker and initiated a third network (evolving into MasterCard).
- Last but not least, Sears Roebuck and Company launched the Discover Card network in 1986.
Since its infancy, the issuing of credit has been an extremely profitable business. The issuing bank makes its profits through various ways including annual fees, late payment fees, over balance fees and of course the interest rate charged.
Types of Credit Card Processing Companies
There are really two types of Merchant Service Providers (MSP’s) that provide credit card processing services to merchants: Acquirers and Resellers.
Acquirers, also known as Processors, are distinguished by their ability to process sales transactions. A Processor has the technical capability and high level security protocols to receive the transaction data, communicate with the appropriate financial institution, approve or decline the specific transaction, settle the completed transactions with the financial institution and deposit the funds into the merchants account. In short, they are the ones that actually process the sale, charging a discount rate and/or processing fee for handling the transactions. Acquirers are registered members of the Visa and MasterCard Associations, soliciting, screening and accepting merchants in their processing programs.
Processors acquire their merchant base through direct marketing to merchants, independent sales agents and utilizing resellers. For example, EPS is an Acquirer (Processor) which provides merchant payment processing solutions and value-added programs to merchants directly through a direct sales force in addition to Independent Sales Organization partnerships (resellers).
Resellers, also known as Independent Sales Organizations (ISO’s), resell the products and services of one or multiple Processors. They are “Third-Party Processors” in addition to sometimes offering their own value-added products. There are basically two types of ISO’s: banks and non-banks.
Banks – banks of all kinds, local community banks, large regional banks, national banks and credit unions have entered into the merchant service provider business as it seemed like an easy vertical expansion to give them another way to increase revenue off their customers. Most banks are ISO’s although they usually private label their services so that it is difficult to tell whether or not they are the actual the Processor.
Non-banks – this group of ISO’s ranges greatly from top-notch, competent and capable providers to less than honorable people just out to make a quick buck. As there is not any regulatory agency enforcing acceptable and ethical business practices in the industry, the most serious problems merchants encounter are usually from dealing with an unscrupulous, rogue sales agent rather than the Processor. Unfortunately, this has given the industry as a whole a bad reputation.
Both Processors and ISO’s offer payment and processing solutions such as credit/debit/ prepaid credit card processing, check verification/ conversion/ guaranty services, online transactions, gift/ loyalty cards, and cash advances with very little, if any, difference in pricing.
A financial institution or bank is also the issuer of the electronic funds cards (debit cards) which the consumer (cardholder) uses to purchase goods, services or obtain cash advances. The issuer is a registered member of Visa and MasterCard Associations. The issuer both receives and pays for transactions from the cardholder’s transaction activity with Visa and MasterCard.
The Interchange System is the bank card/ credit card system managing the transfer of transaction data and funds between the issuing and acquiring members through a process called “Interchange”, which simply means the flow of money and information between the following parties: merchants, cardholders, card associations and acquirers. Interchange fees are those that the financial institution charges for purchases made on the credit/debit card. Interchange consists of the following steps as a requirement in every payment transaction.
Authorization: occurs as the cardholder gives payment for his purchase to the merchant. Later, the merchant submits the information of the transaction to the acquirer. The acquirer in return would verify the issuer and in an instant the transaction amount and card number are validated. Then, the acquirer processes the cardholder transactions.
Batching: refers to the stored authorized payment transactions which are kept in batch. At the end of the day, the merchant themselves will send the information to the acquirer to receive payments.
Clearing and Settlement: The acquirer sends the transaction information through batch for the card associations. It debits the issuer for payment and giving credits to the acquirer. In addition, the issuer pays the transactions to the acquirer.
Funding: If the acquirer has been paid the result will be merchants will receive payment as well. Usually, merchants will receive equal amount of the transactions minus discount rate. This is the fee which merchants are paying the acquirer for their service in every payment transactions.
Visa and MasterCard are the associations that manage both the bank card issuers and acquirers. These associations set and enforce the rules governing bank cards, maintaining the authorization and settlement systems, managing the clearing and settlement processes, supervising the processing and developing new products and programs.
We are quickly becoming a cashless society so although it is not a requirement for a business to accept the various forms of electronic payments, the more options you make available, the better your competitive advantage. Whatever the industry or business size, it is vital that you find a merchant service provider that can focus on your specific area, whether its e-commerce, retail, service, catalog, restaurant, telephone/mail order, wireless, or a home based business. It is equally important to choose a provider that also has the level of infrastructure needed to provide the best system for your needs, from software and terminal plug-in’s to repayment gateways and real time account access. EPS is a full service merchant service provider which means it can handle all of your processing needs and employs a dedicated team for each individual area of merchant accounts including customer service, sales and technical support 24 hours a day.