A man walks into a bar. The bartender takes his order and asks him if he wants to open a tab. The man says “yes,” and hands her his credit card. At the end of the night, the bartender hands the man his card and a receipt, and he goes home.
Both of them are happy. The man got his drinks without having to pay in cash. The bartender didn’t have to count dollar bills or wonder when she would get paid.
How did the money make it from the customer’s bank account to the bartender’s bank? That flow of money requires an ecosystem of payments companies to process the transaction. They have to act quickly, so the bartender doesn’t have to wait a long time to find out if the man has enough money in his account for drinks. They also have to communicate securely so that criminals can’t easily intercept the man’s credit card information.
For this speed and security, as well as any card rewards attached to his transaction, these intermediaries charge a price. And while the cost of each card swipe may be small, the trillions of dollars spent using cards each year quickly add up to fuel a vast payments industry.
This primer speaks mainly to credit transactions, which are processed differently than are debit transactions. Credit card purchases move through a processor and are essentially loans to the customer by a card issuer. Debit card purchases, on the other hand, are debits directly from the customer’s bank account.
Here are a few of the different organizations that get involved in the swipes, taps and clicks used to make purchases across the U.S. payments system.
An acquirer is a bank that allows a merchant to accept credit and debit card payments. An acquirer may also be called an “acquiring bank,” “merchant acquiring bank,” or “merchant acquirer.” When a customer makes a purchase at a business, the acquirer handles getting money from the customer’s bank account.
But the flow of money isn’t instant. It may take a couple of days for the acquirer to contact the customer’s bank, verify the customer has enough money for the purchase, and then retrieve the money. So, the acquirer essentially loans the business the money, allowing the merchant to get paid before the banks settle the transaction.
And things can go wrong. A customer may dispute a charge on their credit card or the business may go bankrupt. If those things happen, the acquirer is stuck with the bill. The riskier a business is, the less likely acquirers will be willing to work with them.
The benefit acquirers get for taking on that risk comes from fees they charge the businesses they serve. Acquirer fees are part of the total amount a business pays each time they accept a card payment. That total is called a merchant discount rate.
Calculating the merchant discount rate can be complicated. The exact formula depends on multiple factors, including whether the customer paid with a credit or debit card and the specific companies involved in the card transaction.
Generally speaking, the total amount a business pays for a credit card transaction will be about 2-3% of the transaction’s value plus $0.10-$0.20. By contrast, the amount that can be charged to process a debit card transaction is federally regulated and can be adjusted. For bank issuers with $10 billion or more, the debit fees are capped at 0.05% plus 21 cents, with the latter subject to adjustment by the Federal Reserve.
The biggest acquiring banks last year were JPMorgan Chase, Wells Fargo and Bank of America, respectively, according to industry research firm The Nilson Report.
A payment processor is a company that connects the business to the acquirer and a customer’s bank. It is the go-between party that makes sure that money flows from the customer’s bank account to the business’s bank account.
The processor does this by quickly performing an authorization or “auth,” to confirm that a customer has enough money in their bank for the purchase. But the money isn’t moved right away, TSG Senior Associate Cliff Gray explained in an interview.
“[Processors] perform the auth and they store all the results, and at the end of the day, they have a capture file that now is processed,” Gray said. “So what has to happen is money has to be sucked out of my bank and put into the store’s bank.”
A processor handles the technical parts of a card transaction, as opposed to the acquirer, which handles the financial piece. Here are a few key differences:
- The processor verifies that the customer has enough money for the payment, while the acquirer assumes the risk of fraud.
- The business will have a direct relationship with the acquirer, but may not necessarily have a direct relationship with the processor.
- The processor connects to the banks using a card network, such as Visa or Mastercard. The acquirer is a member of the card network and settles the transaction.
Like acquirers, processors make their money by charging a business a fee each time a customer pays by card. That fee is part of the merchant discount rate, the total cost a business pays for each card transaction. In addition, the processor may charge businesses an initial fee for setting up a system to process the payment, as well as a flat fee every month. When a business decides to end their relationship, there may be another fee.
In practice, companies may be both a processor and an acquirer. The biggest processors include Fiserv and Fidelity National Information Services, which are also acquirers. Smaller fintechs edging into the field include Square and Stripe.
A payment gateway allows a business to collect payment information from its customers. In a physical store, the gateway is the point-of-sale terminal. In an online store, the gateway is the special “checkout” page where a customer enters their credit card information.
The job of a gateway is to collect and send a customer’s payment information to a processor. It sits between the business and the processor, and is one of the few pieces of the payments ecosystem visible to both the customer and the business.
One company that provides payment gateways for physical stores is Square. The financial services company provides a point-of-sale system that uses a touch screen and a card reader to accept payments.
Another popular payment gateway for e-commerce is PayPal. Once a customer is ready to purchase goods from an online store, they are directed to a PayPal page where they can select a payment method that is saved in their PayPal account.
A card network provides a communication system that allows all of the different players in the ecosystem to talk with each other.
Without the network, the payment gateway wouldn’t be able to talk to the processor, the processor wouldn’t be able to talk to the acquirer or the customer’s bank. Without a card network, businesses would not be able to accept payments via credit or debit cards.
Visa is the biggest network in the U.S., according to The Nilson Report. In 2022 it accounted for about 60% of debit and credit card transactions by volume in the U.S. The next largest card network is Mastercard, followed by American Express and Discover.
These networks can be referenced in a few different ways, including as credit card networks, card associations or credit card companies.
To earn revenue, card networks charge “interchange fees” that are built into the merchant discount rate. Those fees go into building and maintaining the communication system and into cardholder benefits like cash-back rewards, airline frequent flier points and other perks.
Interchange fees, which are the largest component of processing fees, lead some businesses to require customers to spend a minimum amount to pay by card. And they’re also behind some businesses offering a discount for payments with cash, or simply requesting cash-only payments.
They have also attracted attention from U.S. lawmakers, who passed the Durbin Amendment to the Dodd-Frank Act in 2010 to limit interchange fees on debit card purchases. There is a bipartisan bill pending in the U.S. House of Representatives and Senate, called the Credit Card Competition Act, aiming to lower interchange fees for credit transactions too.
An independent software vendor is a company that makes business management software for a particular industry. Say a dentist wants to set up a practice, and prefers dentistry-specific software to manage patient records, store X-rays, schedule appointments and process payments. The company that creates and maintains the software that a dentist might use would be an ISV.
While ISVs are able to build software that manages many parts of a business, they often find it difficult to create their own tools to accept customer payments. So, they frequently partner with a payments processor to manage payments.
These arrangements with individual businesses and payment processors provide two sources of revenue for ISVs. First, they earn money from subscriptions purchased by the individual businesses that use their software. Second, they take in earnings from a fee tied to each payment the business receives and processes through the software. But this arrangement with payment processors may be changing.
ISVs are hungry for a bigger piece of revenue and for more control of the experience, said Jean Boling, who is the director of business development for payment processor Clearent. Instead of contracting out the payments feature to processors, ISVs are seeking to take more ownership and revenue from payments.
In this scenario, “when a business signs up for a piece of software, the ISV says ‘Here’s your software, click here to get your payments,’” Boling said in an interview. “There’s a set pricing structure that the ISV has put with the payment strategy and that’s pretty much an easier experience for businesses.”
The ISV industry is still highly fragmented, with a lot of smaller players in the market and none playing a dominant role. That’s partly because they tend to be industry-specific, and therefore aren’t well-known. Certain ISVs may loom large in a particular industry like dentistry, but wouldn’t have offerings for other kinds of businesses like car dealerships.