Merchant Services

In 2014, Just About Anyone Can Take Credit Cards

Credit cards are on track to replace cash as the dominant form of payment for products and services. Although legal tender is still tenaciously holding onto the "cash is king" mantra that has ruled commerce since the time of Croesus, the democracy of payment cards is enfranchising even the poorest world citizens. In 2014, if you can't process debit and credit cards, you might not make money at all. Thanks to developments like Square and PayAnywhere, your babysitter, PTA marm, or food truck pilot may prefer a clean swipe to your dirty wads of dollars.

Credit Card Processing The popularity of credit card processing goes back to the 1950s, when brands like Diner's Club were taken at the best restaurants, and American Express introduced its cards to the elite. Gasoline stations entered the fray by offering their own branded cards, as a way of enforcing loyalty. Because a good deal of automotive services and repairs were done at the gas station, such cards were also a convenient way to cover expenses. The advantage of revolving credit accounts and celluloid (then plastic) payment appealed to companies with traveling salespeople. The 1950s saw the advent of BankAmericard (now Visa) and the 1960s brought us MasterCharge (now MasterCard) which were both based on associations of banks which would issue cards under a common brand. Today these companies dominate electronic transactions in most of the world, thanks to their acquisition of other companies with similar products. In the old days, cards were often mailed out to people who didn't even apply for them until the practice was outlawed.

Naturally, it was necessary to get store owners to invest in the technology necessary to accept credit cards, and pay for the priveledge. Different companies had different ways to do this. American Express, which was offered as a premium brand, relied the notion that affluent consumers will be attracted to a store that "honors" its cardholders. For other lines of business, up until today, much of the appeal is that (1) a person has more available credit than cash on hand (2) people somehow manage to spend more money when carrying a card, and (3) if you don't accept a particular financial instrument then maybe your competitor across the street will. To offset the approximately 5% cost of authorizing transactions, retailers either raised prices or just slimmed their already outrageous margins. (By the way, if you want to know why "main street" retailers collapsed in the face of big box stores, consider that a lot of these guys were running on margins that would be considered "gouging" if you did it in a disaster.)

Merchant Account Rates

Rates for merchant accounts run the gamut of outrageous to reasonable. If you aren't a shrewd business owner, then you may find yourself paying way too much to accept cards. Some newer developments, like the 2011 Durbin Amendment, may reduce the interchange fees for debit cards, but credit card processing costs are often determined by a matrix of factors that are hard to pin down. It costs more to take a rewards card than a standard one, and government purchasing accounts cost even more. Should you swipe your cards through a terminal, the fees are generally 1% lower than punching the number into the keypad. If you have an ecommerce processing account, then there are fee structures for AVS verification and CVV usage. In short, if you aren't an expert in interchange markups you may be getting the short end of the stick, and this is before the myriad of fees for things like statements, security, IRS reporting (your processor sends a form 1099K to the Internal Revenue Service, and there is nothing you can do to stop it!) and for failing to process a certain dollar amount monthly.

Credit Card Authorization Process

Many organizations have their hand in the authorization process, and we will give an oversimplified breakdown of how it works here. If you present a card at a retailer, you are most often swiping it through a terminal, which communicates with an authorization network. This network typically checks with the bank that issued the card, which verifies the available credit or bank account balance. That network then sends back an authorization code or decline reason, which may be that there isn't enough credit or the card was reported stolen. Assuming the card was authorized, then you as a customer leave the store with your product. The merchant "batches" all the approved transactions which are settled into a merchant account. On the back end, dollars are electronically transferred from various banks through a complex system that is seamless to the store owner, who usually has no idea that much of this money is "fronted" to the account while dozens of computers settle the actual dollar transactions for each card swiped.

This whole process rests on an infrastructure that is invisible to consumers, but reflected on merchant account statements in the form of nearly inscrutable fees. The merchant's relationship with the system generally comes in the place of an ISO (Independent Sales Organization) that represents an Acquiring Bank (whoever fronts the dough) who has the wheels greased by the Credit Card Association (like Visa or MasterCard) which issues card numbers. In between, there are multiple layers of encryption and security, plus complex computer algorithms that are supposed to determine whether any given transaction is real or suspicious. If you ever want to know why it costs so much money to authorize a card, then consider that there may be 6 or more "hops" for information in the few seconds it takes to check the transaction, and all those people need to get paid. Naturally, some parties have argued that the way these fees are set is unfair, and a recent MasterCard/Visa settlement put several billion dollars aside to put an end to this issue.

By far the most significant development in the merchant services industry is the advent of smartphone devices that can swipe cards through hardware that plugs into headphone jacks on iPhones, iPads, and Android phones. As a disruptive factor in the industry, these devices have led many small ISOs to consolidate or get out of low-volume verticals where merchants may have been willing to pay more for a terminal out of necessity, but now see a 2.75% fee as an attractive alternative to merchant services accounts that may have created a higher effective rate simply because fees for statements, minimums, and leasing may have added up to a bigger monthly payment. The threshold for getting a "real" merchant account and being profitable can be as high as $10,000 a month accepted via payment cards, so Paypal, Square, and Intuit devices have a vast, if low volume, demographic that could be exploited. In April of 2014, there were rumors that Square might be sold to someone like Apple or Google due to the currently unprofitable nature of the business. Meanwhile, the marketplace for dongle-based processing is getting bigger, and tablet POS systems are disrupting the tradtional software model by using cloud and SAAS alternatives to big expensive systems.

Most of the major issues associated with credit card processing, that are visible to the public, involve theft and fraud. In 2013 Target reported one of the biggest data thefts in years, comprising over 40 million account numbers. In this part of the process, it may be that a central repository in the system got breached, allowing attackers to capture information from cardholders. While the scope of the data breach was notable, this type of problem could happen to just about any business, including restaurants, supermarkets, and convenience stores. Any Point of Sale (POS) system that takes cards could be vulnerable to attack.