Practical Ecommerce

Credit Card Processing: How It All Works

The credit card processing system is confusing. The players are numerous and the process is complex. To understand how it all works, it helps to grasp the types of companies that are involved, and how much money they typically charge for processing a transaction.

David Schwartz is director of marketing at a leading payment gateway, Authorize.Net. He says, “This is by far the most complex industry I have ever been associated with. I always tell new employees to give themselves six to nine months to become comfortable with the lingo and to understand how the payment processing system works.” Diagrams of the process can also help. Schwartz continues, “We added a detailed ‘how it works’ diagram to our new corporate website in March 2005. It has since become one of the most visited pages, proving that people want to better understand how a payment is processed.”

To understand the payment process, Schwartz suggests a working knowledge of the participants and the services they provide along the way. He also suggests tracking a hypothetical transaction through the entire payment processing system. In that way, Schwartz says, ecommerce operators can understand not only what services these participating firms provide, but also what fees they charge for processing a transaction.

The Participants

For a typical ecommerce credit card transaction, a number of participants play key roles in the process. Those players include:

  • the customer,
  • the merchant,
  • the payment gateway,
  • the acquiring bank’s processor,
  • the credit card interchange,
  • the customer’s credit card issuer, and
  • the merchant’s acquiring bank.

Seven participants, in other words, normally interact with each credit card transaction. Notes Schwartz, “With all of these companies involved in the process, it takes, amazingly, just 2- 3 seconds on average for a transaction to be approved.”

Follow the Money

Let’s say you are a $100 credit card purchase. The moment the customer hits the buy button on the ecommerce merchant’s website, you are zooming across cyberspace on a multi-stop journey, during which you will shed, typically, nearly three dollars as companies that you interact with assess varying fees for their service. (Actual fees vary based upon a number of variables, including merchant type, card type and risk factors.)

Your first destination is the payment gateway (-.10¢), which routes you to the appropriate processor (-.08¢). The processor immediately submits you to what is known as the credit card interchange (-.09¢). After you’ve cleared the interchange, your next leg takes you to the issuing bank (-1.93¢), which verifies the available funds in the customer’s credit card account. Whether you are approved or declined, you now begin the journey back to the customer. However, if you’re approved, you and your authorization results are soon to part after speeding by each stop you made on the way. Your detour is through your merchant account at the acquiring bank (-.65¢) to, ultimately, the merchant’s bank account, where you will be deposited; that is, the $97.15 of you that remains.

Kerry Murdock

Kerry Murdock

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  1. Legacy User April 17, 2007 Reply

    Complex you say?

    Many would argue it much simpler to explain the ‘complex’ physiology of one’s body or perhaps even the dynamics of man-made global warming (fact or fiction).

    Not to suggest that credit card processing is rocket science or that swiping a piece of plastic through a terminal requires a medical degree.

    However, my wife earned her undergraduate degree in chemistry and a doctoral degree in pharmacy and would often inherit a migraine trying to decode what I did for a living (in the world of credit card processing).

    In the past six years, I have started and sold two successful ISO (Independent Sales Organization) companies, both being directly registered agents with Visa and MasterCard. As a matter of fact, I remain a significant shareholder in the first ISO Company, but I have not been active in the industry for a little over a year now.

    It is bazaar how people seem to stumble into this industry, because the elements of complexity (e.g. technology, regulations, risk, liability, etc.) keep most real ‘players’ at arm’s length.

    Here’s the dirty little secret, The Electronic Payment Industry is no more than a sophisticated shell game.

    From a financial and infrastructural perspective, there are so many people, at so many different levels with the tips of their (pinky) finger in the industry pie, that given the opportunity, Stephen Hawking himself, would go blind trying to decipher it all.

    That is because at the end of the yellow brick road is an ever-illusive wizard, and that son-of-a-gun not only pulls all the cords, but has an insane amount of industry money and power.

    BTW, ever heard of merchant profiling, probably not, because I created the term some time ago, but it happens every day.

    Visa and MasterCard’s Interchange Pricing {Ponzi} Matrix, in a nutshell, is all over the board, depending on merchant type (e.g. Grocery Store, Car Dealership, Rock Band, Work-Out Gym etc.).

    Based on merchant’s average profit margin V & MC will tweak their interchange pricing accordingly.

    For instance, a grocery store operates on wafer-thin profit margins, and it would be impossible for a grocery store to accept credit card related sales at the same interchange pricing as the automobile dealership’s service department next door.

    However, in both pricing scenarios, V & MC’s Interchange matrix parlays a profit. For purposes of example, a $100 bag of groceries may cost that merchant 1.29%, but it will cost the car dealership for a $100 brake job 1.79 % (a whopping 50 bases point spread for V & MC using this example).

    This is how dysfunctional and unfair V & MC’s Interchange Pricing Matrix is designed, which has and continues to spawn a significant amount of lawsuits.

    So, based on a genius, but nevertheless, purposefully complex (an unfair) pricing Interchange matrix, the grocery store receives processing rates that are insanely lower than the referenced car dealership pays. This example, in my opinion, denotes merchant profiling and removes all together, a level playing field for merchants that accept or seek to accept credit cards for payment.

    Easily, a novel dwarfing ‘War and Peace’ could be written about the complexities and inner workings of the electronic payment industry; however, just writing these few paragraphs is starting to blur my vision again and the churning in my stomach requires an immediate fix of extra strength Mallox (before I hurl on the laptop).

    “Trust no one but your mother (and only when she is handcuffed to a door)”.


    — *Jonathan Grubbs*

  2. Legacy User April 17, 2007 Reply

    Well I did not think the process was so complex and required that many fees, but anyway it keeps being very practical.

    — *Alejandro*

  3. Legacy User April 18, 2007 Reply

    I work at a company that sells people payment gateways and merchant account. I'm one of their web designers here that sets up ecommerce shopping carts, and your explaination of how payment process works is amazing. I'm going to make a digital copy of this so I can use it to explain it to customers that ask me questions on this. Your article made good sense in figuring out how the process works and explains it in a way that makes sense to the merchant. Good post!

    — *William Mitchell*

  4. Legacy User June 4, 2007 Reply

    Indeed, a fine and easy to understand overview of the payment processing "journey"

    Payment processing may appear complicated; once the basic terminology is understood, it's fairly simple & straight forward.

    — *Tina Brandon*

  5. Legacy User September 10, 2007 Reply

    I also found this post to be very enlightening. I'm actually doing some research into this area for a colleague. I was wondering if anyone could point me in the direction of some good development resources for credit card processing and similar systems. I'm primarily interested in technologies and architectural info but information on the legal side would also be very helpful. I'm worried that there is a lot of red tape involved in implementing such a system in a production environment. True? Any comments much appreciated.

    — *Vivian Farrell*

  6. Legacy User November 29, 2007 Reply

    Is ISO refers to payment gateway company and TPP refers to processor?
    Why do merchant not deal directly with a processor ? What do processor offer that payment gateway do not?

    Thanks :)

    — *Jack*

  7. Legacy User March 19, 2008 Reply

    What are the legal requirements for merchants to check ID from Card holders in order to make payment? Are merchants required to check the card holder's ID before processing the payment or not?

    — *pam*

  8. Legacy User April 11, 2008 Reply

    Frontier Airlines Holdings Inc., the U.S. discount carrier that serves 70 destinations from Denver, filed for bankruptcy, becoming the fourth U.S. airline to seek court protection in less than a month.
    Your explanation of processing is great. Given the following news clip where in the process does the credit card processor get the right to withold payment ? Is the issue that the pieces of the pie accumulate and then are settled at end of month ?

    Frontier took the step after its credit-card processor, First Data Corp., began withholding proceeds from ticket sales, the Denver-based carrier said in a statement today. Frontier pledged to continue flying and keep paying workers while it seeks additional financing.

    — *Bill S*

  9. Legacy User May 19, 2008 Reply

    Frontier is required by FDR to have on deposit a reserve. As the processor that underwrites the account, FDR is liable for every and all transactions processed by Frontier (per membership agreement). If Frontier folds, FDR would be stuck with all unfilled tickets charged by customers of Frontier. FDR's decision to seek a larger reserve from Frontier was most likely made due to the financial status of Frontier, as quoted in recent article, FDR was concerned that Frontier would be able to operate beyond a couple of more months. Every merchant account that is opened is basically a line of credit. The merchant in most cases receives their money for the transaction within 48 hours. HOwever most customers can dispute the charges for up to 6 months. Fraud is a very real concern as well. Reserves minimize the exposure of the underwriter for the account. IN other words, it is a liability and you need good credit.

    — *A. Smith*

  10. Eli Baskin January 4, 2012 Reply

    Am I the only one that sees that -.10 cent is not -.10 dollar?

  11. Brian February 4, 2014 Reply

    Eli, no you aren’t. This particular type of error in this discussion kind of hurts the credibility of the author. but then I was more surprised that no one called attention to it before now.