The payment processing ecosystem: bedrock of digital payment

Payments is an industry in full transition. The power dynamics in the payments industry are changing as businesses and consumers shift dollars from cash and checks to digital payment methods.

Cards dominate the in-store retail channel, but mobile wallets like Apple Pay are seeing a rapid uptick in usage and paving the way for the future of payments.

At the core of the digital payments industry is the payment processing sector. This is a complex network of interconnected players.

There are card companies, which don’t issue the cards, that process and facilitate transactions among all the other players. There are processors, which provide services to merchants and might move money between banks. There are banks that work with merchants, and banks that work with consumers by issuing credit cards and credit.

Below is a rundown of the key actors and how they make money.

Card networks Visa, MasterCard, American Express, and Discover sit at the centre of the payment industry. They facilitate transactions among consumers, merchants, processors, and banks.

These companies supply the electronic networks that allow all the players to communicate and process transactions.

For their trouble, they charge fees to the financial institutions involved in transactions based on total transaction volume (rather than on a per-transaction basis).

Card networks—for simplicity in this explanation, let’s say Visa—receive fees from the issuing and acquiring financial institutions.

Visa makes money by collecting a small percentage of total transaction volume, rather than by charging a fee on each transaction. But it also sets and doles out the rest of the fee paid by the merchant to the other players.

The business models of American Express and Discover differ from Visa and MasterCard: They consolidate the functions of the merchant bank, card issuer, and card network by personally extending credit and cards.

This makes fewer parties involved in their transactions.

Card issuers are financial institutions that provide card network payment cards to consumers.

So, for example, Capital One might issue a Visa card.

These institutions also issue payment to the merchant bank (also called the acquiring bank) on behalf of its customers, the buyers in any given transaction.

On each transaction, the card issuer—let’s say Capital One—receives an interchange fee from the merchant acquirer, like Chase Paymentech, Wells Fargo, or First Data, which work directly with the merchant.

The interchange fee is set by the card network, and the amount tends to be highly variable, based on a combination of factors.

These include card type, transaction type, merchant type, and level of risk for the given transaction.

Processors make most of their money from:

Certain processors, like Vantiv, also work with financial institutions to integrate other services.

For merchant services, revenue is driven by the number of transactions and the dollar amount of sales volume.

Fees may be based on the merchant discount rate, which is a percentage of the sale amount, or be a fixed fee per transaction.

Financial institution service fees are either fixed per transaction or volume-driven based on value-added services, according to Vantiv data.

ISOs make money in a number of ways—similar to the number of functions they perform. Their fees also vary, depending on the contracts they have.

ISOs are paid the remainder of the merchant discount after the card issuer, network, and merchant acquirers get theirs.

So, for example, Square would get a cut after Capital One, Visa, and Chase Paymentech all get paid after a transaction.

On certain transactions, ISOs actually lose money. These losses tend to be offset, though, when they're able to charge the same fee for purchases made with debit cards or when they make money on other services.