The Payments Industry Landscape: What Does It Look Like Today?Varone
The payments industry is a rapidly changing scene that is constantly in flux due to the introduction of new payment methods, mergers and acquisitions, and new technology. Especially as technology advances, we’re seeing payment technology companies play a bigger role in the payments industry—and many of them are even merging with traditional financial institutions to cater to the latest customer and merchant preferences. Unlike in the past, when payment processing was simply about facilitating the transfer of funds, the newest players in the payment processing world are completely redefining the customer experience and enabling business owners to manage their businesses with incredible ease.
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In this white paper, we’ll give a high-level overview of today’s payments landscape: how the payment processing system works, who the major players are, and what the latest technology looks like. Plus, we’ll touch upon some trends in consumer behavior that are likely to impact the future of the industry.
The Payments Ecosystem
The payments ecosystem is made up of a combination of players that interact with each other during the payment transaction process: issuers and acquirers, credit card networks, payment processors, payment gateways, independent sales organizations and value-added resellers, and payment facilitators. All of these entities play specific roles in the payment processing cycle. The following illustration shows some examples of these players.
The Payment Processing Cycle
The payment processing cycle is complex and has a lot of moving parts. When a customer swipes their credit or debit card at a payment terminal, the transaction typically takes only a few seconds—but the process itself entails multiple steps and involves several players that interact with each other. For example, there are companies that work with the other players to process and facilitate transactions, payment processors that provide services to merchants and may facilitate moving money between banks, banks that service merchant accounts and perform the settlement process, and banks that issue credit cards to consumers.
The Authorization Process
- The customer purchases goods or services from the merchant and swipes their credit or debit card through a point-of-sale (POS) terminal or device which captures the customer’s card information.
- The customer’s card information is transmitted to the merchant’s payment processor, who in turn passes the card information and transaction amount to the merchant’s bank (the acquirer, or acquiring bank). Note that some payment processors are also acquiring banks.
- The acquiring bank captures the transaction and forwards the information to the customer’s credit card network (e.g. Visa, Mastercard).
- The card association system then routes the transaction (the issuer, or issuing bank), and requests an approval. The transaction is approved or declined depending on the availability of funds and the status of the cardholder’s account. This approval process is known as authorization.
- The issuing bank sends the response back to the credit card network. If the authorization was approved, the issuing bank assigns and transmits an authorization code along with its response, and a hold is placed on the cardholder’s funds.
- The authorization code is sent from the card association to the acquiring bank.
- The credit card network sends the approval to the merchant’s payment processor, who in turn sends the approval to the acquiring bank.
- The acquiring bank routes the approval code or response to the merchant’s terminal. Depending on the merchant or transaction type, the merchant’s terminal may print a receipt for the customer to sign.
The Settlement Process
- At the end of each day, the merchant closes out the day’s sales and transmits the information to their payment processor, who in turn transmits the information to the acquiring bank. This step, in which the merchant initiates the transfer of funds to their account, is known as capture.
- The acquiring bank routes all transaction information to the credit card network for settlement, who in turn passes on all approved transactions to the cardholder’s issuing bank.
- The issuing bank transfers the funds to the merchant’s acquiring bank, minus the interchange fee.
- The acquiring bank then deposits the amount, less the discount fee, to the merchant’s bank account.
- The issuing bank bills the cardholder for the transaction.
Understanding the Payments Industry’s Key Players
Here’s a breakdown of these various groups and how they each function within the payments ecosystem.
Issuers are banks or other financial institutions that issue credit cards to consumers on behalf of the card networks. Specifically, these are the bank names that appear on credit cards, such as Chase or Bank of America. They also issue payment to the merchant’s bank (the acquiring bank) on behalf of their customers, which means they assume risk in the event that the customer is unable to pay their credit card balance.
An acquirer is a bank or financial institution that enables a merchant to accept credit card payments from a customer’s card-issuing bank within a credit card network. These are typically referred to as merchant acquirers. An acquirer primarily processes credit or debit card payments on behalf of a merchant, but they can also be either a payment processor or an Independent Sales Organization (ISO)—Elavon is one such example of an acquiring bank that’s also a payment processor. The acquirer assumes the risk and passes the merchant’s transaction information on to the card brand associations (the card networks), and the issuers, to complete the payment.
Credit Card Networks
Card networks such as Visa, Mastercard, American Express, and Discover facilitate transactions among consumers, merchants, processors, and banks. They oversee payment processing activity, monitor settlement and the process of clearing sales, and regulate and manage their card network’s compliance policies.
These companies provide the electronic networks which allow all the players to communicate and process transactions, and they charge fees to the issuing and acquiring financial institutions. American Express and Discover operate a little differently than Visa and Mastercard by issuing their own credit cards (rather than an issuing bank), and they consolidate the functions normally provided by the merchant bank, card issuer, and card network.
Payment processors, also known as merchant service providers, are companies that work in the background to provide payment processing services to merchants. Their responsibilities include establishing merchant accounts; accepting and processing credit, debit, and prepaid card payments; managing credit and debit card processing; and implementing certain anti-fraud measures. Processors may be associated with acquiring banks, like Bank of America, or they can be independent from a bank, like Fiserv.
There are two types of payment processors: front-end processors and back- end processors. Front-end processors route transactions from the merchant
to the cardholder’s bank to request authorization. Back-end processors accept settlements from front-end processors and move the payment to the merchant’s issuing bank.
A payment gateway is a software application that enables merchants to accept payments made with credit and debit cards for in-store and online transactions. The payment gateway securely encrypts payment information and transfers that data between the merchant’s store or website, the bank that processes the payment, and the bank that issued the card used to make the purchase.
A payment gateway can be positioned either entirely digitally—with credit card information being routed in from the shopping cart on a merchant’s website—or physically, with an in-store POS system at a brick-and-mortar location.
One of the most important aspects of a payment gateway is that it has robust security standards in place to keep cardholder data safe during the transmission process. When a customer uses their payment card, the payment gateway securely sends the customer’s card information to the payment processor. Some gateways, like Cardknox, also provide merchants with a broader range of payment processing features and benefits.
Independent Sales Organizations (ISOs) sell credit card processing services to merchants, and they act as intermediaries between merchants, payment processors, and acquiring banks. In some cases, they might actually be banks; for example, Wells Fargo is a Fiserv ISO.
ISOs service merchant bank accounts and, at times, create the relationship between a merchant and bank in the first place. ISOs also lease point-of-sale terminals to merchants and may service customers who have problems with their cards. Because an ISO is not a bank, it does not physically manage merchants’ money and it’s also not regulated in the same way.
The traditional payment processing model has looked more or less the same for many years, but this is beginning to change with the recent introduction—and rapidly rising popularity—of payment facilitators (or “PayFacs”). A payment facilitator is an ISO that operates as a master merchant processing account, and it services a myriad of smaller sub-merchants under its umbrella. This business model enables payment facilitators to bring their merchants a seamless and instantaneous onboarding process, as well as transparent pricing structures—all while the payment facilitator itself enjoys full control over their clients’ end-to-end processing experience and fund/settlement disbursements.
Different payment facilitators reach different agreements with their acquirer. This means some may permit different types of businesses with varying levels of risk. Some payment facilitators are ISOs in name only, while others do most of the heavy lifting involved in underwriting, processing, and settlement. Some may just be offering a relationship with an acquirer, while others can offer international capability, risk management, customer support, data analysis, mPOS solutions, working capital loans, and other benefits.
One important distinction of payment facilitators is that these entities do not hold the funds they process. Funds are routed from the customer’s bank account to the merchant’s bank account, with multiple intermediaries taking a fraction of the total purchase price along the way.
Who the Big Players Are
Here’s a rundown of some of the largest, most well-known credit card processing companies.
FIS acquired Worldpay, a global leader in e-commerce and payments, which greatly expanded FIS’ products and services as well as its distribution reach.
The Changing Payments Landscape: Industry Trends
Looking ahead, here are several key trends that will likely reshape the credit card industry as a whole and the payment card processing ecosystem in particular.
New Fintech Players
The giants of technology have moved into the payments industry. Traditional players and banks are merging with technology companies in an effort to get even closer to their customers. For example, U.S. Bank recently acquired a POS system because they wanted to get a foot in the door with technology, and Apple has partnered with Goldman Sachs for the Apple credit card. Facebook has created its own cryptocurrency and also introduced Facebook Pay, which enables customers to make payments and transfer funds using apps such as Instagram, Messenger, and WhatsApp. And beginning in 2020, Google will offer checking accounts through its Google Pay e-wallet in a partnership with Stanford Federal Credit Union and Citigroup.
The appeal of these new mergers for consumers is that, unlike the financial industry, technology companies are very good at creating seamless customer experiences. According to a recent survey by J.D. Power & Associates, customer satisfaction with banking apps declined by 15% because customers felt they were confusing and hard to use. This puts tech companies like Apple and Google in a position to fill the void by offering more efficient and customer-friendly payment solutions.
New Payment Methods
As the adoption of mobile devices has grown over the past few years, so has the number of consumers using “mobile wallet” apps on their smartphones to make purchases. From mobile wallets to retail apps, the rise of Gen Z and Millennial consumers is forcing merchants to adopt mobile point-of-sale (mPOS) solutions that accept mobile wallets, contactless payments, and other digital-native products that catch the eyes of these younger, tech-savvy generations. For example, over half of Gen Z consumers use digital wallets at least once a month for purchasing and about 75% use a digital payment app.
Many expect there to be 16.6 million mPOS terminals in the U.S. by 2024. Customer expectations for fast, secure, and simple-to-use payment methods are bound to drive an increased demand for mobile payment options. And, as more and more consumers discover the convenience of using mobile wallets, the demand for mobile payment options is sure to keep growing.
The Decline in Cash Use
Using cash to pay for goods and services is much less popular than it used to be. Online shopping, credit and debit card transactions, and the increased popularity of peer-to-peer (P2P) payment apps are on the rise as consumers all around the globe embrace mobile and digital forms of payment over cash. Notably, a 2019 study conducted by Harvard Business School in collaboration with the financial services provider, Square, reported that in the U.S., digital payments accounted for over $961 million dollars and could reach up to $1.3 billion by the year 2023.
In addition, point-of-banking technology—also known as a cashless ATM system— is becoming popular for many small-to-medium-sized businesses that cannot get a traditional business bank account that allows them to accept credit card payments. Merchants benefit from this technology by not having to keep large amounts of cash on the premises, and customers enjoy having a convenient alternative to checks and cash.
EFT Payment Methods on the Rise
Electronic Funds Transfer (or EFT) is a broad term that describes the process of electronically moving funds between accounts over a network. There are several types of EFT transactions, including ACH transactions (e-checks), wire transfers, direct deposits, direct debits, ATM withdrawals, and online bill payments made with credit or debit cards. An EFT can be a scheduled transaction—such as when paying a bill with a credit card—or a real-time transaction, such as an in-store purchase made with a debit card. Because no paper checks are involved, EFT transactions are a fast and convenient way to make purchases and process payments.
EFT payments are growing in popularity across most demographics. Peer-to-peer (P2P) apps such as Zelle, Venmo, and Cash App are especially popular with younger consumers as a way to manage day-to-day purchases, and Automated Clearing House (ACH) transfers are seeing increased usage for recurring payments.
New Hardware and Retail Solutions
The mPOS trend is also poised to have a big impact on the payments hardware and software industries. This solution allows merchants to accept contactless transactions on a mobile device without additional hardware.
In 2015, issuing banks began requiring businesses in the U.S. to start accepting EMV chip cards to avoid liability for fraudulent transactions. As a result, most merchants in the U.S. now use EMV-enabled POS systems. Today, all POS terminals that support EMV technology have contactless capabilities built in, and most major retailers, such as CVS pharmacies and Target stores, can accept contactless payments.
Fiserv, Samsung, and Visa recently partnered to create an mPOS solution that successfully accepts a PIN-based contactless transaction on a mobile device. The move to mPOS will continue to put pressure on hardware providers that compete directly against mPOS devices, as well as ISOs that sell legacy devices to merchants.
Customer preference will increasingly drive the trend toward contactless cards because they provide a quicker, frictionless, tap-and-go checkout process. In 2019, up to 60% of all card-present purchases were made at contactless-enabled payment terminals, and that will likely increase as customers demand the speed and convenience that contactless payments provide.
The Growing Popularity of Online Shopping
Mobile shopping, e-commerce use, and the purchasing of products with voice recognition technology have all increased dramatically. Smart speakers like Google Home, Amazon’s Echo and Alexa devices, and Apple HomePod let a person speak commands, such as asking for weather information or placing an order. As part of the Internet of Things (IoT), smart speakers have become more and more popular as home automation systems have expanded.
A 2017 Capgemini survey of Western Europe and the U.S. reported that 35% of respondents said they had bought products using either their smart speaker or with a digital assistant using their mobile phone;
and, 32% said they had ordered a meal or sent or received money. The technology is not meant to be used for complex commands, and is best suited for small orders.
As more and more consumers embrace digital payment methods, the need for secure payment processing takes center stage. For example, 3D Secure 2.0 technology is a security protocol that adds a layer of protection to card-not-present (CNP) transactions by verifying the customer’s identity. It supports a wide range of e-commerce, in-app, mobile wallet, and MOTO (mail order telephone order) payments. Advances in biometric technology are also changing the way consumers view payment processing security issues. Market research studies show that consumers believe that biometric screening methods, such as fingerprint scanners and voice and facial recognition systems, are easier to use than other identity verification methods, and that biometric methods are more secure than PINs or passwords.
For card-present transactions, EMV® (Europay, Mastercard, and Visa) uses “chip card” technology, a payment card with an integrated chip that protects against fraudulent transactions by communicating with a POS device or contactless terminal to authenticate an in-person transaction. Another security protocol gaining popularity with merchants is EMV’s Secure Remote Commerce (SRC). This technology offers a merchant the ability to create a “virtual payment terminal” with one-click checkout capability on a website, mobile app, or other digital channel with American Express, Discover, Mastercard, or Visa credit and debit cards. SRC technology uses robust tokenization to replace card data and protect cardholder information and is designed to be used with a variety of remote checkout environments and devices such as laptops, tablets and PCs, and smartphones.
As payment processing technology continues to improve, expect to see more innovative and user-friendly security solutions in the future.
Real-time payment technology enables instantaneous money transfer between banks and banking systems. There are currently two real-time payment systems in the U.S.: the RTP® (Real-Time Payments) Network, and the FedNowSM system.
The RTP network, launched by The Clearing House in 2017, is a payments system that all federally insured depository institutions can use to clear and settle payments in real time. Its network serves as a platform that allows banks and other financial institutions to create and deliver new innovative products and services to their customers. RTP technology was designed to facilitate payments across all payment categories, including business-to-business (B2B), business-to-consumer (B2C), consumer-to-business (C2B), peer-to-peer (P2P), government-to-citizen (G2C), and account-to-account (A2A) transactions.
FedNow is a real-time payment and settlement service that’s currently being developed by the Federal Reserve Bank. The service, expected to go live in 2023 or 2024, will incorporate clearing functionality into the process of settling payments. This functionality enables banks and financial institutions to exchange the debit and credit information needed to process payments and notify customers whether the payments were successful.
Despite its complexities and diverse array of institutions and technologies, the payment industry is truly a cohesive landscape that’s at the forefront of innovation. And increasingly, the industry’s ability to spearhead cutting-edge solutions is driving continued investments and a growing number of mergers and acquisitions.
Even as new technologies and acquisitions disrupt the payment landscape, though, one thing’s for certain: the industry will continue to do all that it can to make the payment processing cycle as seamless as possible.
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