Understanding the Payment Stack Industry

August 12, 2021
lady with card handing back to customer

The payment landscape seems complex, but the concept of a payment stack is pretty simple. Each card transaction consists of a unique set of software and services, usually involving multiple entities, to process and reconcile the payment. That set of software and services is the payment stack.  Let’s discuss some of the key parts of the payment stack industry and how it works.

The Four-Party Scheme 

There are two main systems in the payment stack. The first is the four-party scheme. In this scheme, the four parties are:

  • the cardholder – the customer who uses their card to make a purchase
  • the card issuer – the financial institution that issued the card to their customer
  • the merchant – the business that accepted a card in exchange for a good or service
  • the merchant acquirer or payment service provider – the financial institution that enrolls merchants in programs that allow them to accept credit cards

Transactions involving the two major credit card issuers, Visa and MasterCard, are conducted using the four-party scheme.

Three-Party Systems

An alternative to the four-party scheme is a three-party system where the merchant acquirer and the card issuer are the same entity. This means there are no interchange fees exchanged between the acquirer and the issuer. The two major three-party systems operating within the United States are American Express and Discover. 

Independent Sales Organizations – The Fifth Wheel

Along with the merchant acquirer, there is often a fifth party: the independent sales organization (ISO). ISOs act as merchant service providers. They resell payment processing services to merchants. ISOs can be banks with existing merchant relationships, like Wells Fargo, or non-banks, such as Square, Braintree, PayPal, or Stripe. ISOs frequently provide merchants with physical point-of-sale (POS) devices, online payment gateways, or both. In its role as a payment gateway, an ISO collects payment credentials from merchants and forwards them to the merchant acquirer or payment service provider. ISOs may also offer other secure merchant services, such as smart routing or fraud management.

man with payment terminal with credit card

Two Key Processes

Whether transactions are conducted through a four-party scheme or a three-party system, there are two key processes involved: authorization and clearing & settlement. 

  • Authorization involves either approving or declining the card presented for payment. 
    • The cardholder’s information and transaction details are transmitted to the merchant acquirer via a merchant’s POS or payment gateway and then passed via the card network to the cardholder’s issuing bank for approval.
    • The card issuer approves or declines the transaction. Their response is transmitted to the merchant acquirer and then to the merchant via the POS or payment gateway.
  • Once payment is approved, and a purchase has been made, clearing & settlement is the second step in the process. 
    • At the close of a business day, the merchant sends their batch of payment authorizations to their merchant acquirer.
    • The merchant acquirer takes those payment authorizations and deposits funds from those sales into the merchant’s account. It also debits the merchant’s account for processing fees. 
    • The card network debits the issuing bank’s account and credits the merchant acquirer’s account for the net amount of the authorizations (gross receipts minus interchange and card network fees). 
    • The card issuer pays the merchant acquirer for the cardholder’s purchase.
    • The cardholder repays their issuing bank for the purchase. 

How Each Party Makes Money

Card issuers, card networks, merchant acquirers, and ISOs collect fees and payments for each card transaction. Card issuers collect interchange fees as a percentage of each transaction. Assessments collected by card networks can be either volume-based or transaction-based percentages of each transaction – or flat fees. Merchants pay per-transaction fees to acquirers in the form of a merchant discount rate for the ability to accept debit and credit card payments. This fee can be an added payment to the interchange fee or a flat rate fee categorized as either qualified, mid-qualified, or non-qualified.

Sorting Out the Payment Stack Industry

Sorting out the various moving parts of the payment stack industry can be confusing and even frustrating. Solutions that streamline online payment offerings make payments simple and easy for your customers, often translating into higher sales and greater customer loyalty. The payment professionals at PayTech Trust work to create unique customized solutions to meet the needs of our merchants and partners.

Contact us for more information on how we can help you.

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