Types of cards

TYPES OF CARDS

The industry typically divides up cards by the business of the issuer. So there are bank cards (VISA, Master Card, Discover), Petroleum Cards (SUN Oil, Exxon, etc.), and Travel and Entertainment (T&E) cards (American Express, Diners' Club, Carte Blanche). Other cards are typically lumped together as "Private Label" cards. That would include department store cards, telephone cards, and the like. Most private label cards are only accepted by the issuer. People are starting to divide the telephone cards into a separate class, but it hasn't received widespread acceptance. (This is just a matter of terminology, and doesn't affect anything important.)

Cards are also divided by how they are billed. Thus there are credit cards (VISA, MC, Discover, most department store cards), charge cards (American Express, AT&T, many petroleum cards) and debit cards. Credit cards invoke a loan of money by the issuer to the cardholder under pre-arranged terms and conditions. Charge cards are simply a payment convenience, and their total balance is due when billed. When a debit card is used, the amount is taken directly from the cardholder's account with the issuer. Terminology is loose - often people use "credit card" to encompass credit cards and charge cards.

A recent phenomenon is third-party debit cards. These cards are issued by an organization with which the cardholder has no account relationship. Instead, the cardholder provides the card issuer with the information necessary to debit the cardholder's checking account directly through an Automated Clearing House (ACH), the same way a check would be cleared. This is sort of like direct deposit of paychecks, in reverse. ACHs love third-party debit cards. Banks hate them.

Another addition is affinity cards. These cards are valid credit cards from their issuer, but carry the logo of a third party, and the third party benefits from their use. There is an incredible variety of affinity cards, ranging from airlines to colleges to professional sports teams.


HOW THEY MAKE MONEY

Issuers of credit cards make money from cardholder fees and from interest paid on outstanding balances. Not all issuers charge fees. Even those that do, make most of their money on the interest. They really like people who pay the minimum each month.

Issuers of charge cards make money from cardholder fees. Some charge cards actually run at a loss for the company, particularly those that are free. The primary purpose of such cards is to stimulate business.

Issuers of debit cards may make money on transaction fees. Not all debit card transactions have fees. Most debit cards exist to stimulate business for the bank and to offload tellers and back-room departments. To date, third-party debit cards exist solely to stimulate business. Providers of such cards make no direct money from their use.

Acquirers make money from transaction charges and discount fees. Unlike the charges and fees mentioned above, these fees are paid by the accepter, not (directly) by the cardholder. (Technically, it is not legal for the merchants to pass these charges directly to the consumer.) Transaction charges are typically in pennies per transaction, and are sensitive to the type of communication used for the authorization. Discount fees are a percentage of the purchase price and are sensitive to volume and compliance to rules. One way to encourage merchants to follow certain procedures or to upgrade to new equipment is to offer a lower discount fee.

Until fairly recently, the only motivation for accepters was to expand their business by accepting cards. Reduction of fraud was enough reason for many merchants to pay authorization fees, but in many cases, it isn't worth the cost. (That is, it is cheaper to pay the fraud than to prevent it.) Recently, electronic settlement has provided merchants with an added benefit by reducing float on charged purchases. Merchants can now get their accounts credited much faster than before, which helps cash flow.

Companies that issue charge cards are real keen on float reduction. The sooner they can bill you, the sooner they get their money. Credit card companies are also interested in float reduction, since the sooner they bill, the sooner they can start charging interest. Debit cards typically involve little or no float.

Affinity cards usually pay a percentage of purchases to the affinity organization. Although it may seem obvious to take this money from the discount fee, this doesn't work since the issuer is not always the acquirer. The money for this usually comes from the interest paid on outstanding balances. Essentially, the bank is giving a share of its profits to an organization in turn for the organization promoting use of its credit card. The affinity organization is free to use its cut any way it wishes. An airline will typically put it into the frequent flyer program (and credit miles to your account). A college may put the money into the general fund or into a scholarship fund.

THE BUSINESS RELATIONSHIPS

Card acceptors generally sign up with a local acquirer for authorization and settlement of all credit cards. This acquirer may or may not be a card issuer, but certainly will not have issued all the cards that the merchant can accept. The accepter does not generally call one place for VISA and a different place for MC, for example. At one time, this was necessary, but more and more acquirers are connected to all networks and are offering a broader range of services.

Acquirers generally are connected to many issuers, and pay transaction charges and discount fees to those issuers for authorizations. Thus, the acquirer is actually making money on the difference between fees paid and fees billed. Most acquirers gather together transactions from many accepters, allowing them to get volume discounts on fees. Since the accepters individually have lower volume and are not eligible for those discounts, there is a markup that the acquirer can get away with. Acquirers also, of course, provide the convenience of a single contact.

Most large banks are issuers and acquirers. Things get real interesting when it's time to settle up. Some small banks are only issuers. There are third parties that are only acquirers.

THE ACCEPTER

An important fact to note is that a card accepter does not have to get approval for any purchases using credit or charge cards. Of course, a merchant is usually interested in actually getting money, and so must participate in some form of settlement process (see below). Usually, the most acceptable (to a merchant) forms of settlement are tied (by the acquirer) to authorization processes. However, a merchant could simply accept all cards without any validation, any eat any fraud that results.

A merchant typically makes a business arrangement with a local bank or some other acquirer for authorization and settlement services. The acquirer assigns a merchant identifier to that merchant, which will uniquely identify the location of the transaction. (This facilitates compliance with federal regulations requiring that credit card bills identify where each purchase was made.) The acquirer also establishes procedures for the merchant to follow. The procedures will vary by type of the merchant business, geographic location, volume of transactions, and types of cards accepted.

If the merchant follows the procedures given by the acquirer and a transaction is approved, the merchant is guaranteed payment whether the card in question is good or bad. The purpose of authorization is to shift financial liability from the acceptor to the acquirer.

There are two basic tools used - bulletins and online checks. Bulletins may be hardcopy, or may be downloaded into a local controller of some form. Online checks could be done via a voice call, a standalone terminal, or software and/or hardware integrated into the cash register.

A low-volume, high-ticket application (a jewelry store) would probably do all its authorizations with voice calls, or may have a stand-alone terminal. A high-volume, low-ticket application (a fast-food chain) will probably do most of its authorizations locally against a bulletin downloaded into the cash register controller. Applications in between typically merge the two - things below a certain amount (the "floor limit") are locally authorized after a lookup in the bulletin, while things over the floor limit are authorized online.

Usually a lot of effort is taken to use the least expensive tools that are required by the expected risk of fraud. Typically, communication costs for authorizations make up the biggest single item in the overall cost of providing credit cards.

Large accepters are always a special case. Airlines are usually directly connected, host-to-host, to issuers and/or acquirers, and authorize everything online. Likewise for many petroleum companies and large department stores. Some large chains use different approaches at different locations, either as a result of franchising oddities or due to volume differences between locations. A lot of experimentation is still going on as well - this is not a mature market.

For voice authorizations, the merchant ID, PAN, expiration date, and purchase amount are required for an approval. Some applications also require the name on the card, but this is not strictly necessary. For data authorizations, the merchant ID, PAN, PIN (if collected), expiration date, and purchase amount are required. Typically, the "discretionary data" from track 2 is sent as well, but this is not strictly necessary. In applications that do not transmit the PIN with the authorization, it is the responsibility of the merchant to verify identity. Usually, this should be done by checking the signature on the card against the signature on the form. Merchants don't often follow this procedure, and they take a risk in not doing so.

In most applications, the amount of the purchase is known at the time of the authorization request. For hotels, car rentals, and some petroleum applications, an estimated amount is used for the authorization. After the transaction is complete (e.g. after the gas is pumped or at check-out time), another transaction may be sent to advise of the actual amount of the transaction.