Introduction To Merchant Services

Dear New or Prospective Credit Card Merchant:

You are a new or prospective merchant who is excited about the opportunity to accept credit cards as payment for the goods and services you provide. You are probably thinking that this opportunity will make it easier for your customers to pay you, open other avenues of marketing and selling (e.g. the Internet), and protect you from the hassles and risks of bad checks. You are right - it can do all of this. However, accepting credit cards for payment carries with it some responsibilities, and is not entirely risk free to you, the merchant. (There is no free lunch!). This white paper is intended to provide you with some important information regarding:

• How the credit card system works,
• Some things to watch out for, and
• Your responsibilities as a merchant.
First, some definitions.

Your customer, the "Cardholder", obtains his/her MasterCard or Visa credit card from a bank. The bank is called the "Issuing Bank" since it is the bank that issues the card to the Cardholder. (American Express and Discover work a bit differently, but the principles in this white paper apply to these card types too!).

You, the Credit Card Merchant, obtain your "Merchant Account" from a "Sponsoring Bank", sometimes called an "Acquiring Bank" or "Merchant Bank". It is called a Sponsoring Bank because the bank is sponsoring you, the Credit Card Merchant, as a business that is qualified to accept credit cards. Your Sponsoring Bank typically uses a "Processor" such as ECHO to acquire the credit card transactions from you and process them through the bank system.

By giving a credit card to a Cardholder, the Issuing Bank is granting the Cardholder the rights to borrow money from the Issuing bank (up to a "Credit Limit") for the purposes of purchasing goods and services from a bona fide Credit Card Merchant such as yourself.

How are transactions processed?

When you, as a Credit Card Merchant, want to accept a credit card for payment of your goods and services, you first submit an authorization transaction to your Processor (e.g. ECHO).

Your Processor accesses the Visa/MasterCard network to communicate the authorization transaction (containing a "Transaction Amount") to the Issuing Bank to ensure that the credit card is valid and that the Transaction Amount does not exceed the Cardholder's credit limit. The authorization transaction also puts a "hold" for the Transaction Amount on the Cardholder's credit limit. That way, the funds are available to you when you submit the corresponding "Deposit" transaction.

If the authorization succeeds, and you subsequently (or at the same time) submit the Deposit transaction, you are informing (in effect promising) your Processor, your Sponsoring Bank, and the Issuing Bank that you are prepared to deliver to the cardholder the goods and services that are expected by the cardholder, and that you wish to receive payment for these goods and services from the Issuing Bank.

Your Processor (e.g. ECHO), based on your Deposit instruction, then again works within the Visa/MasterCard network to request the Issuing Bank to deposit the "Net Settlement Amount" (i.e. the "Transaction Amount" less the "Discount Amount") into your bank account at your Sponsoring Bank.

The Discount Amount (i.e. the Discount Rate times the Transaction Amount) and other fees, such as transaction fees, are used to pay the various entities that help you collect from the Issuing Bank. In particular, the Issuing Bank, the Visa/MasterCard Network, the Sponsoring Bank, and the Processor all share in dividing up the Discount Rate proceeds.

OK, now lets talk about protection.
Who does the credit card system protect?

First, it provides some protection for you, the Credit Card Merchant. When you sell goods to a Cardholder, and you have received authorization for the Transaction Amount from the Issuing Bank, then the Issuing Bank is promising you that after you submit the Deposit transaction it will deduct the Transaction Amount from the Cardholder's credit limit, and in cooperation with your Processor, transfer the Net Settlement Amount into your bank account at your Sponsoring Bank.

However, this promise from the Issuing Bank does not come without some strings attached. When you submit the Deposit transaction, you are, in effect, promising the Issuing Bank that you will deliver to the Cardholder the goods and services that you promised to the Cardholder.

In effect, the Issuing Bank's promise to pay you is only as good as your promise to the Issuing Bank that you will deliver "expected" goods and services to the Cardholder. The word "expected" is important. If you have made representations to the Cardholder, leading the cardholder to create "expectations" in his/her mind, then by accepting a Credit Card for payment, you are in effect promising the Issuing Bank that you have or will "make good" on those expectations.

So it is a two way street. If you make good on your promises to satisfy the Cardholder's expectations, the Issuing Bank will make good on its promise to pay you the Net Settlement Amount.

In order to expedite your payment of the Net Settlement Amount, the entire system operates on the basis of trust with you. When you submit the Deposit, your Processor, your Sponsoring Bank, and the Issuing Bank all TRUST that you have or will fulfill your commitment to satisfy the Cardholder's expectations. The system does not ask the Cardholder if he/she is satisfied before you get your payment, the system TRUSTs that you have or will (in the immediate future) satisfy the Cardholder, and based on this TRUST, your Processor instructs the Issuing Bank to transfer the Net Settlement Amount into your account at your Sponsoring Bank. In fact, that is one reason why your Sponsoring Bank is called "Sponsoring". The bank is sponsoring you as a trustworthy merchant - one that consistently fulfills the Cardholder's expectations.

Now, here is the rub. What happens if the Issuing Bank gets informed by the Cardholder that you did not fulfill the Cardholder's expectations?

Cardholder's Expectations

Maybe the Cardholder thinks that you never delivered the goods and services you promised him/her.

Maybe the Cardholder thinks that he/she never ordered the goods or services that showed up on the Cardholder's credit card bill from the Issuing Bank.

Maybe the Cardholder received the goods and services, but they did not meet the Cardholder's expectations, so the Cardholder wants to return the goods (if any) and wants his money back (e.g. a refund).

Well, the Issuing bank still is operating on the TRUST system. They assume that either the cardholder is mistaken, or that you, as a trustworthy merchant have or will "make good" on your promises to the Cardholder. But the Issuing Bank is obligated to investigate the Cardholder's complaint.

To resolve a Cardholder complaint regarding non receipt of goods or services, the Issuing Bank first (typically) sends a Retrieval Request to your Processor. Your Processor (e.g. ECHO) will then forward this Retrieval Request to you. The Retrieval Request is basically asking you, the Credit Card Merchant, for proof that you sold and delivered the disputed goods or services to the complaining cardholder. This proof usually consists of a document, in your possession, that has been signed by the Cardholder acknowledging the Cardholder's receipt of the goods or services that were charged on the credit card.

If you can prove in a timely fashion that you delivered the goods or services to the Cardholder, then your Processor will forward that information to the Issuing Bank, who in turn will inform the Cardholder, and the complaint is usually dropped (but not always).

Important!. If you do not have such a "proof" document, or something equivalent, or if you cannot find and deliver a copy of that document to your Processor in a timely fashion, then you need to know that the system will assume that the Cardholder is right and that you did NOT deliver goods and services as you promised when you submitted the deposit transaction. When this happens, several things occur. First, the Issuing Bank submits a chargeback to your Processor. Simultaneously, the Visa/MasterCard network takes the original Transaction Amount of the disputed transaction out of your bank account at the Sponsoring Bank. (Often, this is a deduction from the net settlement for your most recent deposit transactions). Finally, the chargeback goes on your Merchant Account Record.

Are chargebacks bad? The answer is YES - you need to do everything you can to avoid them. The system understands that if you do any volume at all, some small number of chargebacks may be unavoidable, and part of the cost of doing business. (You should assume this too in your budgeting). However, if you get too many chargebacks, then the system starts wondering about the TRUST it put in you. This jeopardizes your standing as a Credit Card Merchant. If it gets too bad, then your Merchant Account may be terminated by your Sponsoring Bank, and you may find it impossible to find another Sponsoring Bank. If it appears that you intentionally created many chargeback situations, then you may be liable for charges of fraud, and criminal prosecution.

OK, so part of your responsibility as a Credit Card Merchant is to avoid chargeback situations. It is not all that hard. Here are some guidelines to help you do that.