How companies make money in the Payments Processing Value Chain

A closer look at the economics from each $1 of payment volume

How payments companies make money

Source: Square’s pricing page

A closer look at each of the players in the value chain

Illustrative example of a basic eCommerce transaction
  • Card Networks: The industry’s “tollbooth,” the card networks collect a “network fee” on each transaction as they supply the electronic networks that enable credit card acceptance. For a standard credit card transaction, Visa and MasterCard charge a network fee of 0.14%+$0.0195.
  • Issuing Banks: The banks that issue consumers their credit cards (e.g., Capital One, Wells Fargo, Bank of America) receive an “interchange fee” from each transaction. Though interchange is earned by the Issuing Banks, the interchange rates are set by the Card Networks. The full menus of possible interchange rates are published by Visa and MasterCard. These rates are also quoted as a % of TPV plus a fixed $ charge, but the interchange fee will generally range between 150 bps and 200 bps, and depends on a combination of factors, such as card type, card-present/-not-present, and merchant type, which collectively characterize the risk profile of the individual transaction.
  • Acquirer Processors: Responsible for authorization, and clearing and settlement of each transaction, Acquirer Processors serve a technical role to facilitate the acceptance of each credit card transaction. In most situations, the processing service is tied to the Merchant Acquirer, so it’s difficult to parse out the stand-alone cost of the processing service. Based on a few articles I found (such as this one from Barron’s), my best guess is that the stand-alone processing fee is between $0.05 and $0.10 per transaction, and likely lower for large merchants that can drive greater volumes. If you make the rough assumption that the average transaction is $50, then the processor fee is somewhere around 10 bps.
  • Merchant Acquirer: If you browse through the websites of PayPal, Stripe, Square, or First Data, you will notice that they quote the entire Discount Fee. So, it’s natural to assume that Square earns the entire Discount Fee on each transaction. However, Square does not keep all of this — remember, this is simply what the merchant pays. In fact, Square shares a large portion of the Discount Fee with the Processors, Issuing Banks, and Card Networks. The portion of the Discount Fee that the Merchant Acquirers keep, net of the amounts paid to those other parties, is termed the “Acquirer Mark-Up.”

How large is the Acquirer Mark-Up?

Thinking about the bigger picture

Illustrative example of a $50 eCommerce transaction

What do the take-rates reveal about competition?

  • The card networks publish their fees and there is little-to-no variability between the networks (Merchant Maverick summarizes the four major US card networks’ fees here).
  • The card networks also publish the interchange fees for their issuing banks. Not only is there little variability between the rates published by Visa vs. MasterCard, but the issuing banks can’t even compete on price because the interchange rates are literally dictated to them.
  • For acquirer processors, the stand-alone processing service is undifferentiated and interchangeable, so it’s safe to assume there is little pricing power.
  • The merchant acquirers offer remarkably consistent pricing. It is remarkable because the acquirers can set their own pricing and they effectively take whatever is left of the Discount Fee after the other mouths have been fed. You might expect acquirers to try to compete on price. And yet, a quick look through the websites of Square, Stripe, PayPal, and Braintree, and you find this:
It’s like that intersection with a gas station at each corner

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Principal at InvestX with a focus on software, payments, tech, startups. Opinions are my own.

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Jonathan Ching

Principal at InvestX with a focus on software, payments, tech, startups. Opinions are my own.