Credit Card Processing Explained

One question that comes up with my clients who are new to online selling is how to accept credit card transactions. The answer to this question depends on whether they have an existing swipe terminal at their business location or if this is an entirely new venture. Every merchant processing credit cards needs both a merchant account and a payment gateway. Some of the most popular payment gateways are Authorize.net and Verisign. The clients I work with use both of these two gateways successfully. The key in choosing a gateway is to find out what your merchant account offers, and what your ecommerce package supports. Don't worry if you're unfamiliar with these terms, I'll be going over each one of them at the bottom of this article.

Manual Credit Card Processing
For customers who are already taking credit cards offline, I tend to recommend processing their online orders manually using that swipe terminal. What this does is defray the cost of online processing fees which are typically higher than offline transactions, as well as the need for an additional payment gateway and merchant account. The advantages to the manual processing method is that it's extremely cost effective and does not rely on the merchant doing anything they haven't already been doing. The disadvantage is one of time. As the store grows in order volume the day to day processing of credit cards can become quite time consuming. I once had a customer in the nutritional supplements business who had an employee whose only job was to run credit card transactions, 8 hours a day! Once an online store gets to this level of order volume, the choice becomes clear - begin processing credit cards online.

Automatic Credit Card Processing
Processing credit cards online is also the solution recommended to merchants who are just establishing their business. Since these merchants do not have the existing infrastructure to processes credit cards manually, online processing becomes the least expensive way to start. Processing credit cards online also reduces potential credit card fraud, and the merchant never needs to worry about an order coming through that will be declined by the credit card company.

The process works like this. A customer coming on to your site places some items into their shopping cart. They then begin the process of checking out. After their billing and shipping information is entered into your shopping cart application, the customer's credit card is processed. What is normally done for sites that do not sell electronic goods is that the customer's card is authorized and a hold for the amount of the transaction is put on their card. The customer then receives a thank you page detailing their transaction, and the merchant is notified of the order. Once the merchant is ready to ship the item, they then go into their online store's administration area and bills the card for the order. This process is called settling. It is not until a credit card is both authorized and settled that the merchant actually receives the money for an order.

Sites that sell electronic goods like software, ebooks and website subscriptions generally perform the authorize and settle at the same time. This is because when the customer completes the order their items are automatically "shipped."

A word about authorizing and settling. It is against the law to charge a customer's credit card before the transaction is complete. Over the last 7 years or so, I know a number of merchants who began charging credit cards on orders that were not shipped in order to preserve cashflow as they had to stock larger and larger inventory amounts. One case involved a computer retailer who grew from 10k / month in sales to 1 million / month in sales over a 2 month period. In each case that I know of the justice department was involved and the company was shut down. In some cases the principles of the company were arrested. I cannot stress this point enough, you cannot charge until the order is going out the door.

Credit Card Fraud
Credit Card fraud is a huge problem for merchant's who are the ones that take the loss on a fraudulent order. Even though a credit card may make its way through a processor's fraud detection devices, if that order is found to be fraudulent the merchant is out for the entire amount of the order. Also if you have a high number for fraudulent cards come through, credit card processors will raise your merchant fees. What can a merchant do to protect himself?

Address Verification
Credit Card address verification is the first line of defense in preventing credit card fraud. It works by comparing the street number and zip code of the billing address to the information found on file. If for example a credit card's billing address is 123 Main Street, Anytown, PA 18902. A fraudulent order will still go through using 123 Wayward Avenue, Somewhere Else, PA 18902. Address verification also largely only works within the United States. Some things a merchant can do to increase their protection, is to have their ecommerce package automatically use the City that is assigned to a zip code. Also with this type of fraud the order is always shipped to a different address than the billing address. Merchants who require that items are shipped to the billing address, or that the shipping address be registered on file with the credit card company can significantly lessen their risk.

CVV2
CVV2 stands for "Card Verification Value," and it is a 3- or 4-digit number that is printed on the back of Visa, MasterCard and Discover cards, usually in the signature box. On American Express cards, this information can be found on the front. A merchant can configure any their customers to provide the CVV2 number, which can enhance fraud protection. Most merchants employing CVV2 also add a link to information on where to find this number at to educate their customers.

Merchant Account
This is a bank account that is setup for accepting credit card transactions. Typically these accounts will charge a percentage of each transaction in addition to a setup fee and or per transaction charge. You get a merchant account at a bank.

Payment Gateway
This is the network that the bank uses to communicate between your shopping cart application and your merchant account. The biggest payment gateways are Verisign and Authorize.net. Typically you will also establish this account at your bank. The key thing is to make sure that the payment gateway that your bank uses is supported by your ecommerce package. If it is not you'll either have to change ecommerce software, or change banks.

Authorize
This is the initial hold that is put onto a credit card. If you use online banking you'll often see these charges come up. When pumping gas, the gas station usually puts a $1.00 hold on the credit card being used. If the transaction isn't settled in 15-30 days the money is no longer held. Even though the funds are not withdrawn yet, and you are not paying interest on the transaction, an Authorize will reduce your available credit by the amount of the transaction.

Settle
This is when the money leaves the customer's account and goes into the merchant's account. A settle should only be performed when the transaction is complete, and the item is going out the door to the customer.

If you have any other questions about how online transactions work, and the steps involved in processing credit card transactions online, please drop me a line.