In this blog post, Shachar Oren discusses what e-commerce merchant banking charges comprise of, what is involved operationally in conducting a transaction, and how to develop a strategy that is right for your business.
Online Merchant Banking is handled by banks and their gateways (a “gateway” is the technical systems used to facilitate transactions between a site and the bank). Some retailers interact with both parties (meaning, they sign a deal with a bank to process e-commerce transactions, and separately sign a deal with a gateway of choice such as Authorize.net), while other retailers work directly with banks who include the gateway function as a value-add within the bank offer (all under one agreement).
There are two main charges involved in your conventional online transaction:
1. Authorization fee (charged for the gateway service): This is a flat-fee for the function of looking up a credit card number and authorizing that the amount the retailer seeks to transact is available to be charged to the shopper.
2. Credit card fee (charged for the banking service, and also called “credit card discount” by banks): This fee is a percentage of the total amount of the transaction/purchase being made. Rates vary depending on (a) card, i.e. American Express and Discover tend to cost more than Visa and Master Card; (b) the retailer’s credit line (i.e. history and risk profile with the merchant bank); and (c) the total yearly volume of business the retailer represents for the bank.
There are additional operational costs involved, such as setup fee and monthly service fees, which are marginal in the big scope of things.
The last cost component to remember about merchant banks is the “Charge Back” fine they each itemize. If there is ever a dispute about a fraudulent or wrong charge, the bank invites you to justify it and reference your terms of Service for it. If you LOSE a case, the bank will debit you the amount they are refunding the consumer PLUS a fine (usually $10-$20 per occurrence). It is therefore imperative you include proper security measures and proper ToS on your site to avoid running into any issues.
The owner of the merchant bank account is the “Merchant of Record” that is responsible for any/all tax liabilities involved with e-commerce sales. Tax liabilities therefore apply based on the tax nexus caused by the owner of the bank account being used.
Two technical steps are in the core of an e-commerce transaction:
1. The authorization of the charge: When a charge is “authorized” via the gateway (retailer’s system sends a request, gateway processes it and responds with approval or denial), it means that the amount the retailer inquired about is available at the shopper’s credit card account. This also places a temporary “hold” for that amount on the shopper’s card (thus reducing the shopper’s “available balance” temporarily by that amount).
Temporary holds clear out automatically within a day or two (depending on each bank’s practices) if the amount is never “captured” (this is explained next).
You may have ran into this process yourself when renting a car for a week and being asked by the car rental company to sign on a thousand dollar security hold “just in case you don’t return with it” sort of thing. When you return the car, the rental place tosses away your authorization details. They never process a “capture” so you are never actually charged anything.
2. The “capturing” of the charge: This is when the amount is actually processed and debited from the shopper’s credit card – meaning, the transaction is going through. You can capture less than and up to the amount pre-authorized, but you can’t capture more than the amount authorized. In order to capture more, you’d need an additional, second authorization for the additional amount sought in the larger transaction. For example, if you authorized $10.00, than you can capture anything from $0.01 to $10.00, but you can’t capture $10.50 – to achieve the latter, you’d need to ask for another authorization of at least another $0.50.
Upon capturing an amount against the authorization ID, the original authorized “hold” amount ID is “cleared” and there’s no more record on hold on that shopper’s credit card. The purchase now shows as the final and accurate sum that was captured.
It is possible to run both authorize + capture requests simultaneously in one “call” (one API call to the gateway). This is what normally happens in a brick & mortar retail store for example, since there is no reason for a physical retailer to delay the processing of funds for a product that is leaving the store.
It is also possible to run the authorization first, and run the capture at a later time as a separate call to the gateway. The example I provided above with the rental car “security hold” is one example of how this method can be utilized. The car rental dealership has a hold of X on your credit card, and if you ruin the car, can charge up to that hold amount to your card to refund their losses from you.
APPLYING THIS TO DIGITAL GOODS:
At Neurotic Media, we leverage the separation of “Authorization” from “Capture” for what we call “Daily Transaction Aggregation”. When the shopper first orders a $0.99 song, we authorize that + $5.00 at the bank level, for a total hold of $5.99. At midnight, we total all daily transactions and run a “batch-capture” file. If the same shopper ordered 3-4 songs for the day, they all get captured against the original $5.99 authorized amount. For example, if the shopper ordered 3 songs that day, for $2.97 total, then we capture $2.97, and the balance of that pre-authorized amount goes off-hold and disappears.
- The authorization fee itself only hits the retailer once. It is paid on the initial authorization and therefore could be amortized across several songs, instead of being invoiced repeatedly once per song order.
- The shopper’s credit card shows the final number for the day, not each and every item ordered. In the example above, the credit card statement will show the shopper a total daily purchase of $2.97 worth of downloads, instead of three $0.99 rows.
- The shopper gets only one email receipt for that captured order for the day, listing the items purchased (as opposed to an email per item).
ESTABLISHING THE RIGHT STRATEGY FOR YOUR BUSINESS:
Neurotic Media offers many flexible e-commerce engagement options:
- Use of our default merchant banking account (“Neurotic Media” is listed on shoppers’ credit card statements)
- Open and manage an account we own and operate and D/B/A “you” – which means your name is what shows on shoppers’ credit card statements
- Integrate your own gateway and bank into our e-commerce suite so all the monies flow to you directly
- Use our API suite to integrate us into your existing system and sell our products while continuing to use your existing shopping cart
EVALUATING BANKING OFFERS:
Most merchant banking charges involve an authorization fee of $0.20 or more, and a credit card rate of 2.8%-3.5%. This would obviously be very high for a simple $0.99 transaction – since you’re looking at about 23c on the dollar.
Several years ago, merchant banks introduced the “micro payment” model: They charge less for the authorization and more for the credit card use. For example, an authorization fee of $0.10 or less, and a credit card rate of 4% or more. This is obviously more “retailer-friendly” for small transactions, since you’re looking at about 14c on the dollar.
We actually crunched the numbers and figured out that a transaction of $4.50 and under is where the micro-payment makes most sense, while transactions above $4.50 might as well use the traditional model.
Regardless, it is obvious how Daily Transaction Aggregation helps reduce the impact of the Authorization Fee on a per-song basis, and since most shoppers purchase 3-7 songs at a time, the impact of merchant banking fees is greatly reduced by this technique.
Of course, if you are using a traditional Shopping Cart work-flow, aggregation happens within the checkout workflow itself and you may see no benefit in Daily Transaction Aggregation. The latter is fit for wallet/account based systems, which we often prefer to see in use. They offer considerably less click-thru steps on the path to a download than does a cart system.
As always, we stand ready to help answer any questions, just ping us for a call.
(Shachar Oren, CEO)