Here’s another note on mobile payments. This time, I want to talk about the various paradigms out there that have been proposed lately. But before we go there, I think it is necessary that we understand that the current payment paradigms are. And that’s easy – consumers pay for their purchases with either cash, credit or debit cards – right?
Let’s talk cash – it turns out that cash in the U.S is mainly used for what is termed as micro-payments. Micro-payments are basically small dollar transactions and research has pointed out that on average micro-payments in the US round out to around $11.52 per payment (not to be exact that is…). Credit card on the other hand contribute on average about $44.50 per transaction while checks contribute on average around $54 per transaction.
Hmmm…cash is not used a lot – right? Check your wallets. I, for one don’t carry much cash just like the cabbie who doesn’t have more than a $20 on him. I guess it’s a convenience and safety factor among other things.
In a financial transaction, there are typically two parties, a buyer and a seller. That’s a no brainer for sure. Money normally would flow from the buyer to the seller. And that’s the model for cash. But in the case of the credit card or debit card, there are intermediaries. And that’s the where the fun is and the that’s where the money is for many players. So, who are these intermediaries and what do they do? They are companies like MasterCard, Visa, American Express, Discover etc. They also include your bank that’ll fund the transaction in the case of a debit card. And the ‘Originator’ bank – the bank that’ll actually receive the funds (the seller’s bank account).
A very simple credit card transaction works like this –
- Customer pays for purchase at POS
- POS software reads the card swipe and detects the payment network (MasterCard, Visa etc)
- POS software sends message to payment network to validate your account
- Payment network receives message, checks a bunch of things about the customer (bank account, credit availability etc)
- Payment networks sends back a message to originator (merchant) approving or rejecting the transaction
- Once approved, merchant requests customer signature to complete transaction
- Transaction is complete and customer walks away with purchase
All the customer does is swipe the card and then sign. I have oversimplified the steps in between these two actions, but suffice it to say that a number of things happen at very high speed to facilitate the transaction.
Now, at this point the merchant has still not been paid. The merchant has essentially moved inventory out of the store and in turn has a guarantee from the payment processor (MasterCard, Visa and the like) for the payment. At the end of the day, the payment processor batches all the transactions and processes the transaction using the ACH network to essentially fund the merchant. The merchant bank account is actually funded between in 1-3 days post transaction depending minus the processing fee. The processing fee is in the 1-2.5% range on average and constitutes revenue for the payment processor.
The payment processor then bills the customer at the end of the billing cycle or in other words extends to the customer a line of credit for purchases. Now, a prudent customer will make their payments on time and not give credit card issuers an opportunity to collect fee.
It must be noted that there are two types of credit cards, the ones that are multi-branded and the ones that are uni-branded. Multi-branded cards are those that are issued by banks or financial services companies but on a payment network like MasterCard or Visa. On the other hand uni-branded cards are issued by the payments processor like say a Discover or American Express card. The credit card issuer pays the merchant and expects to be paid by customers on time per the contract customers sign when accepting a card from the issuer. Failure to pay on time results in additional revenue streams for credit card issuers.
In the case of debit cards, which are typically issued by financial institutions, the payment is debited from the customer bank account almost immediately and funneled to the merchant bank account at the end of the transaction. The ACH network is used to validate the customer account to ensure that the account is funded. A debit card is almost like cash, but safer as a PIN is typically required to activate the transaction.
Now, these systems has been in play for several decades now (cash has been there forever) and it has worked well for all players. Mobile payments will augment the current payments paradigm and not displace it at least not in the near future. A decade from now, yes, things could be much different. Now that I have laid out the current payment paradigm, in the next parts, I will discuss the various mobile payment schemes.