Overview of the Industry
To the consumer and the merchant, electronic payments appear to be seamless and nearly instantaneous - but in fact, a highly complex network infrastructure is required to manage the transactions between the person who makes a payment, the person who receives it, their respective banks, and the companies that manage the network connections and nodes between them.
Originally, an ATM was as simple as a transaction with a bank teller, with a customer going to a terminal at their own bank that dispensed cash and collected transaction information for use in their own bank's information systems. The user would authenticate, access their account balances, and transfer funds, all within a single information system owned buy a single firm. Likewise, a debit card transaction originally functioned in the same way as a paper check, with a merchant collecting payment information and authorization from a customer, then redeeming it directly with the customer's bank.
When these systems became networked, the consumer enjoyed the ability to conduct transactions with any number of ATM terminals, or to present a debit card at any merchant whose POS system enabled them to communicate transaction data to any bank. This required banks to open their systems to a broader network, with various components that are owned or provided by a multitude of different providers.
Each provider seeks to profit by its services, which brought about an array of fees. A fee might be assessed by the owner of the ATM or POS equipment, by the owner of the network to which the terminal is connected, by the third party who collects and sorts transactions, and by the bank at which the funds reside for the increased cost of doing business with other fees. These fees are negotiated between the merchant who accepts a payment, the bank from which the payment is issued, or the customer himself.
(EN: Regardless of who is considered to pay for the transaction, all costs are ultimately visited upon the consumer: the fee charged to banks to process withdrawals, or to merchants to accept various forms of payment, constitutes an operating expense that must be covered by revenue. If they do not charge the customer directly for the transaction, they must generate revenue by other means - charging fees for other banking services, increasing the cost of merchandise, which often visits the expense of serving some customers upon others who do not benefit directly from the service. It's a shell game, but customers always pay the expenses of those who provide any service, one way or another.)
Industry infrastructure
The author seeks to differentiate between the frontline participants in a given transaction and the components of the underlying infrastructure.
- For ATM transactions, the frontline participants are the customer, his bank, and the ATM owner
- For debit card transactions, the frontline participants are the consumer, the merchant, and their banks.
A common infrastructure of middlemen exist in these transactions: the EFT networks, offline card processors, and other third-party service providers. Each of these is considered separately:
EFT networks
The EFT network is a telecommunications and payments infrastructure that provides an indirect connection between the ATM terminal or POS equipment at which a transaction is made to the information systems at the bank from which the payment is ultimately deducted.
Two key characteristics are the authentication mechanism (a PIN is used to authorize payments) and the expediency (funds are transferred immediately, or within seconds, and there is no lag in processing).
While some distinctions can be made between an ATM withdrawal and a debit card purchase, they are essentially the same to the network, the chief difference being that a debit card purchase involves an additional transaction - an ATM withdrawal deducts funds from one account, a debit card transaction also credits the funds to another account.
EFT networks are generally separated into two types: regional and national. However, it's something of a misnomer to consider any network to be "regional," as most of them have grown to a point of near-national coverage. Meanwhile, companies such as Visa and MasterCard operate networks that are truly national, and have even become international, in scope.
One important distinction is that the national networks generally serve as a bridge between regional networks - that is, each regional network need not negotiate transactions with every other regional network, but all can interconnect through a national network as a common hub.
Ownership of EFT networks varies: some are owned by a single bank, multiple banks may enter into a joint venture to form a network, or an independent company may own a network and furnish access to it as a service to multiple banks.
Offline debit card networks
Another component of the infrastructure is the offline debit card networks/ These are differentiated from the electronic networks in that they do not immediately transact with the bank at which the payment is made: they do not directly authenticate (though a signature is typically used) and there is a time delay before the transaction is processed and funds are transferred.
This was the way that card-based payments (and even checks) were originally managed, and remains for a significant portion of the market the way that they continue to be handled.
The traditional method for processing payments was to collect payment and process them as a batch - though increasingly, such payments are processed at shorter intervals, or even instantaneously, and avail themselves of the electronic payment networks.
The processing of the payments is still handled differently: online debit transactions are processed over an EFT network, and offline transactions are processed over credit card network. Other differences include that customers are generally not permitted to get "cash back" at the point of sale, and the fee structures are different.
Third-party service providers
Banks and other financial institutions typically rely on a myriad of third-party service providers to conduct certain business activities. These organizations offer a variety of services in different combinations, which include transactional services (collecting information and transferring funds) as well as supporting services (manufacturing the physical cards and issuing them to account holders).
The author classifies third-party processors into six major categories:
- ATM Services - Install, operate, and maintain the physical machines (much in the way one might maintain a vending machine) and maintaining a connection between the machine and the network.
- Merchant Services - Install and maintain point-of-sale terminals for merchants and process payments on behalf of shop owners.
- Account Maintenance - A data service that ensure that a payment is properly authorized and sufficient funds are available via a central database
- Transaction Routing - Aggregate data pertaining to transactions and route it to the appropriate bank or card-issuing institution, such tat a merchant can accept a variety of payment cards through a single system
- Offline Debit Processing - Receive data pertaining to offline transactions and transfer it to the information systems that debit funds from one party and credit them to another
- Clearing and Settlement - A middleman in payment resolution, which pays one party and collects from another, using its own accounts as a bridge to cover any lag between the two
Independent Sales Organizations (ISOs) have also arisen, which enable smaller companies to have a role in the payment processing industry. For example, an ISO may provide supporting services for ATMs, but the actual task of maintaining them falls to many smaller companies licensed and supported by the ISO, via a species of franchise model. The fact that many ISOs also directly operate some "franchises" while licensing others ti different companies has blurred the line between the two.
Brief history of the industry
Arguably, the first "teller machine" was invented in 1939, but none were actually deployed until the 1960s. Even these remained primitive mechanical devices that required the user to enter the branch and fill out a paper voucher to receive a fixed denomination.
The ATM as we know it today began in the early 1970s, complete with plastic cards, access codes, and the ability to deposit, withdraw, or transfer cash, with transactions stored digitally for later input into the bank's centralized computers.
By the 1980s, ATMs became a fixture, and national EFT networks emerged to process credit card transactions, debit cards not becoming popular until the 1990s when grocery store chains began accepting debit payment.
Technology aside, regulatory constraints remained a barrier to providing ATM service over a broad territory. The 1985 Supreme Court decision that differentiated ATM locations from branch offices enabled interstate payment networks and the more extensive deregulation of the banking industry in the 1990s enabled banks to offer a wider range of services and removed many geographic restrictions - not to mention spawning a flurry of mergers, acquisitions, and territorial expansions that changed the industry from a multitude of small local banks to a smaller number of large, national ones.