nderstanding the card acquiring market can be a chore. Many different lines of business make up this market - hardware and software providers; transaction authorization, processing and settlement services; merchant banks; and Merchant Level Salespersons (MLS).

And these businesses don't all speak the same language. I'm not just talking computer language, either. Even terms such as transaction acquiring and transaction processing can have different meanings, depending upon whose business is being defined.

In an effort to dispel some of this mystery, this is the first of a periodic series of primers on transaction acquiring. Future installments will address check transactions, debit cards and additional facts about credit cards.

What roles do Visa, MasterCard, Discover and American Express play in the credit card market?

Visa and MasterCard are independent companies owned by banks that issue transaction cards bearing Visa and MasterCard logos that can be used to access lines of credit or demand deposit accounts (checking and checking-like accounts). Discover and AmEx are non-bank, travel and entertainment card companies. Discover and AmEx issue cards to customers directly; these cards can be used only to access credit lines only, not DDA accounts.

Each company (Visa, MasterCard, Discover, AmEx) is responsible for managing its brand as well as product development; setting and enforcing rules of access to the clearing and settlement system; establishing systems, standards and procedures for cards and acquirers; registration of services providers; and interchange pricing.

What is interchange and how do interchange fees differ from discount fees?

Interchange is set by Visa and MasterCard and represents the fee paid by the merchant bank to the card-issuing bank. Interchange fees vary by retail sector (grocers typically have the lowest interchange rates, while Internet transactions are the highest), type of card (e.g., consumer versus commercial versus check card), size of transaction (large commercial versus small consumer purchases), and authorization procedures.

Think of interchange as the wholesale cost; discount then is what it cost retail or, more accurately, is the cost to retailers. The discount fee incorporates interchange plus mark-ups for processors and other service providers and is paid by the merchant on a per-transaction basis. AmEx and Discover do not charge interchange; instead, merchants pay these companies discount fees.

What's the difference between a bundled rate and an unbundled rate?

Bundled and unbundled are really nothing more than marketing concepts. The bundled rate is intended to include every conceivable charge for a transaction in one set price. The unbundled price strips out every charge, in effect creating an itemized bill for each transaction.

Unbundled pricing is probably more common in the market but results in few merchants having any real idea of what they're paying to accept payment cards.

What is the buy rate?

The buy rate is the cost charged sales intermediaries by the merchant bank; it reflects interchange on a transaction plus the bank's mark-up. This differs from the discount rate, which is what the intermediary charges the merchant after marking up the buy rate.

How come some MLS offices are able to offer lower rates than others?

Beware appearances. Some companies have established elaborate unbundled rate structures that obscure the true cost of services. It's a good idea to shop around for acquiring and processing partners and to understand how each company's prices are set.

How do I build a merchant portfolio?

By offering merchants robust product lines. These are sometimes available as a package from one processing company. But more likely it's something you'll need to pull together on your own, dealing with best-of-breed providers of an array of services, from phone cards and credit cards to loyalty and gift cards, check acceptance, etc.

It's always important to bear in mind, however, that merchant portfolios in reality are owned by acquiring banks, not by the front-line service providers.

How do you determine the value of a merchant portfolio?

There's no hard and fast rule for valuating a card portfolio, but a good rule of thumb is to begin the valuation process using monthly gross net revenues. (Revenues, after all, are an easily gauged source of value.)

To determine that number, take the gross total of discount fees collected from merchants and deduct from that total outlays for interchange, dues, fees and other assessments.

Typically, portfolio valuations are expressed in terms of specified periods, such as 16 months or 18 months; purchase prices are generally expressed as a certain multiple of net monthly revenues.

Which acquirers have the largest portfolios?

The January 2003 issue of GSQ ranks billion-dollar bankcard acquirers based on 2002 transaction estimates. There are more than 30 companies listed, which combined had portfolios representing about 96% of all Visa and MasterCard payments in the U.S. First Data Corp. controls by far the largest share of the market.

What is transaction authorization and how does it differ from processing and settlement?

Authorization, in the context of card payments, involves a communication between the card-issuing bank and the merchant's bank verifying that the cardholder has available credit or available funds in his or her DDA to cover the transaction. The card-issuing bank then sets aside the funds, and an authorization code is assigned to the transaction. Settlement refers to the final accounting during which debit and credits are posted to the appropriate accounts at the card-issuing and card-acquiring banks. Processing is a catch-all phrase that refers to the management of transaction flows. Some processing companies handle everything involved with a card transaction while others merely move transaction data between different parties (e.g., card acquirers, card issuers and the clearing-and-settlement systems).

What is a chargeback?

A chargeback is a reversal of a sale transaction, typically initiated by the card issuer at the cardholder's request. Chargebacks can occur for any number of reasons, including customer disputes, potential or actual fraud (on the part of merchants, sales associates and/or customers), processing errors and authorization issues. Chargebacks are governed by a complex set of rules and time limits that can be costly to acquirers and their merchant customers if disregarded.

How do I ensure against merchant defaults?

Your best defense against merchant defaults is appropriate underwriting procedures that properly assess risks. Also, be sure your merchants follow the transaction authorization and settlement guidelines that are provided by the card companies. In other words, your primary wall of defense against defaults is to have good merchant customers who play by the rules. If that fails, there are some insurance companies that offer policies and/or surety bonds related to merchant card acceptance. These products can provide payouts arising from merchant non-delivery of products, unauthorized transactions, deceptive and misleading practices, misrepresentations by merchants and other matters. It's best to check with your insurance agency and bank sponsor to determine if any of these products are right for your business.

Patti Murphy is Contributing Editor of The Green Sheet and President of Takoma Group. She can be reached at patti@greensheet.com