Merchant Services 101: Where Your Money Goes

Explore the journey your money takes with every transaction and the six different actors that all play a role in making each sale go through.

A Necessary Evil

In 2020, business owners in the U.S. paid over $110 billion in credit card processing fees. Merchant service providers take 2-3% for every transaction made, while this may seem like just another cost of doing business, these fees can really add up.

Filled With Fees

Take a look at a company that brings in $100,000 per month in revenue. Let’s assume that roughly 60% of that comes in from Credit Card Payments ($60,000). Then, we’ll divide that $60,000 in revenue by the average amount of a credit card transaction for VISA cards in the US (amounting to roughly 750 transactions). If we take 4 of the most common merchant service providers the monthly payment for just being paid for your services can be steep:

Any way you slice it, that’s almost $2,000 per month for the privilege of accepting credit cards.

So many business owners are left asking “Why are credit card processing fees so damn expensive?” The moment a customer swipes their credit card a series of steps occur to complete the transaction. Moving money from a customer's bank account to yours requires a synchronized symphony of players that includes credit card networks, credit card issuers, banks, etc. In this article, we’ll explore how these different players interact and how these fees pile up on the bill your merchant services providers give you at the end of the month.

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A Quick Overview

More than meets the eye

Merchant services are the connector needed to complete a payment between a business and its customer. This can be hardware - like a credit card machine, software - like Amazon Pay, or service - like check conversions. They encrypt your data as it gets transferred online, act as an unbiased third party to handle the money between the customer and the merchant, and securely hold credit cards in the case of subscriptions.

Any type of credit-card transaction requires a merchant service to complete the sale. The services are there to ensure your money gets transferred from person to business in a matter that’s safe and secure. Every single transaction goes through a process of steps involving 6 different key players that handle your money.

For in-person payments, you will typically use a physical credit card terminal. These machines are called POS or Point of Sales systems. Typically it will be some form of hardware that can read and accept cards. Common POS systems include credit/debit card machines, tablets with card readers, or even barcode scanners for services.

If you are paying online, the process is still the same. By typing in your credit card information, there is software behind websites that act as the credit card machine to process your information. These are called payment service providers or PSPs. It links business owners with the key players needed for a transaction to go through and provides them with a means to collect and manage payments online. Payment gateways such as PayPal, Stripe, and Amazon Pay, are examples of services that enhance this process for businesses.


Where your Money Goes

Six Key Players

Every credit card transaction goes through a complex web of different parties that all play a part to make it go smoothly. Let's meet the players involved and get the lingo down:

The Patrons - the patrons are the players in a transaction that has their money moved. They require the help of services to complete the transaction desired and pay the fees that come along with it.

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  1. The Cardholder - The cardholder is the owner of the credit or debit card attached to their bank account. This is typically the customer looking to make a purchase of a good or service. The cardholder is important as different variables can change the outcome such as what card they have, the tier of the card, the limits on the card, etc. This is where the money comes from, and the cardholder kicks off the transaction process with the action of swiping their card. 

  2. The Merchant - The merchant is any type of business that deals with the purchase of goods or services through a card. That’s you; the business owner. You play a key role in this play by accepting cards as a source of payment, which subjects you to the fees that come along with it. 

  3. The Merchant’s Bank - You, the business owner, have your own bank account to accept payments. This is where the money on a purchase will end up. The type of bank you’re associated with is important as each bank company will have different rules and limitations when it comes to money transfers. The fees and interest you receive will be affected by the bank you go with and the type of account you own.

The Middlemen- the middlemen are the players that work to manage a transaction and ensure the credit card is valid. These players each take a chunk out of the lump sum with their own fee on every transaction.

  1. Payment Processor - The payment processor or payment gateways are the companies that handle transactions. They are the core of the entire transaction process as they connect all the other key players to make card payments possible. These processors can be the brand of the POS system (credit card machine) or online processors like PayPal, Swipe, AmazonPay, etc. The first fee they’ll take is a processing system fee. This fee is typically an extra 0.1% on the purchase. Payment processors may have their own separate fees on top of the processing system fees that align with their own company guidelines.
  2. Credit Card Network - Credit card networks are the brands of credit cards that customers choose to go with. The four major credit cards that dominate the U.S market are Visa, Mastercard, American Express, and Discover. The payment processing fees are affected by the credit card networks the most. They set interchange rates and qualification guidelines which can widely vary depending on the type of card issued. They act as a moderator between the issuing banks and acquiring banks among other functions. The credit card network takes the second fee which is typically an additional 0.25% on the purchase.
  3. Credit Card Issuer - The credit card issuer is the financial institution, bank, or credit union that issued the card to the cardholder. They are in charge of authenticating cards and validating credit lines. Credit card issuers are different from credit card networks and include companies like Chase or Capital One. American Express and Discover act as both credit card issuers and credit card networks by also authorizing and processing transactions. The issuers charge the largest fee which is the interchange fee roughly 2%-3% of the total purchase. You could imagine how millions of transactions occurring every single day turn these small percentages into a lot of money. In 2021, the interchange fees alone made up roughly $55 billion dollars in the United States.

The Money Journey

With so many players involved each one will have a specific role to play in each transaction. It’s almost hard to believe that this all happens with the start of a credit card swipe. But during the short three seconds, it takes to process payment, there are six respective steps that move your money around from place to place.

1. Authorization - The cardholder sends their info to the payment processor

    • This step is when the buyer willingly uses their card to pay. This can be done by clicking the “pay” button on online purchases or by physically swiping a credit card in person. The payment processor then receives the request and moves it forward from there.

2. Information Relayed - The payment processor relays the information to the credit card network.

    • Once the request is submitted, the payment processor sends the transaction to the corresponding credit card network. This will be the credit card company of the customer whether American Express, Discover, Visa, or Mastercard. The information will consist of the details of the credit card which is taken when you type it in online, or by scanning when you swipe the card. 

3. Down the Pipeline - The credit card network moves the transaction to the credit card issuer.

    • The credit card network acts as the link to the credit card issuer that gave you the credit card in the first place. This step is important as it organizes the channels through which each card is paid. This makes it easier for credit card issuers to detect which card company it's coming from. The type of card and company will have implications on the transaction fees, regulations, and limitations set on the card itself. 

4. Authentication - The credit card issuer thoroughly checks the card.

    • The credit card issuer authenticates the card to make sure the card is real, working, and not expired. If any misinformation was put in it will be detected at this stage. This also validates the credit line to ensure there are enough funds necessary to complete the purchase. For example, if a customer swipes a debit card without any money in their savings account, then the credit card issuer will not proceed with the transaction.

5. Approval or denial - The credit card issuer sends the results back to the payment processor.

    • Once the authentication process is finished, the credit card issuer will relay the result back to the payment processor. If the card is approved the payment processor will immediately complete the transaction and finish moving the funds from the customer's bank account to the merchant's bank account. If the card is denied then the payment processor will not move forward with the transaction and the money will stay unmoved in the customer's bank account.

6. Notification of payment - The payment processor notifies the merchant of the transaction result. 

    • Through the payment system, the merchant then is notified if the transaction was successful. This is where the merchant will also have to inform the customer that the process has been completed. They will usually integrate that into the website with a “Thank you for your Purchase” page and a confirmation email.

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What is the Result?

Credit Cards are Here to Stay

Credit cards create more sales. An MIT study showed that customers spend an average of 83% more when they're paying with credit cards. The rising trend of online sales makes it even more necessary for customers to own a card payment method and for business owners to accept them. Credit cards are here to stay, and with them, so are credit card fees.

Cards have replaced cash as the #1 payment method where a poll found that 41% of Americans who have cards use debit cards for day-to-day purchases, while 36% use a credit card and 23% use cash or other payment methods. Credit cards have become more and more popular as the superior payment method to cash. Banks further promote the use of credit cards by making them easy to use, having a high limit, and offering incentives such as rewards programs. Banks love to push credit cards so that they can benefit off of the fees that come along with them. 

Banks and their fees

With every credit card, there is the potential for annual fees, cash advance fees, late fees, and so on.

Businesses are constantly battling against banks in the case of interchange fees. Credit card networks justify this fee as they say it pays for reward programs like Airmiles and Cash-Back. However, the reward programs are unnecessary and just a means to incentivize customers to spend more in the first place. They also say the fee helps fund things like security and innovation. This puts merchants and banks at a standoff over the proper price setting of interchange fees.

The Credit Card Impact

How they affect customers

With credit cards here to stay, businesses resort to adopting certain practices that affect a customer's buying experience. Although online transactions are handy, giving financial information over the web can be one of the biggest pain points for a customer. In-store purchases are usually altered as well to account for fees. Credit card fees force businesses to typically go with one of two options that affect customers:

  1. Go cash only to avoid transaction fees and simplify the sales process. For customers, however, this means that they will have to carry cash everywhere they go in case of running into a store like this, which can be risky and inconvenient. 
  2. Take credit cards but up their prices to account for interchange fees. This solves the problem for merchants, but it puts the weight of the burden on the customer. They will have to pay more for each purchase just to cover the interchange fee. Customers that use credit cards are essentially paying for their own rewards program, as the fee is integrated into the cost. Customers that use cash are put at a disadvantage because they are paying for the marked-up prices without receiving the benefits of using credit cards.

How they affect businesses

At the end of the day, it is the merchants that are hurt the most by the popularization of credit cards and the fees that come along with it. The fee that banks create put merchants at a compromise with every purchase. The average credit card processing fees for the four most popular credit card brands (Visa, Mastercard, American Express, and Discover) range from 1.5% to 3.1%. However, interchange fees can drastically vary depending on a number of factors:

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    1. The type of transactions most common - In-person vs. online transactions can have a wildly different volume of fees. In-person transactions will include the fixed cost of having a POS system. Online transactions tend to have more fees including a subscription fee to a payment service provider, a percentage sales fee on every purchase, or flat fees on small purchases
    2. Your specific type of business - There is a distinction in fees between low-risk vs. high-risk businesses. Low-risk businesses like retail and convenience stores have lower fees as the payment process is more standard. High-risk businesses require more costly services and present more risk to payment processors, who will charge higher fees to offset this. These businesses will have to pay added fees, meet additional requirements, and may be unable to access certain services.
    3. Your average transaction size - Businesses with larger transactions actually pay fewer interchange fees as a percentage. Small transactions can induce a minimum transaction fee. This will be a flat fee that is more proportionally than a percentage fee.
    4. Credit cards vs. Debit Cards - Debit cards are regulated by federal law whereas credit card fees are not. The Durbin Amendment sets a cap on interchange fees for debit cards by enabling second-network merchants. This creates competition thus lowering fees for merchants on debit cards.
    5. Tier of credit cards - Interchange fees get steeper with premium tiers of cards. Businesses have no control over this as they cannot choose to accept only certain cards. If they accept one type of card, they have to accept them all. Wall Street Journal does a great video on the components of interchange fees and where they come from:

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So what now?

Online transactions are an increasingly popular method of activity for retail stores. In 2022 online sales have reached over $1 trillion for retail stores alone. Powerful search engines make it easier for customers to discover your business and make a purchase entirely online. Getting the transaction process set up right will help customers complete sales in the final stage of the buying process. 

Next steps for your business 

The first thing to do is to review your merchant services agreement. Make sure you aren’t paying for extra fees that are not necessary, and look for ways to cut costs. If you don’t know where to start, go back to the six key players and identify which is a weak spot for you. Then, you can look for other service providers to find the lowest fees.

You can also try to negotiate with your merchant services provider. Often times they will be willing to change the rate based on your specific level of transactions. Other times you can get certain security certifications as a merchant that will get you a lower rate almost like your auto insurance good driver discount.

Look into different merchant service options for your online website; which all have their own unique benefits. General website services like Hubspot, Squarespace, and WordPress can usually integrate with a wide range of payment gateways. Often, it’ll have all the tools you need provided to you, you will just have to set it up. Ecommerce sites like Shopify even have built-in services to make integrating a payment gateway basically automatic. Consider going with niche options that might fit your business for example going with AmazonPay if your business mainly resides on Amazon. Each payment gateway has its advantages and disadvantages and the key is to choose one that best suits your business. If you want to know which are the best online payment services to use for your business we have it covered here.


The last thing to do is to keep doing what you do! Merchant services are there to not only increase sales but also to avoid losing them. With this information, you can now review your current setup and evaluate if there are any steps you can take to bring your fees down. The right bookkeeper can help you plan for merchant services fees in advance and understand what your profit margins are taking into account all costs.


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