11-13-2016, 01:39 AM
A little older, but a very good article explaining the mechanics of the payments system:
Many companies are attempting to use mobile wallets to eliminate the need to carry cash and plastic cards. Powerful entities are attempting to acquire space on your phone. Phone manufacturers are rolling out products with Apple Pay (NASDAQ:AAPL), Samsung Pay (OTC:SSNLF), Google Pay (NASDAQ:GOOG) (NASDAQ:GOOGL) and Android Pay. These networks have products like Visa's Check Out, MasterCard's MasterPass and PayPal (NASDAQYPL). Banks are slowly getting involved, but many are afraid to spend millions investing in constantly changing technology. Currently, retailers have also followed suit. The Starbucks (NASDAQ:SBUX) payment app has been wildly successful and it now represents 15% of all of its US purchases.
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As merchants accept chip cards, NFC technology will ultimately get enabled. As this happens, the number of locations where digital payment transactions can occur will dramatically rise. The tipping point is coming shortly as NFC becomes the dominant technology at most point-of-sale terminals. We believe that once mobile wallets become more prevalent, we will see digital payments increase exponentially.
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With contactless payment capability, merchants could materially improve traffic and sales. Retailers could reach customers on their ever-present devices in real-time. Think of the functionality of sending a consumer an afternoon coupon for Starbucks as he walks or drives by a location. Think of the benefits to a consumer of keeping coupons or promotional offers automatically on his smartphone. Loyalty programs would be dramatically improved, as information about prior transactions and benefits would safely be stored online and on one's phone.
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The process of completing a purchase transaction may seem simple (occurring in a few seconds), but various players participate in this complicated system. It starts with a merchant and a consumer. The average US credit card transaction is $88. On average, this transaction will generate $2.50 in fees split among 3 to 4 players. The merchant discount rate (called the MDR) is the total fee that a retailer pays to accept any cards. This total fee can be broken into separate pieces, since there are multiple players involved. The bulk of these fees (roughly 70% or $1.75) go to the card issuer for accepting credit risk. This is typically the bank that has issued the card to the consumer, and is commonly referred to as credit interchange.
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PayPal (like its payment network peers) generates most of its revenue by taking a little piece of the price of every purchase processed through its platform. This "take rate" typically runs $0.30/transaction plus 2.9% to 3% of the purchase price. Rates can vary depending on the type of merchant, whether a card is present (in-store or online) or the ultimate funding source (credit or debit). If a purchase is similar to a traditional credit card transaction, PayPal will pass-through or pay out 2% of its gross revenue. The margins are obviously much less with these transactions. If a transaction uses PayPal's debit connection with a consumer's bank account, revenue and margins are much higher. As business continues to evolve, we have seen the primary device change from the PC to the smartphone. PayPal has adapted, but so have other players. Visa and MasterCard are developing similar online products to replicate PayPal's online presence. Once again, it is the financial institutions providing the credit that immediately benefit, but the payment networks receive the long-term rewards. Banks favor card usage because it generates revenue and income from their customers. Usage of the ACH network incurs a cost for banks in terms of lost revenue and added complexity. In the event of a chargeback or problem, the bank and card issuer receive the angry phone call, rarely PayPal.
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