How Card Network Economics Actually Work
FX & Float Memo #9
A typical pricing plan for card processing looks like this: “2.9% + 30 cents.” This can make it seem as if the entire amount belongs to the payment processor, but that is not true. Multiple parties power the payment network to complete this transaction. All of them have a share of the quoted price. Understanding who these players are and what their role is in processing a transaction is important for understanding the costs of a payments business.
What most people believe
A common assumption is that a card payment involves two parties - the customer and the merchant, with the payment processor as an intermediary. The payment processor enables the transaction and, for this service, takes a percentage of the payment and passes the rest to the merchant’s bank.
But this simplistic view is wrong in a couple of very important ways. A card transaction actually involves four distinct parties, and the payment processor does not control most components of the price. The role of a payment processor is closer to that of a collections agent who facilitates the collection of the fee on behalf of other parties.
The four-parties in a card transaction
A card transaction involves four parties. First is the cardholder’s bank, known as the issuer. The issuer issues the card and extends credit or holds the account from which the funds come. The second is the merchant’s bank, also known as the acquirer. The acquirer connects to the card networks and settles the funds into the merchant’s account. The third is the card network. These are players like Visa and Mastercard, who operate the rails that connect the issuers and acquirers. The card network also sets critical rules that must be followed in executing this transaction. Lastly comes the payment processor: the entity the merchant has a relationship with. The processor handles the technical integration, reporting, and the merchant-facing experience of the transaction.
For every card transaction, a transaction request flows from the merchant to the acquirer, then from the acquirer to the issuer. The issuer approves the transaction, and all this communication happens on the network. Each party takes its fee out of this flow, and the amount paid by the customer, minus interchange, network fees, and the processor’s own margin, is settled into the merchant’s account.
Where the fee actually goes
The largest component of the fee is interchange. Interchange is a charge by the issuer, not the processor. This is the fee the acquirer pays to the issuer for payment using the issuer’s card. Card networks have a predefined rate table for it. Interchange depends on the card type, merchant category, transaction method, and region, among other factors. Interchange is typically much higher for credit cards than for debit cards, primarily to account for chargeback risk and the cost of funding the loyalty programme.
The second component is the network fee, charged by the card networks. This fee covers the use of the rails and is typically much smaller than interchange. It is also less transparent.
The third component is the acquirer margin. The processor controls this component and can customise it for each customer. Whatever room the processor has to offer a discount generally comes out of this component of the overall fee.
Another layer of fee is added when the transaction is cross-border, i.e., when a card issued in one country is used with a merchant in another country. In such cases, a currency conversion fee is charged in addition to the standard fee structure. This fee is usually in the range of 1 to 2%. It covers not only currency conversion but also the higher fraud risk and the more complex settlement process.
Why this structure persists
This structure for card settlement has remained the same for decades. The reason is that no single party has both the incentive and the ability to change it unilaterally. There have been some regulations, especially when merchants have fought for them. The USA capped debit interchange for large banks in 2011. The EU capped interchange on consumer credit and debit cards in 2015. Both of these reduced interchange revenue for issuers and pushed them to look at other sources of revenue to compensate for this drop.
These interventions demonstrate something important: interchange is not a natural market price. It is a rate set by the networks because of their power. When regulators intervene, interchange moves substantially. But these interventions are specific and narrow, usually covering specific jurisdictions or card types. The networks have the greatest negotiating power in the transaction flow, and they naturally end up controlling most of the pricing in the market.
What this means for a payments company
A payment processor or merchant acquirer charges its customers a price that it does not control, except for a thin margin. This has three consequences.
First, competing on price is a bad strategy for a payment processor because it does not control most of the price. When a processor advertises an aggressively low rate, it is usually operating at zero or negative margins, funding it by cross-subsidising from another product line, or recovering the cost elsewhere through monthly commitments or chargeback fees. This follows the same pattern as cross-border pricing, as covered in Memo #1. The stated fee is not the real fee, and the components hidden from the customer actually determine whether the business is sustainable.
Second, the payments company needs to build its differentiation to protect its margin, which typically sits in the range of 0.3% to 0.5%. For a payments processor, that differentiation lies in better fraud tools, faster settlement cycles (covered in Memo #7), easier integrations, or better reporting. Building an efficient and differentiated service means the company retains healthier margins on the same fee structure over the long run.
Third, processors can improve their margins by understanding how interchange is categorised. Transactions qualify for different interchange rates based on criteria such as whether the card was present, whether address verification was performed, and the merchant type. If a processor helps merchants qualify for the lowest applicable interchange rate, they reduce the interchange cost passed on to the issuer and expand their own margin without touching the fee.
Without understanding the numbers that make up the cost of card processing, you cannot compete for the 0.4% that is actually yours.