Payment mechanisms

The presence of convenient electronic payment mechanisms provides an enormous advantage to on-line transactions across the Internet. It is difficult to manage cash directly in an electronic world; it is much easier to send account numbers that represent virtual money with “reasonable” guarantees of safety and security.

Credit cards are most widely used in eCommerce transactions as they effectively provide a pre-screening of the potential customer as to credit-worthiness and reliability—a cardholder is more likely to hold a job and pay bills on time—if not, card privileges are revoked. The transaction history of charges and payments is retained, and this greatly enhances the risk assessment process for a given transaction.

The credit agencies

The evaluation of credit-worthiness is a big business … credit reporting agencies exist as intermediaries that collect financial transactional data (and information relating to debts and judgements) to help assess an individual’s credit rating.

(equifax, transunion, experian, old TRW)

The credit rating

… is a numeric rating, ranging from 350 (high risk) to 850 (low risk) … factors include the credit history, level of debt, types and amount of credit available, and the relative “age” of the debt.

Fraud detection

Companies are deploying sophisticated software that makes an assessment as to whether a particular transaction is acceptable or potentially fraudulent. It is a relatively easy matter to examine the transaction history of an individual and make an assessment of risk for each new transaction.

The risk assessment is based upon an evaluation of the pending transaction, and whether it falls within the pattern established by the user over time. The more the card is used in daily affairs, the more likely that routine purchases can be identified and cleared, while exceptional purchases would be “flagged” as potential problems.

Outcomes could range from approving the transaction to rejecting the transaction and “freezing” the account due to the “irregular” activity until such time as the cardholder can verify that the transaction is legitimate.

The routine first step for any credit card approval process would include the following inquiries:

   Is the account number a valid number? Is the current date less than the expiration

date on the card?  Is the account up-to-date on payments?Is the credit balance sufficient to make the

purchase?

A negative answer to any of the preceding questions would result in a rejection of the purchase request. Issuing companies have recently begun to include additional considerations in the approval process based upon the transaction history, such as:

 Has the customer shopped in that store before? Is the amount consistent with previous

purchase amounts?  If there is a discernible pattern to prior

purchases, does the new request fit the pattern?

Specific “red flag” indicators might include the following:

         Is the amount significantly larger than typical purchases either by the customer or at that store?

         Does the merchant have a relatively high incidence rate of fraudulent purchases?

         Has there been a series of large purchases in multiple locations in a short time frame?

         Is the charge request coming from a foreign country, with no prior user history in that country?

n the booming on-line auction markets the transactions are often between individuals, and it is much less likely that individuals will maintain merchant accounts with credit card companies. Payment options for an average auction buyer were more limited initially, confined to money orders and personal checks.

This void in auction market payment options quickly drew a variety of mid-level payment intermediaries that effectively served as clearinghouses for auction sales.

The basic idea for an intermediary is that it would set up its own merchant accounts, then require individual buyers and sellers to register with the intermediary. The buyer begins with a modest ceiling of, say, $500.00, and upon making a purchase uses the intermediary account to pay the seller. The buyer settles the account with the intermediary either by using a credit card or keeping money (perhaps from unrelated auction site sales) on account.

The seller, confident that the intermediary stands behind the sale, immediately sends the item to the buyer. The intermediary keeps a small percentage of the sale for handling the transaction and associated risks.

An analogous need for intermediary services is rapidly developing in countries that lack some of the personal credit options that exist in the U.S. The U.S. intermediaries are essentially on-line companies with little or no physical presence; they rely heavily on the standard model for credit card processing, whereas elsewhere the intermediary might be an Internet café that offers browsing, order placement, payment, and delivery acceptance services at a community-based level.

The concept of an intermediary role, outside that of auction services, is potentially enhanced with the “wallet” concept, whereby an intermediary (most famously, Microsoft) would retain customer transaction data and manage related online eCommerce transactions, for a small transaction-based fee.

The concentration of data associated with the Microsoft service is unprecedented, potentially gathering all transaction data related to every on-line consumer over time. It will be interesting to see how the wallet concept in general, and the Microsoft plan in particular, moves forward.

As an alternative to card-based services, there is a growing interest in the concept of “virtual money”, or “digital cash”, which is electronic money that can be spent much as cash is now. In some implementations it is possible to connect the user with the digital money; in others the user remains relatively anonymous.

In this model, the user first ascertains how much money is required to complete a specific purchase. The user buys a fixed amount of digital cash in advance, from a specialized merchant, and spends the corresponding certificate once at a participating merchant’s on-line enterprise. The merchant then submits the certificate to the authorizing agent and is credited with the appropriate amount of money.

An interesting fraud-detection feature in the case of anonymous digital cash is that if a particular certificate is somehow spent a second time, then the user is mathematically, provably identified and revealed.