Chapter 6

E-commerce Payment Systems

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Types of Payment Systems

Cash
Checking

Transfer Credit Card Stored Value Accumulating Balance

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Cash

Legal tender defined by a national authority to represent value Most common form of payment in terms of number of transactions Instantly convertible into other forms of value without intermediation of any kind Portable, requires no authentication, and provides instant purchasing power Free (no transaction fee), anonymous, low cognitive demands Limitations: easily stolen, limited to smaller transaction, does not provide any float
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Checking Transfer

Funds transferred directly via a signed draft or check from a consumers checking account to a merchant or other individual Most common form of payment in terms of amount spend Can be used for both small and large transactions Some float Not anonymous, require third-party intervention (banks) Introduce security risks for merchants (forgeries, stopped payments), so authentication typically required
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Most Common Payment Systems, Based on Number Of Transactions

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Most Common Payment Systems, Based on Dollar Amount

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Credit Card

Represents an account that extends credit to consumers, permitting consumers to purchase items while deferring payment, and allows consumers to make payments to multiple vendors at one time Credit card associations Nonprofit associations (Visa, MasterCard) that set standards for issuing banks Issuing banks Issue cards and process transactions Processing centers (clearinghouses) Handle verification of accounts and balances

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Stored Value

Accounts created by depositing funds into an account and from which funds are paid out or withdrawn as needed Examples: Debit cards, gift certificates, prepaid cards, smart cards Debit cards: Immediately debit a checking or other demand-deposit account Peer-to-peer payment systems such as PayPal a variation

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Accumulating Balance

Accounts that accumulate expenditures and to which consumers make period payments Examples: utility, phone, American Express accounts

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Dimensions of Payment Systems

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Concept of e-money

Electronic medium for making payments. Includes credit cards, smart cards, debit cards, EFT, automated clearinghouse (ACH). Notational money system that may be : Online or offline: each transaction is verified and approved before the payment is made / no validation required Identified or anonymous: contains information to identify the person / leaves no trail to identify
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Four types of e-money

Identified and online (+I + L): eg. Credit cards and debit cards Identified and offline (+I L): eg. Check, travelers check Anonymous and online (-I + L): eg. Cash payments, ATM withdrawal Anonymous and offline (- I L): eg. Making deposit in ones account via ATM

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Current Online Payment Systems

Credit cards are dominant form of online payment, accounting for around 90% of B2C online payments New forms of electronic payment include: Digital cash Online stored value systems Digital accumulating balance payment systems Digital credit accounts Digital checking

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Online Merchants Actual and Preferred Online Payments

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Types of electronic payment media

Trusted third party type

Notational fund transfer-related type Digital cash or electronic money

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Trusted third party type

Maintains all sensitive information Bank maintains accounts and card numbers No real financial transaction is done online Thus the information need not be encrypted because financial transactions are updated offline

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Notational fund transfer-related type

Visa/ MasterCard SET based transactions

Because the process is online, the information transmitted is encrypted for security

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How an Online Credit Card Transaction Works

Processed in much the same way that instore purchases are Major difference is that online merchants do not see or take impression of card, and no signature is available basically, card not present (CNP transactions) Participants include consumer, merchant, clearinghouse, merchant bank (acquiring bank) and consumers card issuing bank
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How an Online Credit Transaction Works

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Limitations of Online Credit Card Payment Systems

Security neither merchant nor consumer can be fully authenticated Cost for merchants, around 3.5% of purchase price plus transaction fee of 20-30 cents per transaction Social equity many people do not have access to credit cards

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The SET (Secure Electronic Transaction) Protocol

Authenticates cardholder and merchant identity through use of digital certificates An open standard developed by MasterCard and Visa Transaction process similar to standard online credit card transaction, with more identity verification The plastic cards are replaced by the digital certificates in e-commerce. Thus far, has not caught on much, due to costs involved in integrating SET into existing systems, and lack of interest among consumers
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How SET Transactions Work

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Digital Credit Card Payment Systems

Extend the functionality of existing credit cards for use as online shopping payment tools Focus specifically on making use of credit cards safer and more convenient for online merchants and consumers Example: eCharge

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Digital Credit Card Payment Systems

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How a Digital Credit Card Payment Systems Works: eCharge

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Digital cash or electronic money

This allows the transfer of money itself, which carries value. Serial numbers representing actual money are encrypted all the way to the destination and can then be converted into real money such as dollars.

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Digital Cash

One of the first forms of alternative payment systems Not really cash rather, are forms of value storage and value exchange that have limited convertibility into other forms of value, and require intermediaries to convert Many of early examples have disappear; concepts survive as part of P2P payment systems
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Examples of Digital Cash

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E-cash Concept
Merchant

5 4 Bank 3

2 1

1. Consumer buys e-cash from Bank 2. Bank sends e-cash bits to consumer (after charging that amount plus fee) 3. Consumer sends e-cash to merchant 4. Merchant checks with Bank that e-cash is valid (check for forgery or fraud) 5. Bank verifies that e-cash is valid 6. Parties complete transaction: e.g., merchant present e-cash to issuing back for deposit once goods or services are delivered

Consumer

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Digicash: How First Generation Digital Cash Worked

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Online Stored Value Systems

Permit consumers to make instant, online payments to merchants and other individuals based on value stored in an online account Rely on value stored in a consumers bank, checking or credit card account

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Online Stored Value Systems

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How Ecount.com Works: A Stored Value System

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Smart card

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Smart Cards as Stored Value Systems

Another kind of stored value system based on credit-card sized plastic cards that have embedded chips that store personal information Two types: Contact Contactless Examples: American Express Blue, health insurance cards
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Digital Accumulating Balance Payment Systems

Allows users to make micropayments and purchases on the Web, accumulating a debit balance for which they are billed at the end of the month Examples: Qpass and iPin

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Digital Accumulating Balance Payment Systems

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Digital Checking Payment Systems

Extend the functionality of existing checking accounts for use as online shopping payment tools Examples: eCheck, Achex (MoneyZap)

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Digital Checking Payment Systems

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Achex digital checking system

P2P small and simple payment mechanism for transferring funds among individuals. Users open an a/c at Achex site and submit their traditional checking a/c number they will use to pay checks. a/c is verified, then the payment can be made to individuals who have an e-mail address and a valid checking a/c into which they can transfer funds. Users access their Achex a/c using a login and password/ IPIN. Recipients receive an e-mail indicating that funds are available for transfer and requesting a valid checking a/c number. Achex transfers the funds to the recipients checking a/c. Service is free to consumers although merchants pay processing fee which is half the price of credit card processing
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eCheck digital checking system

Much more sophisticated system Consortium of banks, government agencies, and technology companies developed a plan for e checking that would use public key encryption and would not require a third party like achex to transfer funds. Requires users to obtain a hardware based electronic checkbook from traditional bank. Hardware could be standard PC card/ smart card external to consumer computer. E-checkbook contains consumers digital signature in form of private key and issuing banks public key
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How Digital Checking Works: eCheck

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 Loosely used term Refers to two different methods

Electronic Checks

Electronic Checks

Online Paper Check

ACH Conversions

Online Paper Check Developed by Financial Services Technology Consortium (FSTC) Not-forprofit group of CA banks Initiated using a PIN and digital signature Receiver prints out paper check for deposit ACH Conversions (most common method referred to) Transactions converted to ACH debits (e.g., ARC, POP, WEB, TEL) Services can be provided by third party processors Account verification determined upfront. Guarantees available. Examples of services provided through third-party CyberSource (POP)
Telecheck: CheckFree: AmeriNet: Paymentech:

Applies to consumer checks only, not business checks.

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Digital Wallets

Concept of digital wallet relevant to many of the new digital payment systems Seeks to emulate the functionality of traditional wallet Most important functions: Authenticate consumer through use of digital certificates or other encryption methods Store and transfer value Secure payment process from consumer to merchant Two major categories: Client-based digital wallets Gator.com, MasterCard Wallet Server-based digital wallets MSN Wallet
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Types of Digital Wallets

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Procedure for using e-wallet

Decide on an online site where you would like to shop Download a wallet from the merchants website where you intend to shop Fill in the personal information s.a. your credit card number, name address, phone number and where merchandise should be shipped When ready to buy, click on wallet and the buying process is fully executed. Billing information is filled out automatically. OR drag info out of wallet and drop it into online form
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Entering Information Into Microsoft Wallet

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Promised Functionality of Digital Wallets

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Digital Payment Systems and the Wireless Web

Mobile payment (m-payments) systems not very well established yet in U.S, but with growth in Wi-Fi and 3G cellular phone systems, this is beginning to change Example: idea, airtel, Qpass, AT&T and Wayport venture to provide mobile payment and billing called GoPort

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B2B Payment Systems

More complex than B2C Two main types: Systems that replace traditional banks example: Actrade, serves as international marketplace intermediary, paying foreign sellers immediately and allowing domestic buyers variable time period for repayment Existing banking systems extending to B2B marketplace. example: Orbian, extends credit instruments to credit verification, non repudiation, financing and integration with large scale corporate backend systems
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Key Features of B2B Payment Systems

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Electronic Billing Presentment and Payment

Online payment systems for monthly bills Allow users to view bills electronically and pay them through electronic fund transfer from bank or credit card accounts. Different types of business models in EBPP market include: Biller-direct Consolidator Portal
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Types of EBPP Systems

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Two Types of EFT

EFT is a generic term Describing two different methods of transferring funds electronically

EFT Wire Transfer ACH

Both performed through Federal Reserve Bank System

(Except for in-bank or on-us transactions)

Common mistake to call an ACH payment a wire transfer

Each are handled by different departments at a bank
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Wire Transfer
Wire Transfer

Fed Wire

Book Transfer

Foreign Wire

Between two banks

Within same bank

Foreign bank

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Wire Transfer Utilization

When appropriate to use Time sensitive - Funds need to be moved same day initiated Large dollar amounts Examples Debt Service Payments (preserve States credit rating) Funding ACH payments (e.g. payroll direct deposit) Funding investments (e.g., at custodian bank) Adjusting balances (between depository banks) Remitting ESC payments (to US Treasury)

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Initiating Wire Transfers

Banks provide corporate customers ability to initiate their own wires via online banking access

Templates are used

Repetitive Transfers Pre-established acct.# Non-Repetitive - Open wire to anywhere

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Disb. Acct. at DST

Online Wire System

DSTs Bank

Payees Bank

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ACH Network A batch-process, store and forward for future settlement

ACH Two types of ACH (Automated Clearing House)

ACH ACH Credits
Direct Deposit. Debit Card Account Direct Deposits Always initiated by sender Senders account is debited and receivers account is credited Receivers Acct
Bank account Debit card account

ACH Debits

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ACH Utilization

When appropriate to use

Large number of payments in a single file (batch) At least one day is available between initiation and settlement Any size dollar amounts

Examples

Outbound Payroll direct deposit to bank account (ACH credits) Outbound Payroll direct deposit to debit card account (ACH credits) Outbound Vendor payments (ACH credits) Inbound Taxpayer payments (ACH credits or debits)
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Governing Org.

Trade Group

ACH Players
2
Originating Depository Financial Institution (ODFI) ACH Operator (FRB)

3
Receiving Depository Financial Institution (RDFI)

1
Originator (Company / Employer)
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4
Receiver (Company / Employee)
Authorization / Enrollment Slide 6-60

Primary Differences
Wire Transfers Item Cost - $6.75

ACH Item Cost < 1 penny

Next day funds One day delay in settlement Used for large batch files (e.g., payroll)

Same day funds Transfer almost instantaneous Use for critical payment (e.g. debt service)

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Managerial issues

Security solution providers should provide secure electronic payment system EPS solution providers should offer EPS to e-stores and banks E-stores should select and promote appropriate set of EPS Banks need to develop cyber banks compatible with various EPS Credit card brand companies need to develop standards like SET and watch for its acceptance Certificate authorities need to identify the types of certificates to be provided.
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Issues and implications

Consumer needs: cheaper and secure EPS Corporate processes: will small and medium businesses be harmed or helped by EPS Corporate strategy: will EPS end up in hands of fewer financial institutes or will it generate a number of small banks that cater to digital processing Regulation of competition: standardization, fair play, regulation of taxes, public interest Economics and social processes: will the government pull out of cash making business
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