Payment of the Seas
The Ultimate Credit Card Use Case - Summer Edition
The payment industry is intimidating in scope, but central to modern societies, a “massive behemoth of how the world works”. But most people have a very limited understanding of what goes on behind the scenes when they pay with a credit card.
Popular books such as Ahmed Siddiqui’s Anatomy of a Swipe, or the more recent The Field Guide to Global Payments by Sophia Goldberg, have their go at explaining the infrastructure of exchanging goods and services for money. Both, however, rely on familiar situations—paying for a coffee in AoaS, and buying online in TFGtGP—that fail to address that cash, checks and gift cards are valid alternatives that, unlike credit cards, do not charge a fee. It is as if they thought that the complexity of the card payment infrastructure is what needs to be abstracted.
The trend pushing towards the convenience of swipe-and-be-done-with-it is likely driving these explanations for how credit cards work. But is that all there is to it? Are Visa and Mastercard built on the premise that I don’t want to deal with banknotes and coins, or that topping up on Paypal is too much effort?
The difficulty of reasoning about things such as credit cards doesn’t come from how complex their internals are; it’s the way we deal with their external interfaces that makes them obscure. Cards, by means of a concert of intermediaries, offer a form of flexibility for the end customer that is beyond the capabilities of cash or checks, all virtually free. It’s simply not that obvious when you buy coffee.
All aboard!
Disruption, as we’ve discussed before, has nothing to do with technology. It’s about what’s valuable: doing current use cases better, coming up with a new business model, and creating entirely new use cases.
Credit cards not only do away with the nuisance of carrying notes and coins with you, but also enable situations where the exchange of goods/services for money must be mediated by some trusted party. They bring predictability to unreliable scenarios. This is not the absence of fraud, but the chance for those involved to pay or collect a fee depending on the level of risk they’re willing to tolerate, all orchestrated by the businesses of credit card networks such as Visa or Mastercard. Cash, instead, gives you Mr Burns losing his trillion-dollar note to Fidel Castro.
To illustrate this in more depth, we are going to pay for the expenses while onboard the Payment of the Seas, a cruise ship on which we are enjoying our holidays. Like most players in the travel industry, cruise companies’ major means of profit isn’t the trip itself, but rather, the add-ons offered while on board, called ancillary services. These include beverage packages, dining on exclusive restaurants within the ship, and most importantly, the excursions.
Unlike in the situation where customers buy coffee on Bucks of Star, cruises keep a tab open for their passengers for the duration of the trip. This particular scenario has three characteristics that make cash really inconvenient.
We don’t know beforehand how much the tab is going to be. This is unfortunate, because being in the middle of the sea for the whole trip forces us to anticipate how much cash we’re going to need, without recurse to an ATM1.
It’s likely that there are going to be many changes on the tab, driven by, for instance, the cruise’s inability to predict which excursions will have to be cancel due to insufficient buyers2.
The Payment of the Seas, priding itself on making the whole experience enjoyable for the passengers, want their passengers to have the flexibility to book excursions and change their mind later, while being certain that they can afford their purchases.
Enter the credit card, which allows for these, and more3, in a very cost-effective manner, with minimal hassle for the cruise and the cardholder.
On a Card Transaction’s Wake
A card transaction, in its most basic breakdown, is divided into three operations. Their goal is to address three important milestones along the way.
A first, reflective question: Is the client worth the whole process?. This is called initialization.
A second question, this time aimed at the client’s bank: Does the client have enough money on their bank account?. This is called authorization.
And last, the commitment to the transaction: I pledge to give the client what they want; please send the money. This is called capture.
Moving money is expensive; but moving information is cheap, thanks to the Internet. This architecture, called Dual Message, provide merchants with a mechanism that allow them to adjust and readjust the total price of their goods and services before the money actually moves.
We’re on our first day on the Payment of the Seas, and we are shopping around. We end up deciding on a few excursions, and give the credit card to “pay”.
But before even asking our bank whether we can cover the costs, a more important question for the merchant is Does this card belong to the passenger?. The infrastructure of credit card payments is, at heart, layers of risk and liability. When merchants accept credit card payments, they do so on the condition that they are liable under scenarios involving risks they are in position to mitigate.
This is because they Payment Card Industry is one of those few examples where self-regulation has proven to work: your government doesn’t care about credit card fraud, and it’s mostly OK. All parties involved are incentivized to keep the channel secure and widen its adoption, beyond any country’s supervision, and every transaction involves the important trade-off between reducing fraud risk and improving payment friction.
Initialize Once, Change Your Mind Many
During the initialization phase, you’re asked to enter a PIN. This will set in motion a process called 3-D Secure whose sole purpose is to establish who is liable if the transaction ends up being fraudulent. I’ve argued before that companies can grow to a certain size where they are exposed to higher-quality data to assess fraud risk than the credit card companies. But for most, some fraud prevention company often shows up in this stage.
Assuming that the card belongs to you and everything checks out, the superiority of card payments over cash for this scenario shows in the authorization stage. From now on, and until the end of the trip, the cruise will freeze enough funds on your bank account to cover for all your expenses, continually adjusting that amount with incremental authorizations, even though money will only change hands once the trip is over. They might go as far as to over-authorize, freezing $50 or so more than what you have actually bought, in order to reduce how frequently they need to make adjustments to the frozen amount in order to keep it in sync with the open tab.
This particular point is crucial, though: authorization locks money on the client’s account, but doesn’t withdraw from it. Your friendly cruise manager will gladly tell you, as they had been telling passengers for years, that the last movement on your bank account doesn’t imply that your money is no longer there. It’s just unavailable.
Over the following days, you’re going to book two excursions for the same day, just in case one of them ends up being cancelled. Eventually, the excursion you wanted to go is going to happen, and thus you may ask for the other one to be “refunded”. In reality, the amount allocated for that excursion on your bank account is going to be "defrozen”, or void. Some banks nevertheless keep that amount unavailable for a few more days, but that’s beyond the cruise’s control: that money is still yours.
Ultimately, the trip comes to an end, and the cruise, having fulfilled all their obligations when it comes to ice-creams, bus trips and tourist guides, will initiate the actual money withdrawal with what’s known as capture.
Once that happens, the final amount should match the price of the goods and services sold4. A few days later—depending on the contractual agreement with their own banks—the cruise company will receive the money that you’ve already part ways with. For now, that amount is considered money in transit.
Accepted Everywhere
Card payments are made possible by a set of well-known companies that fulfill one important mission in all this: Can you imagine how hard would it be for the cruise company to integrate with all their passengers’ banks?
Visa, Mastercard, Amex, and a few more, connect the cruise company’s bank—called the acquirer—with virtually all banks out there. That’s why they’re called networks. They centralize the industry and oversee the communication protocol, distribute and collect fees to and from all participants, maintain the technical standards (including 3D-Secure or tokenization), and a long laundry list of more things.
But more importantly, they are the facade that makes sending money to a merchant in exchange for goods and services seamless. They own the standard, and as long as their technical protocol is conducive to payments, everyone is glad to pay the fee that have made these companies collosus.
Or paying a hefty fee if there is one aboard.
When dealing with refunds, cash is an awful payment method, especially for the merchant, because keeping track of who paid what is a massive inconvenience in the absence of good software or good accountants.
Cash is also very inconvenient in the pool area, or wearing a swimsuit, but this is not the main reason why cruises discourage the use of cash onboard, as we will see.
Making sure that this is the case is called reconciliation.