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What Actually Happens When You Pay at Checkout? 💳

An overview of the transaction lifecycle, plus Starbucks' CEO on the hotseat.

Written by: Ryan Henderson & Braden Dennis

Happy Sunday! (Unless you’re the Starbucks CEO 😬)

This week we’ve got another edition of our Earnings Roundup (Starbucks, Carvana, Amazon, and more) and we take a look at the complete behind-the-scenes process of a credit card transaction.

Let’s get to it.

Earnings Roundup
  • Starbucks: Coffee giant Starbucks reported 2nd quarter earnings on Tuesday that came in well below Wall Street’s expectations. The coffee chain with ~39k stores around the globe reported a 4% decline in same-store sales driven by a 2% increase in average ticket and a 6% drop in the number of transactions. Starbucks new CEO Laxman Narasimhan took over from Howard Schultz in April of 2023 and already appears to be in the hotseat. Many investors are calling for change over concerns that Starbucks is losing market share to competitors like Dunkin’ Donuts, Tim Horton’s, and McDonald’s. Starbucks shares dropped 17% this week.

  • Apple: iPhone maker Apple reported a 4% decline in revenue with 1% growth in earnings per share on Thursday, both surpassing expectations. Despite a 10.5% decline in Apple’s iPhone revenue, the company announced a new $110 billion share buyback authorization (equivalent to 4% of its current market cap) which helped to propel the stock. Apple shares finished up 6% this week.

  • Amazon: The world’s largest e-commerce and cloud computing company reported earnings this week that surpassed expectations. Amazon generated $143.3 billion in revenue, which was up 13% compared to the same time last year, and its EBIT (earnings before interest and taxes) margin came in at 10.7% versus 3.7% the same period a year ago. During its conference call after the report, CEO Andy Jassy gave some optimistic commentary around the company’s main profit driver. He said We remain very bullish on AWS. We're at $100B+ annualized revenue run rate, yet 85% or more of the global IT spend remains on-premises. And this is before you even calculate gen AI.” Amazon’s stock was up 2% this week.

  • McDonald’s: The world’s largest fast-food chain reported a bit of a mixed bag for earnings this week. Sales topped estimates, while profits came in a little light. Though the 4% total top-line growth might not appear too exciting, the company seemed relatively proud of the results given the tough operating environment overall for quick-service restaurants at the moment. On the company’s quarterly conference call, CEO Chris Kempczinski stated “Consumers continue to be even more discriminating with every dollar that they spend as they face elevated prices in their day-to-day spending”. McDonald’s stock was down 1% this week.

  • Carvana: Popular online used car retailer Carvana has seen an absolute whirlwind over the last couple years. After emerging from COVID as a stock market darling, concerns over profitability sent the stock dropping 99% from peak to trough. However, since its lows, the company has seen a resurgence. Over the last year, Carvana’s stock is up 1,590%, which was aided by this week’s strong first quarter report. Carvana delivered $3.1 billion in revenue, up 17% from a year ago, and the company generated net income margins of 1.6% versus -11% last year. On its quarterly conference call, CEO and Founder Ernest Garcia III stated “We are now focused on our long-term phase of driving profitable growth and pursuing our goal of becoming the largest and most profitable auto retailer.”

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What happens at checkout?

Have you ever wondered what actually happens after you purchase an item with a credit card?

Well in that 5-10 seconds when you’re waiting at the checkout stand, there’s an entire daisy chain of companies working together behind the scenes to process your transaction.

Here’s a look at the entire system:

In any transaction there are two separate processes at work, clearing and settling.

Clearing:

  1. A point-of-sales (POS) terminal ingests the cardholder information. Common POS providers include Square, Toast, Clover (owned by Fiserv), Lightspeed, and others.

  2. A “gateway” then picks up and encrypts the card details. Popular gateway providers include Visa’s Cybersource and PayPal’s Braintree.

  3. The encrypted details are then sent by a merchant acquirer (Global Payments, WorldPay, Chase Paymentech) to the card networks using a payments processor.

  4. Think of the payments processor as software that actually facilitates the transaction. Popular processors include First Data (also owned by Fiserv) and Vantiv.

  5. Once the networks (Visa, Mastercard, American Express, or Discover) receive the transaction details, they send it to the cardholder’s bank to check for sufficient funds.

  6. The cardholder/customer bank (most common ones are JPMorgan Chase, Bank of America, and Wells Fargo) then either approves or denies the transaction based on the customer’s account balance.

  7. If it’s approved, the bank puts a hold for that amount in the customer’s account.

  8. Once approved or denied, the message is sent back to the merchant acquirer to display at checkout.

Sound complicated? It is. However, modern payment service providers (PSP’s) like Stripe and Adyen pull several of these functions under one roof. They are gateways, merchant acquirers, and processors all in one unified solution. This simplicity and the easy implementation process has allowed each of them to win over nearly $1 trillion in payment volume.

Settling:

If you look at the clearing process, you’ll notice that a hold was put on the cardholder’s account but no funds were ever actually transferred. The settlement process is where the actual transfer of funds occurs.

  1. After transactions have been approved, they get batched together and sent by the merchant’s bank to the card networks. Some of the most common merchant banks include JPMorgan, Morgan Stanley, and Citi.

  2. The card networks (Visa, Mastercard, American Express, and Discover) pass the authorized purchases, which you can just think of as sales receipts, along to the cardholder’s banks.

    *Side note* In the old days, this would literally require sending reams full of paper to all the customer’s banks. Needless to say, the digital process works a lot better.

  3. Once the customer bank receives the authorized transactions, that’s when they actually transfer the funds that they put on hold during the clearing process.

  4. After the funds are transferred to the merchant bank, then the funds are finally passed along to the merchants themselves.

So if you’re a merchant, and you’ve ever wondered why 2%-3% of each transaction gets taken away, here it is. Here are all the stakeholders in the process helping to securely verify and transfer a customer’s funds.

Meme of The Week

Markets in a nutshell

If you like to read Hedge Fund Letters, you may have noticed that several managers have begun to discuss the idea that markets are “broken”. This belief often stems from the idea that the vast majority of investors today no longer care about valuation.

Ironically, it appears that most of the funds espousing the idea of “broken markets” also just so happen to be underperforming the major indices.