Re-imagining the Concept of Bid-Ask for Payment Authorization

Oct 30, 2022

“An auctioneer is a man who proclaims with a hammer that he has picked a pocket with his tongue.”

That satirical definition by Ambrose Bierce is based on the perception that there’s something inherently “wrong” with the concept of an auction. Either the property owner earns substantially more than an item’s actual value because of the irrational, aggressive nature of competitive bidders, or a bidder gets away with “a steal” because he recognizes value where others don’t.

In short, auctions — like many commercial negotiations — are generally regarded as having a winner and a loser: the item is either under-valued or over-valued, and someone has gotten the short end of the stick.

While this is often not too far from the truth in the auction-driven art world, online bidding on sites like eBay has proven to be more level-headed and fair. The bidding is not as instantaneous and high-pressured, and those interested in an item can research, compare prices, and make a more grounded decision. Technology is making auctions more palatable.

But it gets better: There are negotiations that leverage the dynamic of Bid/Ask that are designed to benefit both parties simultaneously, as each side can make careful, well-structured calculations about optimum sums to pass between hands. A prime example is Kipp’s unique approach to reducing declined transactions in e-commerce payment processing.

First, let’s review the fundamental problem and our general approach to solving it

Credit card issuers must, naturally, protect themselves from transactions at risk of insufficient funds. Remember that with each payment approval, they earn only a few percentage points as compensation, which must be balanced against the risk taken. They deploy conservative rule-based models to reject transactions that might represent a valid reason to decline.

This phenomenon is not only a shame for the issuer;  merchants sending them the transactions have a lot more to lose. They have invested a sunk cost in the pipeline — branding, marketing, website support, inventory, and more — and of course for them, the issuer’s rejection of an order may cost a hefty 20, 30, or 50% profit, not two or three.

This is where the Bid/Ask relationship comes in

It’s in both parties’ best interest to increase authorized transactions where there are indicators that it’s very likely safe to accept them, even if the case isn’t “airtight” and the customer may very well be able to pay.

Here’s what happens: When a transaction is about to be rejected, the issuer sends an “Ask” message — automatically, and based on a preset algorithm — to Kipp to tell us how much they would need to be paid by the merchant as a premium to accept the risk on this specific purchase. That figure is, of course, based on the risk factors they have identified. This may be, say, for the sake of illustration, 2.75%. The merchant has a similar algorithmic calculation that automatically makes a Bid. If the merchant bid is, say, 3.5%, they have surpassed the required minimum; they pay the issuer its requested 2.75%, and the sale goes through. Remember: If they were going to earn a 25% profit on the order, this small investment is more than worthwhile.

Each side has its own criteria for taking the risk, and for good reason: While a merchant may earn a different profit margin on each transaction, it’s actually an incredibly easily calculation for the issuer, who earns a (usually more modest) set percentage of each transaction and thus can easily calculate a reasonable premium to overcome the risk.

Everyone communicates, everyone wins

In short, this Ask/Bid model for card authorization in no way resembles an adrenaline-fueled auction house with irrational decisions that leave a happy winner and a frustrated loser. The two sides deploying the Kipp platform (a quick integration for the issuer and none for the merchant) each make a careful, consistent, logical assessment of how much of the risk they can comfortably share, and then use a collaborative process to virtually “shake hands” on the win-win victory.

Incidentally, this payment optimization is actually a win-win-win, because the customer — completely unaware of who is actually responsible for the rejection or what’s going on behind the scenes —is spared the frustrations of an order they cannot complete. That experience could send them to a different credit card (dooming the card to back-of-wallet status), or to a different merchant whom they perceive is more eager to have their business.