When a customer uses a credit card to pay for an order, money isn't necessarily transferred from their bank to the merchant. Often times, the payment processor only authorizes the card payment for a limited period of time. This time period is called an "authorization hold" and can last anywhere from a week to a month, depending on the payment gateway.
During this period, the credit card money is blocked, which means the cardholder can't spend it, but the money hasn't hit the merchant's bank. The payment needs to be captured before the money can be transferred.
There are many reasons why the payment process is divided into two steps rather than being completed in one. Generally, placing an order doesn't mean the order process is over. The merchant needs to confirm the order. Obviously, merchants would like to accept all orders, but sometimes things can go wrong.
When selling physical products, it makes sense to capture payments only when the order is ready for shipment. The reason is that some of the items may be out of stock and can't be fulfilled. This is a typical overselling scenario. The availability on the website didn't match the actual availability in the warehouse.
If that happens, the merchant can't confirm the order. Typically, a customer service rep contacts the customer to offer an alternative product or communicate a delay. That's a bad customer experience and there's a good chance the customer won't buy again if the issue isn't handled well. That's why it's so important to display accurate stock information and delivery lead times on the website.
If there is no agreement, the authorization is void and the amount is released. Despite this not being the best experience for the customer, from a financial standpoint, nothing happened. Transactions never took place. Invoices are only required once the money has been captured. The merchant would have had to issue a refund and credit note if they had taken the payment at checkout.
Chargebacks and frauds
Merchants don't capture payments when orders are placed for another reason. The authorization hold is a delay that they can exercise to prevent chargebacks or chargeback frauds, often called friendly frauds. This is when consumers fraudulently attempt to secure a refund using the chargeback process. Instead of contacting the merchant directly for a refund, consumers dispute the transaction with their bank, thus initiating the chargeback process. As long as the payment is only authorized and not captured, the merchant can just remove the hold when a chargeback is requested.
If a suspicious transaction requires a manual review, an authorization hold provides merchants with enough time to investigate the issue and resolve it. In this way, fraud can be reduced. Nevertheless, merchants cannot approve and capture all orders manually, especially if the order volume is high. It's always bad to be a victim of a fraud, but it's even worse when it's a lot more money. This is why many merchants set up rules like automatically capturing orders under a certain amount. When selling internationally, those rules can vary from country to country.
Authorization and capture are also helpful in managing situations where a customer wants to change an order after submitting it. A merchant can always capture less than the authorized amount if the customer wants to remove an item from an order. Also in the case of adding an item, the amount captured can sometimes be higher than what was authorized. How much higher depends on the payment gateway. If the amount is too high, merchants will have to request another authorization.
Pre-orders and made-to-order
There are also some challenges associated with the authorize and capture flow. In the event that the delivery lead time is too long, the authorization will expire, and the merchant will not be able to capture the payment. Pre-orders or made-to-order are typical examples. A possible solution is to split the order workflow into two phases: in the first phase, the merchant gets the pre-order by validating the customer's card or capturing a percentage of the order to prove their commitment. As soon as the order is ready, they ask for the remaining payment or charge the credit card on file.
Don't forget about SMS notifications!
Always keep in mind that every transaction will be notified to the customer by their bank. Even though authorize and capture are very different transactions, customers won't likely understand that difference and will contact customer service, request a chargeback, or even block their credit card if something looks suspicious.