The ABC of Payment Gateways

Global Ecommerce growth continues to outpace the entire retail sector.

Choosing how you will accept payments from your customers is one of the most important decisions that you can make for your online business. In order to accept credit card payments, you need to choose a payment gateway. Any online transaction via a credit card must go through one of these gateways that connects you to the acquiring bank. Most gateways require you to set up a merchant account and refer to the services they provide as merchant services.

Not all payments gateways are created equal, but most have their strong suits. One popular trend is the strong move to a subscription model. Everyone from airlines to law firms and the new wave of OTT and IoT companies has to lead to a boom in subscription services.

Behind any successful subscription-based company lies a reliable, scalable recurring billing solution. This billing solution must also be tied to a payment gateway to process all these small, recurring payments. Trying to decide on a payment gateway can seem overwhelming, since choosing the wrong one can end up being more than just a simple annoyance and exact a real cost in dollars and cents. In the cut-throat world of online e-commerce, getting it right from the get-go, can mean the difference becoming the next Uber or the latest Yahoo.

Knowing exactly what a payment gateway is can be the first step to making an informed decision. It can help to remember the ABC’s of payment processing: Actors, Bureaucracy, and Costs.

Actors

There are six main actors that are involved in any payment transaction. The first one is obviously you, the merchant. On the other end is the customer. In between are the two services that make the transaction possible.

  1. You, the merchant: For you to accept credit card payments, you will need to create a merchant account with a merchant bank (sometimes called an acquirer bank).
  2. The merchant bank can accept the payments on your behalf. Once they have accepted the payment, they can deposit it into your merchant account.
  3. The customer: To make a purchase, the customer needs to have a credit or debit card with an issuing bank.
  4. The issuing bank is the bank that approves your customer for their credit or debit card and leads him or her the money to pay to you.
  5. The payment gateway is the first service. It is the software that connects your site’s shopping cart to the issuing bank so that it can be approved and then sends requests to the merchant account once the transactions have been approved.
  6. The payment processor (sometimes call the merchant service) moves the transaction through the processing network after it has been approved so that you can be paid. In many situations, your merchant bank may also be your payment processor, which can keep things simple.

Bureaucracy

There are two main steps to processing an electronic payment: getting approval for the sale and settling the payments (moving the money into your account).
Getting approval for a credit or debit card transaction can be done in just a few seconds:

  1. A customer chooses a product or service to purchase with their credit or debit card.
  2. The information on the sale is sent to the payment gateway, encrypting the data so that it can not be viewed by a third party and then sending it on to the payment processor.
  3. The payment processor forwards the request to the customer’s issuing bank, the one that gave them the credit card, and asks for approval to charge their account.
  4. The issuing bank responds with a yes (approval) or a no (denial) to the request.
  5. If the transaction is approved, the payment processor tells your site that the transaction has been accepted, and asks your merchant bank to credit your account for the transaction.

The second part of the process is the settlement, where you get the money for the transaction, and can take a few days or weeks:

  1. When the transaction is approved, the customer’s card issuer will send the money to your merchant bank, who in turn deposits the money into your merchant account.
  2. After the banks have settled the transaction, your merchant bank will let you access the funds. In some cases, the bank may allow you to access the funds immediately. On most new accounts, they may hold the funds until the banks have fully settled and they are sure that none of your customers will return items, or that there will not be any chargebacks. This is known as a reserve.

Costs

Once you know what you are paying for, you can start to look at the costs for these services. It goes without saying that anyone involved in the transaction will want to take their cut including the issuing bank, the merchant bank, the credit card associations and the payment provider.

Most transactions carry the same set of standard fees, although the rates can vary wildly. Because the fees are often bundled together, you may not even be aware who is being paid what amount, but it is important to at least know who has their fingers in the pot:

  • Interchange: The issuing bank will take a pre-negotiated percentage of each sale. It depends primarily on the industry, the amount of the sale, and the type of card used. This list is nowhere near comprehensive and there are hundreds of factors that influence the interchange fees.
  • Assessment: As well as the issuing bank, the credit card association (Visa, MasterCard, American Express, etc.) will also charge a pre-negotiated fee based on a percentage of the sale, known as an assessment.
  • Markup: Your merchant bank will also charge a percentage of the sale based on the amount of the sale. This fee varies more than the other types of fees and is the easiest to negotiate with your merchant bank. It also varies by industry, the size of the sale and your monthly volume.
  • Processing: The final actor who is involved is the payment processor. This is usually a fixed-rate fee for every transaction. Transactions include sales, declines, and returns. Quite often the payment processor is also your merchant bank and will charge fees to set up or cancel the account, and maybe also a monthly fee.

Even though these are the fees that are being charged, you might only see a basic pricing plan present from your merchant bank. These fee plans generally fall into three categories: Flat-rate, Interchange plus and tired

  • Flat-rate: This is the most common fee structure where all the costs are bundled into a single percentage rate plus a fixed cost per transaction. A typical rate is 2.8 percent of the total price, plus 30 cents per transaction. At this rate, a $100 sale would work out to $3.10.
  • Interchange plus: Another option is that your merchant bank charges you the interchange fee (which is charged by the customers issuing bank) plus a set fee of their own. Each issuing bank can have a different rate so the cost of each sale would vary. If your bank charged 2 percent plus 10 cents per transaction and the interchange fee was 1.6 percent, the total for a $100 sale would be $2.00 + $0.10 + $1.60 = $3.70.
  • Tiered: For larger accounts, the processor could choose to take your account into consideration, along with the hundreds of factors that influence the interchange rates and stratify them in three or more pricing tiers. While this makes it easier for you to understand, it also means that the payment processor can define each tier however they want. This can make some transactions much lower than expected, but at the same time, increase the cost of others unexpectedly. On the same $100 sale, you would pay anywhere from $2.00 to $3.50, depending on how the payment processor ultimately classifies it.

To choose a payment processor, it is important to know your ABC’s. Know the actors that are involved: you, your merchant bank, your customer, their issuing bank, the payment gateway and the payment processor. Know who is responsible for what, so that you can increase your approval ratings, without increasing your risk. Finally, keep in mind that everyone who is involved wants to get their cut, so know exactly what they want and who is going to pay for it. Any savings you can pass on to your customer will earn their loyalty and build your business.