E-commerce merchant accounts and payment service providers (PSP) give online merchants the ability to process digital transactions. While both allow you to accept electronic payments, there are some important differences between the two. In this post, we’ll examine how payment processing works for online orders and how merchant accounts and PSPs enable this process.
How Payment Processing Works
Online payment processing happens in two stages: authorization and settlement. Here is a brief overview of the authorization process:
- The customer enters their payment information when submitting their online order.
- The information is passed through a payment gateway. The data is encrypted to keep it secure and is sent to the payment processor.
- The payment processor sends a request to the issuing bank of the customer’s payment method to see if they have the available funds to cover the transaction. The bank also authenticates parameters such as the card CVV, expiration date, and address verification service (AVS) details. The data exchange process is overseen by card networks like Visa and Mastercard.
- The issuing bank responds with an approval or a denial.
- The payment processor sends you the response letting you know if the sale was approved or not.
This authorization process takes place in a matter of seconds. The settlement process can take several days and usually involves some variation of the following steps:
- Merchants compile their authorized transactions into batches and send them to their payment processor.
- The payment processor sends the transaction details to the card provider who then passes them on to the issuing bank.
- The issuing bank charges the cardholder for the amount of the transaction.
- The issuing bank transfers these amounts to the merchant bank.
- The merchant bank deposits the funds into the merchant account.
With a PSP you do not normally have to send batches to a payment processor or wait for the funds to be deposited into a merchant account. PSPs essentially serve as a group merchant account and will use their pool of resources to make the funds immediately available. This could be a Paypal balance that you have instant access to or a Stripe ACH transfer that is issued the same day as the transaction.
Merchant Accounts vs Payment Service Providers
An e-commerce merchant account is an agreement between an acquiring bank and a merchant. It allows the merchant to receive and process electronic payments. There are two parts to the merchant account.
The first part is the account established with the acquiring bank. It is not the same as a traditional bank account but rather serves as a holding place for deposits. Because returns are a common part of commerce, there is a risk that some of your transactions will need to be paid back. With a merchant account, funds can easily be subtracted from your balance without having to recover them from your bank.
The other part of the merchant account is the payment gateway that is used to submit payment details to banks for approval. It also accumulates deposits from all your transactions in the merchant account, allowing them to be sent to your bank account in a single transaction. Some merchant accounts will provide access to a variety of payment gateways while others only offer a single gateway option.
Because the bank assumes a financial risk in allowing a merchant to process electronic payments, they will seriously vet any applicants before approving their accounts. Merchant accounts also have a variety of different fees including:
- monthly minimum
- customer service (maintenance)
Payment service providers
Payment service providers are an alternative solution to managing online payments. PSPs aggregate groups of merchants together to create a single merchant account. By combining all their clients into one merchant account, the PSP takes on the financial risk of accepting payments for each merchant. They usually have their own payment gateway that is used to authenticate payment details. Popular examples of PSPs include Paypal, Stripe, and Square.
You can get up and running with a PSP quicker as you do not need to enter into long-term contracts as is often required from merchant accounts. These services have simple flat-rate pricing, making it easier to forecast the impact transaction fees will have on your product margins.
Extending Payment Processing With Headless APIs
While merchant accounts and PSPs both allow you to easily process payments on your e-commerce website, they often require additional tools to accept payments through other channels. Headless commerce APIs can provide this functionality.
With a headless checkout API, you can push a checkout endpoint to collect customer payment details on any sales channel. The API passes the details to your store’s connected payment gateway. This initiates the payment authorization workflow. In seconds, you’ll receive approval or denial from the issuing bank. Approved transactions will generate an order number and trigger the settlement process.
The ability to accept payments from any touchpoint will continue to grow in importance as more sales channels emerge.