Credit Card Processing – What’s the Right Choice?

In our previous article we examined the range of e-commerce merchant systems and shortly reviewed the points to consider when selecting each the one for yourself. In this blog entry today we'll take a deeper look at the forms of merchant payment services and give you some hints and tips on choosing the right one for your business.

When dealing with online payment many questions may arise as for merchant accounts and credit card processing instances. We’ll try to clarify the technology behind online credit card processing and explain some corresponding terms you may have found intricate. So, get the gist of what there will be referred to and look for the information you may find useful.

Payment Gateway, Merchant Account Provider and Third Party Credit Card Processor – differentiate the mixed-up terms

When it comes to a payment gateway, it is a separate e-commerce service that authorizes payments for e-businesses and online retailers and acts as an intermediary between the merchants' shopping cart and all the financial networks involved with the transaction, including the customers' credit card issuer and personal merchant account. One of the other main functions of credit card processing payment gateways, besides communication, is the encryption. A payment gateway uses SSL 128-bit encoding technology to encrypt and decrypt all the data being sent through it.

The e-commerce merchants can get a merchant account from a merchant bank or a merchant service provider in their local area or in another country (offshore/international e-commerce merchant account). As for merchant account provider, it is typically a separate company from the payment gateway. Some merchant account providers have their own payment gateways (in this case they offer a payment gateway and a merchant account all in one package), but the majority of companies use 3rd party payment gateways. An e-commerce merchant account is basically a service for which e-commerce merchants apply, and thereafter use online credit card processing services.

Another option is a third party credit card processor which is basically a payment gateway and merchant account rolled into one. Such companies handle your credit card processing on your behalf without requiring you to have your own merchant account. As such, they take care of different aspects of the transaction process such as authorization, billing, reporting, and settlement.

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Let's now better differentiate these aspects.

Talking about the methods of accepting credit card payments we could say that there are actually two distinct types of services to enable e-commerce businesses to accept credit card payments. It is either using your own real merchant account or through a third party payment processor.

With a third party merchant account type of service, the merchant outsources the payment processing part of the transaction cycle to a third party. This means that such credit card processors do not require the sellers to create merchant accounts, as they offer both the merchant account and the payment gateway all-in-one package accepting credit cards payments on seller’s behalf in exchange for various fees and percentages. With most third party credit card processors all you have to do is to sign-up and you are ready to accept credit cards on your website. PayPal, Google Checkout, 2Checkout, Moneybookers, etc. are a few well known third-party service providers.

The main benefits and shortcomings of operating a third party merchant account are:

• There is no need to pay for an expensive real merchant account, fancy processing software, customer service fees, and monthly gateway fees to accept credit cards on the web. (+)
• The merchant does not have to worry about purchasing and installing SSL certificates and payment gateways, as all sensitive personal information is hosted on the third-party provider’s server and the provider is responsible for handling it securely. (+)
• One of the best things that the merchants can get from these third party companies is the ability to run an affiliate program for their own business, because it will help them promote their website. Plus, the merchants work for their own payment history that’ll help to apply easily for a real merchant account in future. (+)
• Another benefit of using a third party credit card processor over establishing a merchant account is that you pay a percentage of the sales, and only when you actually sell your product. (+)
• It is relatively fast and easy to establish a 3rd party merchant account, which makes it attractive for any start-up. (+)
• Another advantage of using a 3rd party payment solution is that you share fraud and charge back risks with the 3rd party company. (+)
• However, the transaction fee is much higher when you use a third party payment company as compared to when using your own merchant account. (-)
• With a third party solution, your processor has a complete control over your payment processing activities which results in a limited merchant account control. (-)

Real merchant account enables a seller to accept payments directly to his own merchant/bank account through a gateway. As a rule, such model suggests that payment details are entered on the seller’s website, however it is not compulsory. It’s up to the seller to decide which model to use. Hosted solution, which is when the payment details are entered on the website of the gateway, is used when the seller chooses not to deal with the PCI compliance.

To have your own dedicated merchant account you’ll need a bank or a merchant account provider that will allow you to have a merchant account and a payment gateway to work with it. Afterwards the process is rather simple - when the customers select the items to be purchased, they are taken to the check-out page which is SSL-secured on the server hosting the merchant’s website. Then the merchant’s payment gateway gathers the transaction information, encrypts it and sends it to the card issuer for authorization. The authorization response is routed back to the merchant through the gateway and the transaction is completed. The examples of real merchant account providers are RBS Worldpay, PayQuake, Worldpay, and others. These companies offer complex solutions from a 3rd party payment processing to opening a real merchant account. In the second case they also offer gateway services. Some companies like Authorize.net are working as a gateway only and help you in creating a merchant account.

The main benefits and shortcomings of operating a real merchant account are:

• Having your own real merchant account associates your business with a certain amount of professionalism. It shows you are more established, your business is credible and it is committed to providing a complete shopping service to its customers. Plus the merchants are provided with their own payment descriptors, which help buyers recognize and identify the seller’s charge on the financial statement. (+)
• The merchant will benefit having lower processing costs, these fees when charged by the merchant account company are substantially lower than the high percentage charged by the third party processor. (+)
• There is the advantage of choosing your own bank for creating a merchant account and negotiating reasonable processing fees. (+)
• Setting up a dedicated merchant account solution is a much more involving process, requiring a certain level of technical knowledge. Moreover, once the account is set up, it requires continuous maintenance and constant attention. (-)
• The merchants bear full liability for possible risks including fraud and charge back ratios. Exceeding the charge back level may result in high penalties and even account termination. (-)
• Note that the initial costs of opening your own merchant account is usually higher than when you use a third party merchant. (-)

What does this mean for us as e-commerce business owners?

When it comes to credit card processing solution, note that the correct form of payment selection will give you just the appropriate tool for your business, whilst the incorrectly chosen will throw you in the whirl of troubles. If you're an e-commerce beginner and have a small credit card processing volumes, you should better consider using a third party credit card processor which will incorporate a payment gateway with a merchant account instead of going directly with a merchant account. This type of solution is good for businesses that are just starting out and don't have the money to purchase a merchant account right off the bat, but note that in the long run you’ll pay more.

However, 3d party credit card processing will significantly simplify the entire process since you’ll initiate with something cheaper, easy to manage and trusted and don’t have to worry about transaction process, security issues, various frauds and charge backs – the 3d party merchant takes care of everything for you. By starting out this way, you can determine how many customers will make purchases with credit cards before you go through the process of applying for a merchant account and getting everything set up. So, a third party payment solution enables you to estimate your business when taking first steps.

As your business grows, you could start looking into the alternatives and consider purchasing and setting up a dedicated merchant account. In this case it is possible that your processing volumes grow to be large enough to justify it.

Obtaining a merchant account can be difficult sometimes, it is much more expensive or hard to get it. Business must go through a strict application process when the processing bank verifies the legitimacy and trustworthiness of both the organization and its owners. However, it is proved that e-commerce entrepreneurs can save substantial amounts of money by using a merchant account for their online credit card processing, as opposed to processing with a third party processor. Most third party processors leverage the high levels of risk and charge backs they must face everyday, by charging enormous fees and rates to their entire customer base. So, it’s up to you to decide which of these payment methods to choose eventually.

Though, make sure you will provide as well the diversity of alternative payment options for allowing your customers to pay you the way they find appropriate and feasible for them.

TemplateMonster blog team would like to thank Mitch Greenwood, the Chief Financial Officer at TemplateMonster, for kindly sharing his experience and suggestions on credit card processing solutions.