What Is Merchant Processing? Your Complete Guide to Merchant Services
The American credit card industry plays a key role in the country’s economic growth. Retail purchases made by cardholders, restaurant meals, and eCommerce transactions generate millions of dollars in revenue daily.
According to IBIS World, the credit card-issuing industry has a market size of $164.3 billion. This is projected to grow by 3.4% during 2022.
To process card transactions, each merchant works with a merchant services provider. This entity facilitates transaction processing and supports the merchant throughout the process. In this article, we’ll discuss how merchant processing works and share a snapshot of merchant services.
What Is Merchant Processing?
The term “merchant processing” can have two slightly different meanings. First, merchant processing refers to the business owner’s ability to accept secure card transactions.
The term also involves the technology and services required for the completion of a credit card payment. The payment can take place at a brick-and-mortar location, through an eCommerce platform, or via mobile phones.
Entities Involved in Credit Card Processing
A typical credit card processing (or payment processing) transaction involves several entities. The transaction may take place at a brick-and-mortar business or via an eCommerce or mobile interface. Regardless of the point of sale (or POS) platform, these entities cooperate to smoothly execute customers’ payment card transactions.
Cardholder: This is the customer using a Visa, Mastercard, American Express, or Discover EMV or gift card to make the purchase. Contactless payments and digital wallets like Apple Pay are also seeing increasingly wide use.
Merchant: This small business owner sells the product or service the customer wants to buy. The purchase can take place onsite, online, or via mobile phone.
Payment gateway: An electronic payments corridor that links the merchant to their payment processor. A payment gateway is essential for completing an online credit card or debit card transaction.
Payment processor: The entity that enables electronic communication between the merchant, the cardholder’s bank, and the credit card network.
Credit card network: This entity is also called the credit card brand or card association. The four major card networks set the interchange fee and payment card industry data security standard (or PCI DSS). Merchants are expected to meet PCI compliance standards designed to protect customers’ sensitive data.
Issuing bank: Also called the issuer or cardholder’s bank, this financial institution sends the customer their credit card. During credit card transactions, the issuing bank determines whether the cardholder has sufficient credit available.
Acquiring bank: Also called the merchant bank, this entity holds the merchant’s sales transaction proceeds. The acquiring bank also provides the merchant with a card reader and other equipment to process transactions.
How Payment Processing Works
Each credit card transaction involves a series of carefully orchestrated steps. Unless technical difficulties occur, each purchase only takes a few seconds from start to finish.
1. The customer swipes, dips, or taps their credit card at the merchant’s payment terminal. In a card-present transaction, this occurs via the merchant’s in-store POS system. Mobile and online payments are considered card-not-present transactions.
2. The payment terminal collects the transaction details and forwards them to the merchant’s payment processor.
3. The payment processor sends the transaction details to the credit card network.
4. The card network sends the payment details to the issuing bank. This entity determines whether the customer has enough credit or funds for the purchase. Based on that, the issuing bank approves or declines the transaction. The issuing bank sends its decision to the payment processor via the payment terminal.
5. For an approved transaction, the issuing bank releases the sales proceeds to the business’s merchant account. The acquiring bank maintains the merchant account, which acts as a funds repository for each merchant’s sales proceeds.
6. After a defined period (usually two to three business days), the transaction is settled. The merchant account transfers the sales proceeds (less the processing fees) to the business owner’s bank account.
What Products/Services Do Merchant Service Providers Offer?
A merchant services provider serves as a bridge between merchants and the banks that process card transactions. The following types of businesses may play the role of a merchant services provider:
- Bank (or other financial institution)
- Independent sales organization (or ISO)
- Electronic payment gateway provider
They offer diverse products and processing services to help merchants meet their card processing needs. Today, merchant service providers frequently offer gift cards and loyalty programs as well. Some of their most common product/service offerings include:
- Point of sale system: Equipment that accepts onsite payments and offers other services
- Credit card terminal: A small device that enables the acceptance of card-present payments
- Card reader: A tiny device that enables card processing via a mobile phone or tablet
- Electronic payment gateway: Essential for eCommerce payment acceptance
- eCommerce platform software: Essential for operating an online retail outlet
- Customer support
How to Select the Right Merchant Service Providers for Your Small Business
Choosing a merchant services provider shouldn’t be a spur-of-the-moment decision. When evaluating candidates, business owners should select the provider based on multiple criteria. Merchants should opt for a provider that represents the best overall fit for the business. Let’s take a look at some of the criteria you should use to evaluate providers.
1. Payment Types Supported
A forward-thinking merchant services provider offers a full menu of payment options. Merchants should be able to process credit card transactions and debit card transactions. Next, business owners should be able to accept contactless payments and digital wallet payments. Customers should also be able to make Automated Clearing House (or ACH), PayPal, and traditional check payments.
2. Payment Processing Equipment
Merchants should compare each provider’s equipment offerings against their business needs. Business owners should also determine whether the company sells the hardware or provides it within a promotional package. Ideally, the company will reprogram the merchant’s existing hardware so it integrates with the provider’s system. Leasing equipment is strongly discouraged, as it’s more expensive than purchasing the hardware outright.
3. Ease of Use
With basic instructions, even first-time users should be able to process payments via a POS system or card reader. The merchant services provider should also maintain a library of video tutorials and/or other reference materials.
4. Transaction Security and Fraud Protection
Business owners should choose a PCI-compliant merchant services provider. For card present transactions, the provider should offer POS systems that accept more secure EMV (or chip) cards. EMV-based credit card payments utilize encrypted data, making the transactions less accessible to scammers. Finally, the provider should institute measures to protect against fraudulent credit card transactions.
5. Contract Provisions
Many payment processing service providers place merchants into extended service contracts. A three-year contract is the industry norm. Merchants who exit the agreement early pay stiff early termination fees. With negative merchant feedback, some providers now offer merchants a month-to-month agreement.
6. Pricing Structure
Merchant services providers typically offer one of four basic pricing models. Business owners should choose the pricing structure that fits their transaction volume and overall business needs.
The transparent interchange-plus pricing model is popular with many small businesses. Here, each transaction amount is separated into the card network’s interchange rate and the payment processor’s markup fee.
Flat Rate Pricing
In this pricing model, the merchant pays a flat rate regardless of the customer’s card type. However, this easy-to-understand pricing model may not offer the lowest transaction processing costs.
The tiered pricing model separates transactions into qualified, mid-qualified, and non-qualified categories. Several murky factors can cause transactions to be downgraded to higher-priced tiers. Merchants should steer clear of tiered pricing models.
In this subscription pricing model, the merchant is assessed a monthly membership fee but pays lower transaction fees. Payment Depot’s popular membership-based model offers wholesale interchange-plus rates.
7. Account Fees
In addition to transaction fees, merchant services providers typically charge merchants a host of other account services fees. Common payment services fees include:
- Account setup fee
- Statement fee
- Monthly minimum fee
- Equipment leasing fee
- Payment gateway fee
- Batch processing fee
- PCI compliance fee
- PCI non-compliance fee
- Chargeback fee (for disputed transactions)
- Early termination fee (for contract cancellations)
8. Customer Support
A reputable merchant services provider should offer knowledgeable customer support and tech support. Ideally, the provider should feature 24/7 support via phone, email, and chat. Some providers may promote good customer support while outsourcing services to less-informed contractors during non-business hours.
9. Software Integrations with Popular Third-party Apps
Merchants should consider whether a merchant services provider’s program integrates with the merchant’s business operations software. Common software programs include accounting, business banking, financial services, and customer relationship management systems. In addition, the provider should ideally support integration with popular third-party apps.
10. Business Scalability
Many merchants plan to gradually scale their businesses. Companies may grow their product or service offerings, enter new markets, or both. In any case, the merchant service providers should be able to support that growth with no operational hiccups.
Selecting the Right Merchant Service Providers
Every small business owner’s goals, operating requirements, and budget combine to create distinctive credit card processing needs. Payment Depot’s membership-based pricing, wholesale processing rates, and superb customer support are tailored to suit the needs of small businesses. The company also offers month-to-month agreements with no cancellation fees.
Contact our award-winning customer service team today to learn how we can help you save hundreds of dollars every month in payment processing.