Payment Processors: What They Are, How They Work & Top Tools
Oops! Payment Process Woes: A problematic payment process leads to cart abandonment, causing frustration for customers who were ready to finalize their purchase.
Leap of Faith Frustration: The abandonment isn't due to lack of interest; customers already made the commitment but were hindered by technical issues.
Tech Hiccups Are Costly: Glitches in the payment process can result in lost sales, affecting the bottom line significantly.
Cart abandonment due to a glitchy payment process is such a bitter pill to swallow. Your customers already took the leap, so it’s not about them.
Some 28% of them are already fearful of giving online stores their credit card information. So a slight hiccup could very easily ring the alarm bells, pushing them to drop their carts, never to be seen again.
This is just one of the many reasons having a reputable payment processor is essential.
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In this post, we'll go over the basics of payment processors, how they work, and how to choose one that keeps your customers' trust—and sales—pourin’ in.
What is a Payment Processor, Anyway?
A payment processor is a service that helps businesses accept and process electronic payments.
It acts as a conduit, securely transmitting payment information between the merchant's and customer's banks to complete the transaction efficiently.
Retail businesses, including ecommerce, count on these systems to facilitate, authorize, and secure electronic payments—whether it’s done face-to-face, digital, or via mobile.
They handle various payment methods, including credit cards, debit cards, and digital wallets.
Clearing up the confusion: Payment processors vs payment gateways
Payment processors and payment gateways work together to make digital transactions safe and secure for you, the merchant, and your customers. They’re not interchangeable.
Let’s break down how they function together:
The payment gateway captures, verifies, and encrypts your customer’s payment information before transmitting it to the payment processor.
It bridges the physical gap between your online business and your customers, fulfilling the role of POS systems in in-store settings.
Upon receipt, the payment processor takes over. It sends the encrypted data to the financial institution for approval.
Then it shuttles the funds safely from your customer’s bank or credit card company to your merchant account.
This explanation makes it easy to see how they’re two separate systems.
However, since providers like Stripe and Paypal can serve as both the payment gateway and payment processor, things can seem a bit complicated to the average ecommerce manager and business owner.
To help you avoid the confusion, let’s break down how they’re different:
| Payment gateway | Payment processor | |
|---|---|---|
| Primary function | Encrypts and securely transmits customers' sensitive payment information. | Facilitates the transfer of payment from the customer's bank account to the merchant's bank account. |
| Additional Functions | Provides multiple payment types (e.g., credit cards, BNPL, digital wallets, mobile payments, crypto). | Manages chargebacks, ensures compliance with banking regulations, and detects fraud. |
| Dependency | Requires a payment processor to complete the transaction. | Can operate independently but is often integrated with a payment gateway for added security and convenience. |
| Customer Interaction | Customers interact with it during the checkout process. | Customers have no direct interaction with the payment processor. |
| Key Players Involved | Business, customer, payment processor | Business, customer's bank, merchant's bank |
To sum up: Payment gateways verify and secure a customer’s debit or credit card information, then toss it over to the payment processor to facilitate the transaction flow and shuttle payments safely to your account.
How Do Payment Processors Work?
I've given you a quick rundown of how payment processors work, but in this section, we’re going to go deeper.
The payment ecosystem is straightforward. It only becomes puzzling if you don’t know the key parties involved.
So before we dive into the process, here are the several entities involved in approving, processing, and settling payments:
- Cardholder: Your customer who initiates the transaction
- Merchant: You, the seller, who receives the payment
- Payment gateway: The technology that securely transmits payment information from the customer to the payment processor
- Payment processor: The entity that handles the transaction data between the merchant and financial institutions
- Acquiring bank: The merchant’s bank that processes credit card payments on behalf of the merchant
- Issuing bank: The bank that issued the customer’s credit card and approves or declines transactions
- Card networks: Card companies that facilitate communication between issuing and acquiring banks
Remember them because you’ll see how they interact below.
Step-by-step payment processing flow
Before your bank credits the money to your account after a successful purchase, it moves around behind the scenes.
Here’s how it works:
- Customer initiates payment. The customer selects their payment method and types in details (e.g., card number, CVV) on your checkout page. Or, if you own a physical shop, they could also swipe or tap their card in-store.
- Payment gateway encrypts and transmits data. Your payment gateway collects and encrypts card information and forwards it to the payment processor or directly to the acquiring bank if it also doubles as a payment processor.
- Payment gateway authenticates payment. If the card and/or issuing bank is enrolled in 3D Secure, the payment gateway prompts the cardholder for additional verification. This can look like asking for a password, OTP code, or biometric authentication
- Payment processor forwards to acquiring bank. Your processor reviews the transaction for any signs of fraud before forwarding the details to the acquiring bank—your bank.
- You can work with one or partner with multiple providers to increase payment flexibility, authorization rates, and geographic coverage. On average, merchants use 4 different payment processors to support ecommerce payments.
- Acquiring bank communication with card networks. Your bank verifies the transaction and sends it to the card networks (e.g., Visa, Mastercard) for further validation.
- Card network routes to issuing bank. The card network routes the transaction to the issuing bank—the customer’s bank. The latter checks the account status and available funds and runs additional fraud checks.
- Issuing bank authorizes the transaction. Based on the account status and risk assessment, the issuing bank can approve or decline the transaction.
- Card network relays the authorization response. This authorization response (approval or decline) travels back through the card network, acquiring bank, payment processor, and gateway to your system.
- Merchant confirms the order. If approved, your system directs the customer to a confirmation page. They’ll receive a confirmation email containing order details, receipt, and tracking information if applicable.
- Merchant settles funds and transfers. You, the merchant, batch-approve and send transactions to the acquiring bank.
- Startups and small businesses may opt for less frequent payouts (i.e., daily or weekly) to reduce transaction fees. Enterprises can negotiate more frequent payouts (i.e., multiple times a day) and lower processing fees due to higher transaction volumes.
- Acquiring bank deposits the payment. Your bank requests the funds from the issuing bank via the card network and deposits them into your merchant’s account. Standard settlement takes 1 to 3 business days, though expedited options may be available.
- Merchant reconciles bank accounts. Finally, you reconcile your records to ensure online transactions match your bank statements. Payment processors like Stax Pay and Stripe can generate reconciliation reports for you.
The whole payment process may seem like a big, tangled web, but it actually wraps up in seconds.
The more robust your setup, the faster the transactions. Minimizing downtime and avoiding glitches depend on the right payment partners and tools.
Payment Processing Costs
Now that you know how payment processing operates in the background, let’s talk about what many retailers, online and offline, call the “necessarily evil”.
Payment processing comes with fees, a pain point that still startles many merchants, especially online sellers, despite knowing it's the cost of doing business.
Knowing what these fees are will help you figure out what’s disputable and what’s reasonable.
Payment processing costs can be split into three categories: interchange fees, assessment fees, and transaction processing fees.
Let’s look at each in detail.
1. Interchange fees
Interchange fees go back to the issuing bank. Financial institutions take a leap when they release a credit or debit card into a customer’s hands.
Every time this customer makes a purchase, the bank takes a risk, not knowing if this individual is going to pay the charges back.
By charging merchants who accept these modes of payment, they can better mitigate that risk.
It’s hard to pin down the actual cost of interchange fees because credit card networks are responsible for setting them; they update the rates twice a year.
But here’s a good baseline according to Forbes:
| Card network | Credit card | Debit card |
|---|---|---|
| Mastercard | 1.5% to 2.6% | 0.05% |
| Visa | 1.4% to 2.5% | 0.05% |
| American Express | 2.3% to 3.5% | 0.05% |
| Discover | 1.55% to 2.5% | 0.05% |
Rates depend on factors like type of sale, type of card, cardholder status, transaction amount, and location.
For instance: ecommerce fees are higher because there’s a greater chance of fraud in card-not-present transactions compared to in-store payments.
Debit card fees are typically lower than credit cards because debit cards provide access to the cardholder’s existing funds, making reimbursements more accessible.
Knowing these differentiating factors can help you better anticipate and manage interchange fees.
2. Assessment fees
Assessment fees, also called credit card association fees (or simply association fees), cover the cost of using credit card networks. They support the network infrastructure that facilitates card payments.
On average, association fees can range from 0.1% to 0.15%.
Accept these fees as a necessary part of processing electronic transactions. You can always factor them into your product pricing strategy to preserve profitability.
3. Transaction processing fees
Processing fees are the only sum that goes to your payment processor for the software and service it provides.
This means value-added services can influence the difference in processing margin across providers.
Expect every provider to have its own fee structure and pay arrangement. For the most part, you can either pay a flat fee or a percentage-based one, and the charge may show up after every transaction or as a monthly service fee.
To see how this looks like in real life, let’s talk about Helcim’s processing fee, which includes a percentage rate and per-transaction fee.
This can be heavy on the wallet for many ecommerce businesses, so the platform has set discounted rates depending on your card processing volume, like so:
Then there’s Stax Pay, which is one of the standout services offering subscription-based payment processing with a 0% markup.
This can be a better option for businesses with high-transaction volumes since they won’t be hit with a hefty fee at the end of the month.
Regardless of the payment processor or pricing structure you have, processing fees are the only type of transaction fee you can contest or negotiate. Take advantage of it.
Our Favorite Payment Processors
You may have noticed I’m mentioning a ton of payment processors in this post. We conducted thorough testing and review process on these systems to make sure that they’re up to the task.
Here’s a complete list to help you find the best payment partner for your business:
How to Choose a Payment Processor
The best payment processor for your business can help you deliver a smooth payment experience.
Here are some tips to help you find the right provider to optimize your ecommerce payment processing.
Assess business and customer needs
Your payment setup must accommodate customer preferences while meeting your operational needs to reduce friction during checkout.
Extract and analyze historical sales data from your ecommerce platform's reporting tools, so you can note down peak sales periods, transaction sizes, and most used payment solutions.
Understanding these preferences helps you select a processor that meets your current needs while allowing for future growth.
Otherwise, you might face slowdowns or even downtime during high-traffic periods.
For example: Out the Dough, a family-run cookie dough company, chose Clover POS to manage their online and offline shops.
When a Good Morning America feature caused an unexpected surge in online orders, Clover POS’s robust setup kept up with the increased demand.
This goes to show, when you anticipate what your business and customers will need, you end up with a payment processor that can handle your transaction volumes and offer payment flexibility, and security.
Evaluate payment processing costs
We’ve talked about the different types of fees associated with payment: interchange, association, and transaction processing fees.
But other extra fees can add up—an act that merchants dub the “fee creep”.
Maurice Griefer, CPP, CRO at Maverick Payments, outlines the sneaky fees you can avoid or negotiate:
- PCI non-compliance: Payment processors can charge you up to $125 per month
- Non-EMV: Up to 0.75% on non-EMV transactions plus penalties
- Monthly fees: Can be avoided with daily or batch billing
- Monthly minimum: Applied if you don’t meet the minimum processing amount
- Next-day funding: Extra charge for expedited funding services
- Interchange savings adjustment: Fee for automated interchange savings
Understand the pricing structure beyond the initial setup costs. Then, list and compare your options.
My frustrations with previous credit card processors were that it always seemed like they were mixing and matching different deals just to make mine look good.
One thing I really appreciated about working with Payment Depot: They’ve really made this process very simple to understand what I’m paying and how to set everything up.
I’d always suspected that I was overpaying a bit for credit card processing.
It was really neat to see that they (Payment Depot) could compare my old statements and really show me up front how much money I was going to save by switching.
Explore integration capabilities
Choose providers with APIs and plugins to streamline integration with your existing business tools, such as an ecommerce platform, CRM tool, accounting software, and POS system.
Alternatively, check if your existing tools already have built-in payment processing services in place.
For instance, Quickbooks is known for its accounting features, but it also offers online payment processing solutions.
Ecommerce platform Shopify also has its own tools: Shopify Payments for online retail and Shopify POS for those that manage online and physical shops.
For my business, Shopify Payments proved to be the best fit as it offered seamless integration with our existing setup, negating the need for a third-party processor.
Focus on security and compliance
Invest in a payment processor with robust fraud detection measures like end-to-end encryption (E2EE) and tokenization.
These features secure customer payment information (e.g., card details) from data breaches. Protection goes both ways.
For your safety, consider the processor’s PCI compliance, SSL certification, and 3DS enrollment. Other authentication features to look for include biometric recognition and multifactor authentication (MFA).
A provider with effective chargeback management also helps reduce disputes and financial losses.
For instance, Square offers expert dispute assistance, taking care of bank communications and keeping you updated on active issues.
Check support coverage
Downtime can mean lost sales in ecommerce.
Opt for a payment processor known for reliable customer support, 24/7 availability, and fast response and resolution times.
Look for SLA clauses that guarantee the provider’s system uptime. You should also check out reviews from other ecommerce businesses, which you can find on the website itself and websites like G2.
We read the reviews of other ecommerce experts to learn about their experience before we committed to the provider Stripe.
We also spoke to the sales reps to better understand their offering and asked any questions we had.
Consider business-specific requirements
Service providers don’t offer the same suite of ecommerce payment processing solutions.
For instance, Helcim supports automatic prorated recurring billing for subscription-based ecommerce. But Clover’s recurring plans are limited to the default amounts and frequencies.
Hopscotch, on the other hand, specializes in working with invoice-based businesses, such as B2B ecommerce and subscription services.
Aside from pinpointing a platform’s expertise, it should also have additional capabilities that fit your operations, such as:
- Point-of-sale hardware (e.g., card reader, terminal, receipt printer) if you also accept in-person card transactions via your physical store
- Multicurrency options if you cater to international customers or process online and in-person payments in different currencies
- Mobile payment processing to offer a smooth checkout for customers using smartphones and tablets
I used a comparison tool to analyze different providers and ultimately chose based on a cost-benefit analysis and alignment with my business goals.
Some payment processors allow free trials, like FreshBooks. Consider testing them out to assess their performance and suitability before making a final commitment.
Final Thoughts
Payment processing only takes a few seconds. But you and I both know, these quick moments can make or break the transaction—and your cash flow.
You need the right processor to secure your customer payments and orchestrate every transaction without a hitch.
Use the tips in this post to lock in the payment processor that'll keep your cash flowing smoothly.
Need help understanding more about credit card-related processes? Crack the code with these useful resources:
- How to Authorize Credit Card Use: A 7-Step Guide for Ecommerce
- Setting Up Credit Card Authorization for Your Business: Best Practices
- Credit Card Authorization vs. Authentication: What’s the Difference?
For more tips and the latest insights on how to give your ecommerce business a competitive advantage, subscribe to The Ecomm Manager newsletter today.
Payment Processors FAQs
What security measures should I look for in a payment processor?
A payment processor’s security measures should protect your business and customers. This can look like:
- Compliance: PCI-DSS is a security standard worldwide. For the UK and EU countries, PSD2 (Payment Services Directive) is another regulatory requirement.
- Features: Fraud detection, encryption, tokenization, and authentication measures like 3D security. Keep tabs on promising emerging tech like biometric verification and machine learning.
You should keep your payment processing software updated to make sure it has the latest security features.
How can I integrate a payment processor with my existing ecommerce platform?
Most ecommerce platforms like Shopify, BigCommerce, and WooCommerce readily integrate with the top payment processors on the market.
The process is simple.
Go to the platform’s app marketplace. Search for your chosen payment processor, then click install. In some cases, you might have to authorize its use through your admin page.
If your platform doesn’t have a built-in integration with your chosen popular payment processor, you can use middleware or connection services like Zapier or look for the platform’s API credentials to create custom integration.
What are the common challenges businesses face with payment processors?
Ecommerce brands often report running into unexpected fees or changes in fee structures. Brands like Southwestern Rugs and Irresistible Me reported experiencing this.
If you don’t do your research and end up with payment processing software that’s not up to the task, you could experience poor customer support, fund transfer delays, and account holds (or worse, closures).
According to Kristin Uptain, marketing manager of Redde Payments, the latter can stem from platforms offering “instant account approval.” She explained:
“While fast onboarding sounds appealing, it often means merchants start processing payments through a “pre-approved” account that later undergoes underwriting. This can result in sudden account closures and held funds, with little or no support to resolve the issue.”
To steer clear of this big headache, choose a processor that is transparent about their approval process and fully approves accounts upfront.
How do payment processors handle chargebacks and disputes?
Payment processors check the transaction details, notify merchants so they can submit evidence proving its validity, and handle the communication between banks.
While resolution can still take time, payment processors help cut down on the tedious parts.
