What Is Merchant Payment Processing? Everything You Need To Know
Mastercard says that small businesses that accept digital payments grow twice as fast as those that don't. My own experience confirms this.
I was operating a thrift store on Instagram in 2020. From my bedroom. At the height of the pandemic.
Imagine if I’d only offered cash on delivery as a payment option. My customers would’ve physically recoiled at the thought of greasy currency notes crawling with germs.
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Plus, I noticed that businesses that only accepted COD payments experienced more order cancellations than we did. Quite often, customers change their minds at the last minute.
A simple tap or click can make a big difference at the checkout page.
So, what exactly is merchant payment processing? What are the behind-the-scenes operations, challenges, and solutions?
I'll cover everything you need to know.
Feel like listening to the content of this post in a (somehow) natural sounding back and forth between AI hosts? Let's try this:
What is Merchant Payment Processing?
Merchant payment processing, in essence, is a partnership.
You work with a payment provider to accept online payments from your customers through credit cards, debit cards, digital wallets, and more.
As compensation for facilitating these sales, the processor takes a small fee and deposits the balance into your business bank account.
Why is merchant payment processing important for ecommerce?
The point of ecommerce isn't just to have a pretty website and cool products.
The deal closes at the checkout page. In the online world, 18% of potential sales are lost due to a difficult, time-consuming checkout process.
A merchant payment processor is the digital cash register for your online store, making transactions safe and easy.
But it’s more than just a digital swipe of the card. Here's why:
- Multiple payment methods. Companies that accept credit cards, debit cards, and digital wallets cater to a broader range of customer preferences, boosting sales.
- Increased sales opportunities. Ecommerce depends on electronic payments to reach global consumers. Compared to brick-and-mortar stores, this expands market reach substantially, leading to higher revenue and sales.
- Streamlined operations. Automating the payment collection process eliminates the need to handle cash or checks manually. In turn, this efficiency frees up resources and reduces errors.
- Faster payment processing. Electronic payments are processed almost instantly, increasing cash flow. Financial stability, expense management, and growth are all dependent on quick access to funds.
- Reduced risk of fraud. Payment processors protect both businesses and customers with advanced security measures.
- Compliance with payment standards. Payment services providers make sure businesses adhere to PCI DSS regulations. (More on this soon.)
Not to be confused with…
The transaction process is governed by a complex network of financial institutions, technology providers, and regulatory agencies.
These are some independent actors:
- Payment gateways. The technology connects the merchant's website or point of sale to the bank's acquiring network.
- Payment processors. The companies in this category handle the technical aspects of transaction processing, including communication with card networks and banks.
- Acquiring banks. These are the institutions that help merchants accept cards.
In contrast, merchant payment processing handles everything from secure payment acceptance to fraud prevention, from transaction reconciliation to customer support.
6 Key Components of Merchant Payment Processing
Now, let's look at the key players that make every swipe, tap, or click-to-pay possible.
1. Merchant account
You're a merchant if you take payments from customers, whether you’re an ecommerce giant or a consultant selling online courses.
Now, a merchant account isn't the same as your typical business bank account. These are special accounts designed for handling customer payments—usually electronic payments such as credit cards.
This is like your business's waiting room for money, holding it until it reaches your main account.
2. Payment gateways
A payment gateway is a digital bridge between businesses, customers, and financial institutions for both online and in-person payment methods.
It's basically what lets your customers pay for online purchases or tap their card at your store.
These gateways protect sensitive payment data during transmission, preventing unauthorized access, and link your checkout process to the payment processor.
3. Payment processors
A payment processor is the workhorse behind the scenes of every transaction.
It's the machinery that makes sure card transactions don't just disappear into the ether. The payment processor takes care of everything from that first tap or swipe to the moment the funds hit your business's bank account.
4. Card networks
A card network, such as Visa, Mastercard, American Express, or Discover, allows communication and transactions between all parties involved in a transaction.
They act as global connectors, setting the rules and technical standards that make it easy to interact between different banks and payment systems, regardless of location or currency.
5. Acquiring banks
Acquiring banks facilitate card acceptance by providing merchant accounts to merchants. Consider them your financial ally, covering chargebacks and disputes for the merchant.
6. Issuing banks
The issuing bank, which issues credit and debit cards to consumers, is on the other side of the transaction.
Their job is to authorize transactions, verifying that the cardholder has enough funds or credit available to make purchases. Additionally, the issuer manages customer accounts and provides funds to the acquiring bank.
Payment Processor vs Merchant Account
For businesses to accept electronic payments, both payment processors and merchant accounts are essential.
However, they serve different roles.
Think of the payment processor as a highway, that facilitates the transfer of funds between the customer's bank and the merchant’s bank.
A merchant account, in contrast, acts as a secure rest stop along the highway, temporarily holding funds until the business's regular bank account is ready to receive them.
Here are some key differences between the two:
| Payment processor | Merchant account | |
|---|---|---|
| Role | The system that handles the approval and processing of payments. It’s the “highway” that moves money between banks. | A special type of account that temporarily holds your funds before they’re transferred to your main bank account. The secure “rest stop” for your money. |
| Function | - Communicates with banks to verify and approve transactions. - Transfers funds between customer’s and merchant’s accounts. | - Collects and holds payments from customers. - Waits to release funds to your business bank account after processing. |
| Interaction | Works in the background during each transaction, ensuring funds are moved securely. | You check it to see your incoming payments before they hit your main business bank account. |
| Fees and costs | - May include setup, transaction, and monthly fees. - Costs vary by provider, industry, and transaction volume. | - Can include monthly fees, chargeback fees, and transaction fees. - Costs depend on the provider and transaction type. |
How Merchant Payment Processing Works
The merchant payment processing sequence is a multi-step journey that securely and efficiently moves funds from a customer's account to a business's account, allowing purchases.
Here's how it works, some common challenges and solutions, and the importance of security and compliance throughout the process:
The process
The journey of an online payment begins here.
1. Initiation
The customer provides their payment details at the point of sale.
This can be swiping or inserting a physical card at a terminal, entering card details online or over the phone, or using alternative forms of payment like digital wallets.
2. Encryption and transmission
In order to protect the payment information during transmission, it's immediately encrypted. Here, a payment gateway secures the channel, sending encrypted data to the processor.
Arguably the most important step, this ensures customer payment data makes the trip unaccosted by digital bandits.
3. Authorization
In this step, there are a few processes involved:
- Verification request. The payment processor sends the details of the transaction (amount, merchant ID, etc.) to the acquiring bank.
- Bank-to-bank communication. The acquiring bank sends the request to the issuing bank (the customer's bank).
- Checks and balances. The issuing bank verifies the card details, checks the credit limit, and assesses security risks.
- Authorization code. The bank sends back a code indicating approval or decline.
4. Response
Once the authorization code is received, the payment processor immediately informs the business (and often the customer) about the transaction's status.
If it’s approved, the sale can proceed.
If it’s declined, however, the business must inform the customer and potentially offer alternative payment options.
5. Settlement
Most transactions are settled in batches at the end of the day or another pre-defined time. Afterward, the issuing bank transfers funds to the acquiring bank.
In the end, the acquiring bank credits the merchant's account with the transaction amount minus the processing fees.
6. Reporting and reconciliation
The business and financial institutions both keep detailed records. Businesses compare their sales records with bank statements to make sure they're accurate.
The documentation is imperative if there are any discrepancies or chargebacks.
Security and compliance
In 2006, major card brands like Visa, Mastercard, and others formed the Payment Card Industry Security Standards Council (PCI SSC) to address data security concerns and foster trust in the payment ecosystem.
The council's mission was, and is, to create and maintain standards for data security, making sure that any company handling credit card information is doing it right.
AUTHOR’S TIP
The bad guys never sleep, and neither should your security standards. In the same way threats and technology evolve, so does PCI DSS.
Those handling cardholder data, including merchants and payment facilitators, should be aware of the new 4.0 requirements.
PCI DSS 4.0 takes a holistic approach to security and access control.
⚠️Also, non-compliance with PCI can result in fines of up to $500,000. So, read up!
PCI compliance is the global gold standard for the security of cardholder data.
Any company that accepts or processes payments is subject to this law to protect consumers and minimize fraud and data breaches.
But, what happens when payment processing services are insecure?
Let’s look at a real-life payment gaffe.
Home Depot breach's price tag
Home Depot's breach of 2014 wasn't a small whoopsie. This was one of the largest breaches of POS systems ever recorded.
The hackers waltzed into the system with stolen third-party credentials and accessed over 50 million credit card numbers and 53 million email addresses.
From April-September 2014, they had five months of unfettered access. The financial consequences, as you can imagine, were, severe.
Home Depot paid out $134.5 million to credit card companies and banks, plus $19.5 million to customers and $25 million to financial institutions. That's not all…
Then came the lawsuits. The regulatory fines. One after another, each one a reminder that the company doesn't protect its customers.
New, enhanced security measures were implemented—a costly band-aid on a gaping wound.
Another $17.5 million went to settle with 46 states and Washington, DC. And Home Depot also had to hire a top CISO, train its people, and beef up its security.
Often, merchants see PCI compliance as nothing more than a checkbox exercise.
But they're missing out on the opportunity it presents: a chance to step back and evaluate their data practices comprehensively.
A strong security strategy starts with understanding where, how, and by what rules your data is stored, used, and protected.
Challenges and solutions
There are a lot of logistics involved in digital payment transactions—so naturally, challenges abound. I collected information from 33 ecommerce business owners—of them, four brands weighed in on the challenges they face with merchant processing as a small business.
So, what are these challenges and how are they solving them?
1. Pretty Moment faces problems in settling and resolving chargebacks
Despite the required compliance with the stringent standards of the PCI DSS, one of the prominent challenges we commonly grapple with is settling and resolving chargebacks
Why does this happen?
These usually occur when a customer disputes a charge, potentially affecting our revenue stream.
Have they found a way around this problem?
We've learned to efficiently manage them with clear communication and providing high-quality customer service.
2. Best Online Cabinets has trouble managing multiple payment methods
Josh Qian, COO and co-founder of the company, explains why:
Customers prefer different options, from credit cards to digital wallets, and ensuring seamless integration across all these platforms can be daunting.
Plus…
Handling international transactions often leads to issues such as currency conversion fees and varying compliance regulations, which can complicate our operations.
Have they found a way around this problem?
For our payment processing solution, we chose a provider specializing in ecommerce and offering customizable features.
This flexibility allows us to tailor the payment experience to our customers' preferences while providing comprehensive analytics to track transaction performance.
3. The Laundry Basket LLC has trouble with transaction fees
One of the biggest challenges is dealing with transaction fees—they add up quickly, especially with high-volume sales,
The average merchant processing fee is 1.5% to 3.5%, but there’s no one-size-fits-all approach.
You'll likely have to pay different fees depending on what kind of business you run, how many transactions you process, and what kind of cards you accept.
Have they found a way around this problem?
We use Stripe for our payment processing because it's reliable and user-friendly.
What I trust most are their strong security features—knowing that my customers' data is safe gives me peace of mind.
Plus, the customer support is solid, and that makes a huge difference when an issue arises.
For context, Stripe’s in-person transactions using their credit card terminals come with a competitive rate of just 2.7% plus 5 cents per transaction.
For every successful online transaction using a card or digital wallet, Stripe charges a 2.9% base rate plus a $0.30 flat fee.
4. The Trade Table struggles with fraudulent transactions
Forrest Webber owns a small ecommerce business specializing in high-quality home products.
Their most common challenge is fraudulent transactions. When someone uses a card without the cardholder's permission, it's a fraudulent payment.
Imagine this:
A thief uses a stolen credit card number to buy something from your online store (say, an assortment of dad joke-themed apparel).
Maybe the payment goes through.
However, when the real cardholder notices this unauthorized charge, they'll contact their bank and file a chargeback. Even if you try to fight it, if the transaction is actually fraudulent, the cardholder will win.
Have they found a way around this problem?
Webber explains that they mitigate this risk by ”using Stripe's Radar tool, which leverages machine learning to detect and prevent potential fraudulent activities.”
In addition to the above, payment processing delays and failed card payments were other major issues.
How to Choose the Best Merchant Payments Solutions
Choosing the right merchant payment solution isn't a game of pin the tail on the donkey—you need precision, not blind luck.
Because this decision will directly affect your bottom line, customer experience, and overall business success.
Of the 33 ecommerce experts I spoke with, 17 of them trust Stripe as their primary merchant payment solution. Now, this might be a small sample, but the majority has spoken.
Stripe may have a solid fan base—however, the remaining 48.48% prefer other solutions, which is a significant portion of the market.
So, what are some key considerations when choosing a merchant payment solution?
Here’s what I found, and here’s what other ecommerce businesses have to say:
1. Pricing matters
Don't let fancy features blind you.
Make comparisons between merchant providers based on their transaction fees as well as monthly charges. Keep an eye out for hidden fees, like the interchange fee, and make sure you understand any contract obligations.
For Jonathan Goldberg, president and CEO of Kimberifre, Square is a great fit.
Why?
We particularly like that it offers a set fee regardless of the type of credit card used, which simplifies things for us and ensures cost predictability.
Square’s pricing is transparent, which we value greatly, and their technology solutions are easy to use and integrate well with our QuickBooks system.
Square's straightforward pricing, ease of integration, and strong technology offerings make it “our top payment solution.”
2. Customer support is king
A smooth transaction is essential, but when things go wrong, like errors in credit card processing, you need reliable support.
Take a look at reviews, and ideally, choose a company that offers 24/7 customer support.
Poalo Piscatelli, owner and CEO of Alarm Relay, places his trust in Stripe.
Why?
As our business grows, Stripe can handle more transactions without any problems, which is important for our future plans.
We trust Stripe because it is widely used and has a good reputation, plus they provide excellent customer support when we need help.
3. Security features
The information you collect about your customers is extremely valuable. Be sure your provider is PCI-compliant and offers advanced security measures.
Because fraud is a major concern in ecommerce, Gavin Yi, founder & CEO of Yijin Hardware, depends on “Authorize.net for its comprehensive security features and strong fraud prevention measures. The implementation of tokenization and sophisticated security protocols ensures the protection of our customer information.”
Plus, since their mobile payment integration runs smoothly, Yijin Hardware can offer “different options without hassles.”
Gavin also speaks highly of the system’s excellent reliability, with very little downtime.
4. Integrations and unique business needs
The payment solution you choose should not disrupt your existing workflow.
Make sure everything's integrated with your ecommerce platform, accounting software, and other essential tools.
At Klatch Coffee, for example, a significant piece of the ecommerce strategy is subscriptions for automatic coffee delivery.
Therefore, Justin Christopher, manager of ecommerce and marketing, says:
“Any merchant payment solution must first be available on Shopify, our chosen ecommerce platform,” and also, it must be designed “to explicitly support subscriptions on Shopify to handle the recurring orders.”
This particular business need, in his opinion, “limits the payment processing choices available to merchants who offer subscriptions.”
Additionally, consider your business's individual needs.
Are you looking for multi-currency support or specific payment methods? Choose a scalable solution that can expand with your business as it grows.
Bradley Fry, the owner of PinProsPlus, has chosen Braintree specifically because the tool can “handle multiple payment methods, including PayPal and Apple Pay.”
5. User experience and ease of use
When selecting a merchant payment solution, consider the user's perspective.
Look for solutions with streamlined checkout processes and clean, uncluttered user interfaces. The fewer steps and clicks required to complete a payment, the better.
For this reason, Sergio Pedemonte, CEO of Your House Fitness, makes use of several payment solutions.
Here’s how:
We use Stripe, which I think is one of the best options, especially because it allows for customization and offers useful APIs.
PayPal is another option, as many customers prefer to pay through PayPal. Additionally, for in-person transactions, we use Square.
Square is great because it offers flat rates and a variety of features, making it an excellent point of sale system.
How does this benefit their business and their customers?
These platforms benefit our business by offering flexibility and convenience to both us and our clients.
With Stripe, we're able to customize many features, allowing us to tailor the user experience and business operations on our website.
PayPal is equally valuable, as some clients prefer using it despite the flat fee, which has worked out well for us overall.
And why does Sergio trust them?
I trust these platforms because they have a proven track record.
I've been using them for over eight years, and they continue to be industry leaders, consistently delivering positive results.
AUTHOR’S TIP
If your business is ready to go global, don't let your payment gateway be a homebody. Look for one that supports card networks and payment methods popular outside your primary region.
For instance, Visa, Mastercard, and American Express control the US credit card market, but UnionPay dominates the global market, securing 40.03% of the market share in 2023
Top merchant payment solutions to check out
The shoppers have spoken—they want the convenience and speed of digital payments, whether online or in-store.
A whopping 73% prefer contactless, debit card payments, or credit card payments.
Businesses, big or small, need to adapt. As a merchant, you need to select solutions that perfectly blend functionality, security, and cost-effectiveness.
Here are some of our top recommendations in key categories to simplify your decision-making:
Payment processors
Yes, Stripe rules the roost in my findings, but it’s worth checking out our list of top 10 payment processing software solutions for your unique business needs:
Payment gateways
Similarly, a payment gateway that works well for another ecommerce business may not cut it for you.
Here’s our shortlist of the best payment gateway providers on the market right now:
Fraud prevention software
8% of online revenue is at risk of fraud. And the bearer of these costs? It’s likely going to be the merchant—you.
So, you need to invest in solid fraud-prevention software. Here's what we've got for you:
Make It Rain (Digitally)
No more fumbling with cash or worrying about bounced checks. This is the 21st century, gentle readers.
We've covered the basics, the challenges, and even the horror stories (looking at you, Home Depot). But here's the deal: pick the right merchant payment solution, and you're golden.
Security matters. It's all about the user experience. And pricing? Well, let's just say your wallet has opinions too.
Stripe, PayPal, Square—the big players are there for a reason. But don't ignore the underdogs. Sometimes, the perfect fit wears a smaller shoe.
The world of ecommerce moves fast—and so do you. Subscribe to our newsletter with the latest insights for ecommerce managers from leading experts in the industry.
Merchant Payment Processing FAQs
Since we’ve promised you everything you need to know, here’s more!
How do I choose a merchant account provider?
Your business needs will determine what type of merchant account provider is best for you. While a small online shop might benefit from Square’s simplicity, a high-growth tech startup might prefer Stripe’s scalability. The key is to find the right fit based on your individual needs.
ELI5: Why do I need a merchant services provider?
You need a merchant services provider so you can accept credit and debit card payments from your customers. However, they offer much more than just swiping plastic.
They’re your financial concierge, facilitating smooth transactions, safeguarding data, and providing valuable insights into your business.
