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How Merchant Accounts and Payment Gateways Work

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If you sell products online, you may already use an e-commerce service like Paypal to enable customers to make purchases. However, Paypal is only one of many such services available for online shoppers. Other services, priced at different rates, are available for smaller or larger online purchases as well as non-commerce related purchases such as charitable donations.

The key to understanding how these services function is to first learn some e-commerce terminology. To begin with, e-commerce is enabled by two critical components: the merchant services account and the payment gateway.

Merchant services accounts

The merchant services account is, in essence, a temporary bank account that holds your customers’ money for you. Typically, these accounts work with customer debit and credit cards. Funds are transferred from the merchant account to your own bank account on either a daily or weekly basis. Dharma Merchant Services is one place where you might go to set up a merchant service account.

Merchant accounts typically charge fees for their usage, termed the discount rate. This rate may or may not include the interchange rate, which is the actual fee that Mastercard, Discover or VISA charge. Typical interchange rates are 1.5-2% of the total transaction; rewards-based credits cards, such as those that awards points or airline miles for purchases, might tack on an additional 0.2-0.4% for interchange. American Express adds on an extra 1% or so for transactions- a big reason why many merchants do not accept this card.

On top of the basic interchange rate is the fee for using the merchant account, which is typically a given percentage of the total transaction plus a per transaction fee. Dharma, for example, charges a 0.35% + $0.15/transaction interchange+ fee.

Finally, most merchant accounts charge a per month use fee, which can range from $5 to $20/month.

Payment gateways

The payment gateway is the other half of ecommerce equation and functions as a virtual credit card terminal. As such, the payment gateway encrypts and then authorizes the credit card transaction. If the credit card is approved, the gateway stores its data until payment is completed. Examples of payment gateways include Authorize.net, Stripe, Simplify and IntelliPay.

Payment gateways can perform numerous payment and billing services, including recurring and “Buy It Now” billing. They can also work with virtual terminals, which enable you to accept credit cards through smartphones or just about anywhere there is an Internet connection. Additionally, payment gateways can accept payments that are sent in by simply clicking “yes” to a text or email invoice.

Payment gateways charge their own fees; for example, Authorize.net charges a $20/month use fee plus a $99 one time setup fee and a $0.05/transaction fee.

Integrated merchant services and payment gateways

You may have used Paypal to accept payment from your customers by simply opening an account and linking it with your bank. How does this work? Essentially, Paypal functions as an integrated merchant services account plus a payment gateway.This streamlines the payment process and reduces the total number of moving parts that an ecommerce merchant must deal with.

For e-commerce sites that sell only a few goods online or under $10K/month, Paypal works incredibly well. However, as sales volumes and payment methods increase, the Paypal fee structure can become extremely stifling for e-commerce merchants who operate on razor-thin margins.

This is why many merchants, such as affiliate marketers, eventually move out of Paypal and start using separate merchant accounts and payment gateways. These items usually fit in well with WordPress e-commerce platforms like WooCommerce. Alternately, they may try alternative payment processors like VISA Checkout or Google Wallet.

How do you select the right merchant services provider and payment gateway?

With all these services available and competing for your business, how do you select the one that’s right for you and won’t eat too much of your profits?

You can start by looking at which payments you’ll be taking online, and possibly offline. Will you only be accepting “one-off” payments on goods that are ready to go? Or will you be integrating recurring payments, such as for subscriptions? You might also not have all your items in stock all the time, necessitating back order notices and repeated credit card charges as items become available.

The more complicated your product inventory and ordering options, the more likely it is that you will need a separate merchant services account that charges you a low monthly fee and some percentage of your transactions.

Once you’ve selected your merchant services provider, you will need to choose a payment gateway. In many cases, the merchant account will direct you to select a gateway that it already works with fairly well. However, if you don’t like those choices, ask if your own selected gateway will “fit” into the account. In most cases, almost any payment gateway can be made to work with the merchant account.

Before you make any decisions about your merchant services account or payment gateway, find out if there is any contract involved. Some services ask that you sign on for a minimum of six months or even a year. You don’t want to get stuck with a platform that costs you a lot of money and/or won’t let you switch out to a service that’s a better suited to your selling preferences.

Finally, don’t be afraid to call up your candidate service providers and speak to their reps about your concerns. This is a good way to test out who will provide you with the best customer and/or technical support in the future. Knowing who is behind the service, and whether they can actually help you out, will be critical should your customers not be able to complete their transactions or start asking for refunds.

One Comment

  1. Good article – thanks for clearing up the differences between merchant accounts and payment gateways. Having an awful time with Authorize.net currently and looking to change.


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