How Does the Payment Processing Industry Work?

Hundreds of billions of transactions are taking place annually and much of the world is only just getting started. If you have ever had an issue with a payment or if you are thinking of entering the world of e-commerce, it’s important to understand how the payment processing industry works. 

Key Players

To process payments, several entities or actors must come together. Each of these entities plays a role in the entire payment process. These entities include the merchant, the customer,  payment processor, payment gateway, and payment service providers. 

Merchant

The merchant is an individual, or a company, that offers something in exchange for your money, such as goods or services. To be able to process your traditional payment, the merchant must tie-up with a bank of their choice. This bank will provide them with an account number, or a unique identifying number, where they will receive their payments. 

So this is typically a business checking account, in layman terms. In turn, banks register themselves with card networks. Examples of these card networks include Visa, MasterCard, American Express, etc. Emerging countries are coming up with their own card networks, such as UnionPay of China and RuPay of India. This allows the registered bank to accept payments from card networks on behalf of the merchant. On the other hand, Paxum works worldwide and makes the sending and receiving of payments between businesses and individuals easier. 

For the most part, business bank accounts are a paid service. The monthly maintenance fee the merchant pays the bank would be in addition to the fee that the card networks levy in the first place. Keep in mind: when you agree to an account with the bank, you must also agree to the regulations that the card associations put in place. Overtly, the card network and the bank are very different entities. This is important, though, as it allows transactions to flow smoothly and makes refunds easy when requested. If it wasn’t for these regulations, we would not be averaging several thousand transactions every second across the world today.

Customer

The customer is the entity that supplies the money in the transaction. An order may be placed online or at a point-of-sale at a retail location. The customer must enter their card details, credit or debit. This is done automatically when you swipe your card or if you use the NFC technology on your phone. It is also done for you by a wallet if you use something like Google Pay or Apple Pay. Otherwise, you may have to manually enter this information, especially if you are trying to check out online.

In this day and age, every online page that accepts your card information is required to have encryption. Therefore such pages should be prefixed with HTTPS. The information captured on the web page is then sent by the browser (Firefox, Chrome, etc.) to either the merchant server or to a payment gateway. Payment gateways are often used as they tend to offer greater security. The transaction is not complete until the payment is authorized by the bank that issued the card. Upon authorization, the merchant receives the confirmation and you get your copy. Only after this confirmation is received will an order be processed and fulfilled. 

Payment Processor/Processing

The payment processor is someone who takes transaction information from the merchant. It is chosen by the acquiring bank, or the bank that is about to receive the proceeds of the sale. While often confused, it is different from the Payment Gateway.

Payment Gateway

A payment gateway is simply a software that enables the communication between the merchant and the payment processor. Of course, a few enterprising banks have come out with their own payment gateways. Payment gateways must stay on top of privacy and security concerns given the sensitive information they process. This requires payment gateways to continually update their software. It is also important that the payment gateway software is user-friendly so merchants can incorporate it into their websites, often without any coding knowledge.

Payment Service Providers

Certain payment gateways are just not user-friendly enough, making it complicated to integrate them into basic mom-and-pop websites. This is where payment service providers are helpful. Payment service providers are most certainly third-party solutions that are easy to use and help the merchant facilitate their payments. Common payment service providers include PayPal, Stripe, and Square. 

Card Authorization

Authorization is the primary reason why all of this communication between these key players takes place. With each transaction, the information is sent to the bank that issued the card for the particular customer. Once they give the go-ahead, the transaction moves forward and the acquiring bank receives the funds. This is the most important step in a transaction because the card could be stolen, expired, maxed out, or, for whatever reason, has a hold placed on it.

What Happens During a Sale?

Each time there is a sale, using a debit or credit card, the information about this transaction must go from the merchant to the acquiring bank. Then this bank starts talking to the Card Association network, handing over all of the information and the request for money. The card Association network, in turn, takes this request to the bank that actually issued the customer’s card. Visa or MasterCard themselves do not issue cards. Instead, they collaborate with banks like Wells Fargo, PNC, or even the Bank of America!

How Do Digital Wallets Work?

Now let’s say the customer is using a digital wallet such as GooglePay. In this case, the merchant would send the transaction data over to the provider of the wallet, Google. Subsequently, Google will forward this information to the payment processor, and so forth. To stay relevant, Internet wallets tie-up with merchants to offer periodic deals and discounts. They also anonymize your identifying information, including your card number. In turn, on certain occasions, these wallets make money off of your purchases.

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