As a new business owner, one of the most important decisions you can make is choosing which payment methods you’ll accept. Will you operate a cash-only business, or will you accept all payments methods?
If you’re like most businesses, we’re betting you want to accept cash and credit cards at a minimum. While in the past it was safe to say that cash was king, the times are changing. Card-based transactions are more popular than ever. Research from TSYS shows that 82% of consumers prefer to pay with credit cards and debit cards while only 10% of consumers prefer cash.
To run a more profitable business, you need to accept electronic payments. To do that, you need to sign up for a merchant account with a merchant service provider (MSP). At this point you might be asking yourself “What is a merchant account?” and “How do merchant services work?” And that’s the point of this post.
We’ll explain everything you need to know about merchant services and accepting credit cards. We’ll also give you tips for vetting MSPs so that you can choose the right one for your business.
What Are Merchant Services?
The phrase merchant services is a technical term for the financial services that allow a business to accept credit card transactions, as well as other electronic methods like debit cards and mobile payments. These services can cover everything from software to hardware to specific products that enable online or mail order sales.
How Do Merchant Services Work?
To thoroughly understand how merchant services work, it’s helpful to know how credit card processing works at a high-level:
- Your customer pays for their purchase by swiping their card at your credit card terminal
- Your terminal sends the details to the acquiring bank (also called the payment processor, acquirer, or merchant account) and requests payment authorization
- Your processor sends the transactions to the appropriate card association (Visa and MasterCard, etc.) who passes it onto the issuing bank or the card issuer
- The issuing bank (the organization that issued the card to your customer) then approves or declines the transaction based upon the status of your customer’s account
- The approval or denial message then flows in reverse back to you and your terminal
With the above in mind, the term “merchant services” refers to your merchant account. Typically businesses get a merchant account from a Merchant Services Provider (MSP). MSPs are also sometimes known as an Independent Sales Organization (ISO). The merchant account is an intermediary between your business bank account, the credit card networks, and the customer’s issuing bank. Without one, you aren’t able to accept credit card and other electronic payments.
What Else Do Merchant Service Providers Do?
Due to their critical role in the credit card transaction process, MSPs typically offer a variety of other payment processing products. In fact, these additional areas of service are one of the main ways that MSPs compete. When you’re comparing MSPs against one another, it’s a good idea to look at these services to find the most value for your business.
With that said, here are some things an MSP could offer you:
Payment Processing Hardware
Many MSPs will sell you or lease you payment processing hardware in the form of a credit card terminal or credit card reader. This reader will need to connect to the internet to transmit payment data to your merchant account and along to the rest of the parties involved in a card transaction. So, in addition to your card reader, you’ll also want a modem or router that your reader can plug into with an ethernet cable.
As far as leasing versus buying a terminal outright, the choice is up to you, but we recommend purchasing a terminal if it fits into your budget. This will save you money in the long run as a multi-year lease will often result in you paying more than the cost of the reader. It’s also worth noting that you can also buy a reader from a third-party seller. However, you’ll need to ensure it’s compatible with your point of sale system (POS) if you have one. It’ll also need to be reprogrammed to work with your payment processor’s network.
Lastly, to future proof your business as much as possible, you’ll want to ensure that your hardware works with EMV chip cards, as well as NFC payment methods like Apple Pay and Google Pay.
A payment gateway is a piece of software or a web service that sits in front of the merchant account in the credit card transaction process. It’s specifically used in ecommerce and online stores. Essentially it encrypts and sends the transaction data to your merchant account, which then passes it along to the right credit card association as it does in a brick-and-mortar transaction. Once the payment gateway receives the authorization response, it prompts your ecommerce platform to process the payment.
More advanced payment gateways can include additional features like address verification and fraud detection tools. Since ecommerce is such a large part of retail today, many MSPs offer this functionality in their suite of services. If you want to sell online today or in the future, it’s definitely something you’ll want to confirm. Additionally, if your MSP doesn’t offer this service directly, they may work with a third-party payment gateway that you can use.
A virtual terminal is exactly what it sounds like it is. It’s a virtual representation of a credit card terminal, and it allows you to accept credit card transactions with a computer instead of a physical credit card reader. These virtual terminals are an excellent fit for mail order or telephone order businesses that don’t need a physical credit card reader.
In recent years, however, some MSPs now offer simple USB magstripe and EMV reader hardware that allows a brick-and-mortar merchant to use a virtual terminal in place of a physical card reader. One of the most significant benefits of this hardware is that you can avoid the higher processing rates and risk of fraud that accompanies card-not-present transactions.
Merchant Cash Advances or Loans
The last major service that MSPs often offer are financing products like a small business loan or a merchant cash advance (MCA). These products are valuable tools that can help your business buy inventory or equipment, bring on seasonal staff, launch more extensive marketing campaigns, and more. Most businesses take on funding at one point or another, so it’s worth investigating whether a prospective MSP offers the options you want.
Different Types of Merchant Service Providers
When understanding how merchant services work, it’s helpful to look at the two categories of MSPs: merchant account providers and Payment Service Providers (PSPs).
Merchant Account Providers
Merchant Account Providers are the most common form of MSP. Typically these organizations will offer you a merchant account, and perhaps some merchant services. But they don’t actually process your transactions for you. Organizations that provide processing services in addition to a merchant account are referred to as direct processors. Direct processors are large industry players like First Data and TSYS Merchant Solutions.
Payment Service Providers
If you want to accept credit cards, but aren’t interested in signing up for a merchant account, you aren’t entirely out of luck. Payment Service Providers (PSP) are the answer. PSPs include popular brands like PayPal and Square. This is a category that Square essentially invented when they first launched. As far as target customers are concerned, Square focuses on brick and mortar merchants, and PayPal focuses on the ecommerce side of things.
PSPs function by grouping their customers into something that’s similar to one large merchant account. In doing so, payment service providers can bring down costs, and also skip the lengthy underwriting process found in traditional merchant accounts. As far as processing is concerned, PSPs almost always offer simplified flat-rate pricing. For new businesses, this flat-rate is often attractive as it’s far easier to understand than the multiple rates you get with interchange-plus pricing.
While this paints a rosy picture, payment service providers do have some significant drawbacks:
The flat-rate pricing that seems so attractive at first is almost always higher than the overall rate you’ll receive from a traditional merchant account using interchange-plus pricing.
Lack of Customer Service
Payment service providers operate on a mass-market basis. Their objective isn’t to offer each merchant customized, white-glove service. Their focus is to satisfy the basic needs of as many micro-merchants as possible. Since these merchants transact at a low volume and irregularly, they don’t need the same quality of service as full-time merchants. As a result, PSPs typically offer limited customer service. This might not seem like a big deal right now, but what happens when you have a technical issue, and you can’t process payments? Wouldn’t you feel better knowing there was always someone you could call for help?
Since it’s so easy to sign up for a PSP account, there’s a high instance of fraud. This makes PSPs extremely conservative when it comes to merchant behavior. For example, if you see a rapid increase in transactions because you ran a recent promotion, or if you make a sale that’s significantly larger than your “normal” transaction value, PSPs are likely to shut down your account. Not only does this prevent you from being able to accept credit card and debit card transactions, but PSPs will also withhold your funds indefinitely.
Credit Card Processing Pricing
One of the issues that business owners find the most confusing is understanding how credit card processing pricing works. We get it. Trying to read a credit card statement can feel like attempting to translate a foreign language. To help you out, we’ll go over the three most popular ways that MSPs and PSPs price their processing.
As we mentioned before, flat-rate pricing is the approach employed by payment service providers like Square and PayPal. With this pricing model, you pay the same rate for every transaction regardless of the size or payment method. The only time you’re likely to see a different rate is when you’re looking at swiped transactions versus card-not-present (CNP) transactions, but this is true regardless of the pricing model employed.
The reason for this is that most credit card fraud happens via CNP transactions. Fraud and chargebacks aren’t good for anyone so processors will charge retailers a higher rate to encourage them to prioritize swiped transactions.
This pricing model does what it sounds like. It breaks the rate you pay out into several different tiers. These tiers are based on a variety of factors, including:
- Credit card versus debit card transactions
- Swiped in-person transaction versus a card-not-present transaction
- Transaction settled within 24 hours versus settling in a longer period
Tiered pricing can be a beneficial upgrade over flat-rate pricing because you’ll likely pay a lower rate. But it’s not perfect. The biggest problem is the lack of transparency. Some processors take advantage of merchants by making it unclear which tier a transaction will fall into, resulting in a higher than desired markup.
Interchange-plus pricing is the most transparent of all pricing models. MSPs that use this model will clearly indicate the interchange rate (non-negotiable rate set by the credit card companies), as well as their markup, on a per transaction basis. This gives you a very clear picture of what you’re paying, when you’re paying it, and why you’re paying it. As with the other pricing models, you’ll still see your transactions falling into different tiers, but at least you’ll know why this time.
Which is Right For You?
For most businesses, we recommend signing up for a traditional merchant account that uses interchange-plus pricing. This will give you the best combination of customized service, transparent and fair pricing, and additional services (financing) that will help you run a profitable and efficient business. The only exception is if you’re a very small merchant that transacts on an irregular basis, and, therefore, doesn’t need all of the tools and support that a full business does. In this instance, a PSP could work for you. However, you might quickly find that you outgrow their service and need to move to a traditional merchant account anyway.
Ultimately, you know your business better than anyone. Take a look at how you’re operating today, and where you want to take your business in the future. What role will credit card processing play in your success? From there pick the solution that offers you the best combination of features to get you where you want to do.