Payments 101: A Brief Overview of Payment Processing
Payment processing hasn’t changed much since the world upgraded from bartering to currency. You want to sell something and your customers want to buy it – transaction complete.
But what makes payment processing different today is the ability to do it well at scale, which includes technology, compliance, information security, accounting, tax, shipping, global reach, and other key elements that are integral to selling digitally.
Good news for buyers: getting your next t-shirt online is much faster, greener, and more convenient.
Good news for sellers: facilitating the transaction is trickier than with cash, but infinitely scalable with the right payment system in place.
Payment Processing in the Internet Age
The marketplace has become increasingly comfortable with digital payments as security, regulations, and compliance have caught up with the internet wave. Today, you could even say we’re dependent on it. As a result, you can now choose between building a custom payments platform or a slew of ready-out-of-the-box payment processing solutions with varying capabilities.
Both have their perks and downsides, but the most important consideration is functionality and your return on your investment. Whether you’re new to the subject or a seasoned veteran, it’s well worth the time to look before you leap on a solution to ensure it meets your business goals five or ten years from now.
To lend a hand in this evaluation process, we’ll be diving into these topics the next few months:
Payments in a Global Economy
Globalization enables businesses to operate across vast distances, nations, cultures, and currencies. According to the Federal Reserve Bank of San Francisco, online or remote purchases doubled in the last 6 years. Even physical money has become rare as people favor debit/credit cards and online payment platforms like Venmo, PayPal, or Zelle – or now even your smartphone.
As a merchant, you may sell three products to someone in Maine today, seven to a buyer in Portugal tomorrow, and 15 in your Minneapolis brick-and-mortar store this week. Ultimately, this means that any tech-enabled organization needs tech-empowered payment solutions to make the purchasing experience as quick and convenient as your customers expect.
Key Features in Modern Payment Processing Systems
1. Basic Payment Flow
When a customer comes to your physical store or online store, they do their shopping and we hope they initiate payment. It tends to look a something like this:
You are the merchant, they are the customer, and if they’re using a digital payment method, a payment gateway is a key part of the process.
In short, payment gateways request certain information about a transaction and a customer to help confirm the validity of the card or direct payment. For example:
Brick-and-mortar stores generally use POS (Point-of-Sale) systems to collect payment information, such as credit and debit card numbers. In this case, the information you need about the customer is stored on the card, plus some sort of security like a PIN.
Online merchants use payment gateways to collect the necessary customer information to make a payment. This info is key for facilitating transactions, but it’s just the start.
The latter group of merchants may include eCommerce, eBusinesses, online retailers, “bricks and clicks,” and more. Your customer makes their selection and upon checkout must fill out a form gathering payment details such as name, address, shipping information, coupon codes, card information, and more – depending on the scenario.
Payment gateways like these typically work with a variety of card-issuing banks and card associations.
Card-issuing bank: financial institution that offers branded payment cards from card associations directly to consumers. This may include credit cards, debit cards, key fobs, and prepaid cards.
Card association: a network of issuing banks and acquiring banks that process branded payment cards. For example: Discover, MasterCard, Visa, etc.
Besides ensuring that the payment details are securely transferred, the gateway can also check the customer’s credit card number and billing address to make sure that they match. Otherwise, the transaction may get flagged for potentially being fraudulent. If everything checks out, the information passes to a payment processor.
Note: Some services like PayPal and Stripe provide combined payment gateway and payment processing services. For simplicity, we’ll treat them as separate. Let’s dive into payment processors next.
3. Payment Processor: Processing the Transaction
Payment gateways work with payment processors to make the transaction process fast and simple. A payment processor connects customers and their card-issuing bank with merchants and their acquiring bank to facilitate transactions.
Once the payment processor receives payment information, they contact your customer’s credit/debit card issuer, often their bank, or other relevant financial institution (say, PayPal). With credit and debit card transactions, like Visa or Mastercard, a card network facilitates communication and transfers.
The customer’s card issuer or other relevant financial institution (sometimes called the merchant acquiring bank) will then check to make sure that the customer has the necessary funds or credit to cover the transaction. If the financial institution notices any red flags, say suspicious purchases, they might pause the transaction and contact the cardholder/client. Otherwise, if the funds are available, they will approve the transaction.
From here, the payment processor will pass the info back to the payment gateway, which will update you (the merchant) and your customer.
4. How Funds Get Transferred from Customer to Merchants
The payment gateway will let you and your customer know whether the transaction was approved or declined. Assuming it was approved, your customer’s bank or other relevant financial institution will send money to your (the merchant’s) acquiring bank, which is the financial institution you use to accept payments.
The acquiring bank will deposit the money either into a merchant account specific to your business’ merchant ID (MID), or an aggregated merchant account. Your money stays in this account in case of chargebacks, returns, and/or other issues later on. After the appropriate time frame, it’ll be deposited into your designated business accounts.
5. Fast and Secure Transactions
Don’t worry if this is still a bit confusing. Fact is, modern payment systems are intricate and have many stakeholders. But what you get is the ability to process payments worldwide within a matter of seconds. This way, customers can get the products and services they need, and businesses can reel in the revenues needed to thrive.
Yet when it comes to money, speed isn’t everything. In fact, payment systems sacrifice a fair amount of speed in exchange for security. This is a trade we gladly make to preserve relationships with customers who expect us to handle their sensitive information with respect and care. Fortunately, modern payment systems are typically quite safe.
6. How Are Transactions Secured?
Where there is money, there will be fraudsters trying to get away with the loot. The internet is massive and data constantly bounces around on different pieces of hardware via highways of digital infrastructure. Often, criminals will try to hijack the data while it’s being transmitted.
Fortunately, there are many steps merchants, cardholders, banks, and other entities can take to reduce the risk of criminal activities.
We’ll dive into this topic in more detail soon if you need to know more about acronyms like TLS, SSL, SIEM, PCI DSS, GLBA, GDPR, FISMA, and more. But for now, it’s worth noting that when shopping for a payment system solution or team of developers to help modify what you have, security is an essential component.
The Wrap Up
We covered a lot here, but we just skimmed the surface. We love this topic because it’s our specialty and it’s important.
Modern payment systems simplify purchases for customers in a world where money is invisible and everything rides on how you handle the data. You may find yourself in a situation where you’re choosing between a custom payment system or an out-of-the-box payment system, depending on your business needs and goals.
It’s worth a hard look, because as business models change and relationships with customers evolve alongside the internet, out-of-the-box payment solutions often fall short of meeting many companies’ need for more flexible, custom payment platforms.
Whichever you choose, Clear Function is always here to lend a hand. Book a call with us at a time that works for you and we’d be happy to help.