Payments 101: Learn the Fundamentals
Gone are the days when a payment transaction was a matter of simply asking and receiving money for a commodity. For global merchants, the payment ecosystem is increasingly becoming more complex, and as payments are shifting towards eCommerce, the challenges and players in this sphere are growing by the day and are not showing any signs of slowing down. Just in the retail segment, global eCommerce sales are expected to reach 16.1% of all retail sales in 2020 and 22% by 2023.
Now that a big chunk of transactions is performed online, merchants need to face new challenges in the execution of transactions e.g. increasingly smaller approval rates, new regulations for the benefit and protection of customers, and transactions that are flagged as fraudulent.
The following article is designed to simplify some basic terms and processes for those dipping their toes in the world of payments. The first section will discuss the journey of a payment transaction while the next section will arm you with some useful terms to help you understand the ins-and-outs of the payment ecosystem.
The Payment Cycle
To the average consumer, when a purchase is made, it seems that the process is instantaneous and straightforward. In reality, behind each transaction lies a complex infrastructure that involves a multitude of players that each has a part in the execution of the payment. The five main players in this flow are:
- Payment Networks/ card schemes
The payment cycle begins with the buyer, that chooses to purchase a commodity for, let’s say, a $100. The moment the buyer presses the confirmation button in its shopping cart, a process of Authorization begins, in which the Merchant forwards a request to the acquirer, and the acquirer, in turn, forwards the request to the card scheme associated with the buyer’s card. The card scheme (visa, Discover, American Express etc.) forwards the request to the issuer and the issuer checks if the cardholder has enough money to pay for the transaction. If all goes well a confirmation is sent back via the different stages until it reaches the merchant who submitted the request in the first place. Then, a Settlement process takes place in which the merchant submits the transaction via all of the channels again until it reaches the cardholder, which is then charged for the money. On its way back to the Merchant’s account, there are multiple processing fees and “cuts” taken from the sum by the different players.
I want to start to receive money. What are the key elements I need to have in my payment stack?
You may have heard of terms such as Gateways, PSPs (payment service providers) and POLs (Payment Orchestration Layer). When kickstarting a business that needs to receive money, you will need to get to know them, and some more personally than others.
The basic and most important thing you will need as a merchant is an acquirer/PSP. The market is filled with acquirers and your choice will rely on the scope of your business, the location(s) in which you operate or plan on operating and your business needs. Some acquirers have better acceptance rates in certain geographical locations than others or with specific banks. It will all come down eventually to your business strategy and logic. If you plan on operating in multiple locations you might need more than one provider to maximize your acceptance rate and customer conversion rate (your customers’ willingness to pay) by offering your target customers their preferred payment methods of choice.
When you have more than one PSP/acquirer, you might need a Gateway to channel the payments to one provider or another. Some acquirers also function as gateways which can add another complexity to the mix.
What about a Payment Switch? Or Payment Orchestration?
The above solutions are more advanced layers that have some of the functionalities of a payment gateway, but their main strength lies in the tools they have to optimize payments (e.g. smart routing/failover rules, data and report generation, and more). These tools become more crucial to hypergrowth merchants or merchants that have an increasingly complex payment stack, as they are an added functionality that – as the name implies – is designed to orchestrate between multiple elements.
You can read more about the functionalities of Payment Orchestration.
Regulations and Fraud prevention
Another aspect merchants need to take into consideration when they start to receive money is the aspect of regulations and the risk of fraud in online transactions. It will not be long before terms such as Tokenization, SCA and PCI-DSS will be popping and require your attention. These regulations are obligatory to merchants and come to both protect customers from card theft and fraud as well as to increase the acceptance rate and make the checkout process smoother and successful. These parameters – even though obligatory – benefit both the customer and the merchant. Learn more about them here.
Your Pocket Payment Glossary
Below you’ll find a summary of essential payment terminology which will be extremely useful for you to always have on-the-go. Some terms are basic and define processes and players, while others refer to slightly more complicated acronyms, which you’ll encounter sooner or later:
- Alternative Payment Methods (APMs): Alternative payment methods are a new way of paying for goods or services not via cash or major credit card schemes. APMs include prepaid cards, mobile payments, e-wallets, bank transfers, ‘buy now, pay later’ instant financing, and more.
- Acquirers: If a transaction is associated with a credit/debit card, the acquirer connects to the buyer’s issuing bank and requests authorization (after running a risk assessment).
- Batch Processing: A type of data processing and data communications transmission in which related transactions are grouped and transmitted en masse for processing, usually by the same computer and under the same application.
- Card Not Present (CNP): is a payment card transaction made where the cardholder does not or cannot physically present the card for a merchant’s visual examination at the time that an order is given and payment effected, such as for mail-order transactions by mail or fax, or over the telephone or Internet.
- Chargeback: A chargeback – or a reversal – is the return of credit card funds used to make a purchase by the buyer. A chargeback can occur if a consumer disputes a purchase made using their credit card, claiming that it was fraudulent or made without their knowledge or permission. When a buyer disputes a purchase, the credit card company involved reverses the charge, reimbursing the buyer in full and debiting the business’ account.
- Cross-Border Payments: Payments made between accounts in different countries, from the payment system of the country of origin through a gateway operator to the payment system of the country of receipt.
- Gateway: The interface between the payment process and the customer. The gateway connects the payment technology (terminals, shopping carts, etc.) and the issuing bank’s card processing networks.
- Interchange Fees: Fees paid by the acquirer to the issuer as part of the transaction process.
- Issuer/Issuing Bank: An issuer is a financial institution, such as a bank or a credit union, which offers a credit/debit card and is liable for the use of the card. The issuer is also responsible for the billing and collecting of funds for purchases that were made using that card. In the payments value chain, the card issuer pays the acquiring bank for purchases of goods and services made by the cardholder.
- Know your customer (KYC): A common practice that’s become a go-to for financial institutions, credit companies, which require that customers will provide them with detailed information about their business to ensure that they are not involved with corruption, fraud, money laundering, etc.
- Merchant Application Form (MAF): A Merchant Application Form needs to be filled by merchants to be able to process payments. The application involves the information about the organization, the executives along with partners (owners), and personal data about the owner’s business type and information about the account in the financial institution.
- Micropayment: A payment of under $20. These payments are particularly popular for selling information and content online.
- Payment Orchestration Layer (POL): Payment Orchestration Layer is a technological layer designed to consolidate a company’s payment data, facilitate the easy addition of payment providers and functionalities into a company’s payment stack, and allow it to optimize its payment operation with both the payment data and the tools to implement its business strategy.
- Payment Service Provider (PSP): A Payment Service Provider is a third party that provides merchants with the ability to accept electronic payments, enabling connectivity to financial institutions and credit card acquirers.
- PCI DSS (Payment Card Industry Data Security Standards): All entities that store, process, and/or transmit cardholder data are required to adhere to these standards, and they are therefore obligatory for merchants, financial institutions, software developers, processors, etc. These security standards are intended to help ensure the safeguarding of payment card account data.
- Point of Sale (POS): The terminal where the payment takes place (credit card swiping infrastructure). An mPOS is a mobile point of sale, referring to infrastructure that attaches to a mobile device to accept credit card payments.
- Processing: The payment processor receives a response from the acquirer and either process the payment or lets you know it was declined.
- Recurring Payments: A transaction charged to the cardholder (with prior permission) periodically for a variety of goods and services, (e.g. memberships and subscriptions).
- Settlement: As the sales transaction value moves from the merchant to the acquiring bank to the issuer, each party buys and sells the sales ticket. A settlement is what happens when the acquiring bank and the issuer exchange data or funds during that function to complete the transaction.
- Tokenization: A data-security technology that substitutes random numerical sequences for sensitive credit card data in the transaction process so it can be passed over the internet without exposing the data and user identity to cybercriminals.