Ecommerce: What’s a Payment Gateway, and How Do You Know Whether You Need One?

Writing recently about how to choose a shopping cart, I realized that you can’t really talk about carts without talking about payment collection. How do you actually collect your customers’ money? To get your online store to work the way you want, you’ve got to to hack through the whole confusing mish-mash of shopping carts, payment gateways, merchant accounts, and third-party processors. It tends to make people’s heads spin. So, in the interests of sanity, here’s the quick-and-dirty on what’s what with payment processing.

When you buy something in the grocery store, you choose your items, put them in a cart, then check out by getting your stuff run through the scanner and paying the total. The transaction path, the mechanics of transferring the money from your pocket to the store owner’s, is something like this:

In an online store the process is similar. You put your items in a shopping cart, which is actually a bit of software that remembers your items and computes their cost when you’re done. When you check out, instead of a cash register where you fork over your money, there is a “payment gateway.” The gateway sends your money along to the bank, where it goes into an “Internet enabled merchant account,” a business account which is specially configured to receive money from the gateway. With an online store, the transaction path looks like this:

Here, the payment gateway is the conduit between the online shopping cart, and the bank.

Each of these three components is essential in order to process transactions. They’re independent of each other, yet must all work together… or, in Internet parlance, they must be compatible. Sometimes a particular bank sets up their accounts to work with one gateway; sometimes your bank gives you a choice of gateways. So, for example, you could mix and match by selecting one item from each of the three columns below:

This kind of setup works great. You have control over the entire purchase process. There are good fraud protections in place. No one else’s brand goes anywhere on your site, unless you want it to be. So what’s the catch? For many start-up web retailers, the hangup is price.

Sample fees for each component:

If your credit history is poor, or you’re running a business considered “fringe” by banks (astrology readings, energy healing, etc.), or you don’t have much in the way of tangible assets, you’ll rates at the high end of the range. Banks scrutinize this kind of account much as they would a loan. In fact, because of the delay between the computerized transaction and the money actually moving from one place to another, they consider it to be a loan. For a sole proprietor or microbusiness who wants a web store to pay for itself, it’s hard to pony up this kind of bucks before the site has made even a cent.

Third Party Payment Processors

But all is not lost. This is where “third-party payment processors” come into the picture. There are two basic types of payment processors. First, there are the kind who take a percentage of your sales, hold the money and distribute it on a weekly or monthly schedule, sans their percentage. 2checkout.com and ccnow.com are two well-known ones.

The second type of third-party payment processor is what I call the “pseudo-banks,” services like Paypal and Google checkout, which process your transactions, take a smaller percentage of your sales, and hold the money in your account until you withdraw or transfer it. Percentages taken are generally less with this type of account. They can supply a free shopping cart, too.

In either case, the transaction process looks like this:

Both types of processor can supply shopping carts too, so that your entire transaction process is handled, start to finish. Most can handle multiple languages and currencies, and can accept all major credit cards. Additionally, most third-party processors can be used like gateways, that is, you can select your own shopping cart, and you use your own bank account. They simply process the money for you.

Here are comparable costs:

So what’s the catch here? Control. You pay little or nothing in setup costs, and the percentage fees are reasonable. But, your 3^rd-party processor hosts the checkout page, and controls its entire appearance except, perhaps, for the placement of one logo image by you. It may not allow you to process certain types of transactions, like subscriptions, or memberships.

Additionally, there is a 3^rd party interposed between you and your customers. If there’s a transaction issue, people can be aggravated and confused by having more than one party to deal with, whereas with a merchant account, your business is responsible for the entire transaction, so a customer only has to deal with one business entity.

Finally, In the “pseudo-bank” kind of account, However, they tend to require users to already have an account with them, or to sign up for one during the transaction process. This can make for a confusing checkout process, and one that many people will simply skip. And, they are “pseudo-banks,” so generally your money is not insured.

What Should You Do?

If you want to give your customers a seamless purchasing experience from start to finish, a merchant account plus gateway plus cart is the way to go. If you’re on a tight budget, take a look at the reputable third-party processors who have a good track record, a long history of successful payouts, and few online complaints. Make that whatever combination you choose can handle the kind of transaction, and the types of payments, that you need for your business model. And happy selling!

If you’re setting up an online store, read my post on how to choose the best shopping cart for your site.

Tagged as: Ecommerce, merchant account, payment gateway, shopping cart, third-party payment processor, web site, website