What is a payment processor?

A Payment processor is an entity that acts as an intermediary between the merchant and the customer's banks (card issuers). It is responsible for transmitting the transaction details from the merchant to the customer's bank and carrying the bank's response (approval or rejection of the transaction) back to the merchant. Payment processors are essential for the validation and authorization of credit or debit card transactions.

In addition, payment processors also handle tasks such as fraud detection, ensuring that transactions are authentic and secure. They are also responsible for compliance with data security standards, such as the Payment Card Industry Data Security Standard (PCI DSS), which are crucial to protect sensitive cardholder data.

How does payment processing work?

Payment processing is a procedure involving several stages and multiple parties to ensure that money securely moves from the buyer to the seller during a transaction. Here's a breakdown of how this process generally works:

1. Transaction initiation 

It all starts when a customer decides to buy something and provides their payment method details. This could be by entering credit card data on an e-commerce website, swiping a card in a physical store, or via a digital payment method.

2. Transaction capture

The customer's payment information is captured at the point of sale (POS) via a credit card terminal, an e-commerce website, a mobile phone, or another type of payment capture device. This information is encrypted to keep it secure and then transmitted to the payment processor.

3. Authorization

The payment processor sends the transaction information to the customer's card issuing bank (i.e., the bank that provided the customer with their credit or debit card). The issuing bank reviews the transaction to verify the card's validity and to make sure the customer has enough funds or credit to cover the transaction. If everything is in order, the issuing bank authorizes the transaction and the purchase amount is reserved from the customer's account.

4. Settlement

At the end of the business day, the merchant will send all authorized transactions back to the payment processor in a batch. The processor sends this batch to the issuing bank to request payment. Once the issuing bank sends the funds, the payment processor then deposits the money from the transactions into the merchant's account. This settlement process can take a couple of days.

5. Payment

Finally, the transaction amount is charged to the customer's account and appears on their statement.

Throughout this process, measures are also taken to detect and prevent fraud, such as verifying the customer's CVV code and billing address. In addition, all parties involved in payment processing must comply with the Payment Card Industry Data Security Standards (PCI DSS) to protect the customer's payment information.

What does the cost of payment processing include?

The cost of payment processing is made up of several fees that merchants must pay to be able to accept credit or debit card payments and other electronic payment methods. The specific components of the cost can vary depending on the payment service provider or payment processor chosen by the merchant, but common elements may include the following:

• Interchange fees: These are fees that the card-issuing bank charges for each transaction. These fees are usually a fixed percentage of the transaction value plus a flat fee per transaction.
• Assessment fees: These are fees that credit card networks (like Visa, MasterCard, Discover, and American Express) charge for using their networks to process transactions.
• Processing fees: These are fees charged by the payment processor or payment service provider for their services. These fees can include a fee per transaction, as well as monthly or annual fees.
• Authorization fees: Some processors charge a fee for each transaction authorization attempt, regardless of whether the transaction is approved or rejected.
• PCI compliance fees: Some payment processors may charge fees for compliance with the Payment Card Industry Data Security Standards (PCI DSS).
• Chargeback and refund fees: These are fees that merchants must pay if a customer requests a chargeback or if a refund is made.
• Point of sale (POS) terminal fees: Some processors charge for the hardware or software needed to accept card payments at a physical location.

It's important for merchants to carefully read their contracts with payment processors and payment service providers to understand all fees associated with payment processing. Merchants should also consider these fees when comparing different processors and payment service providers to find the most cost-effective option for their business.