Merchant account vs. payment gateway

Customers used to queue to purchase their favorite sports shoes or the latest tech products. But things have changed...

As Henry Ford once said:

"We do not make changes for the sake of making them, but we never fail to make change when once it is demonstrated that the new way is better than the old way."

Today, virtually any product or service is just one click away. This is thanks to eCommerce and social media commerce.

It may look easy on the surface. But at the core of each transaction lies a complex payment processing system which relies on many different elements. These include a merchant account and a payment gateway.

In this article, we explore these two elements. We will explain what role each of these elements serve, as well as their main features and their core differences.

What is a merchant account?

A merchant account is a specialized bank account that enables business owners to accept electronic payments, such as debit or credit card payments.

It is used as a holding account where payment information about the transaction is collected and verified.

How does a merchant account work?

When customers pay for goods or services online, or via a point-of-sale system (POS), card processors send the transaction details to a dedicated merchant account.

The provider of the merchant account will then confirm that there are sufficient funds with the customer’s card issuer or bank. These funds will then be sent to the merchant account.

The funds remain in the merchant account for a couple of business days. This is done to verify the transaction’s legitimacy (e.g. check for potential fraud) and conduct risk assessments.

Finally, authorization takes place. The merchant account provider will then transfer the funds to the business bank account.

Benefits of a merchant account

1. Accept electronic payments

Any business that wants to accept electronic payments will need a merchant account. They are the only intermediary between a customer’s bank and the business bank account.

Without a merchant account, transactions would need to be completed via check or direct bank transfer. With one, both main forms of electronic payments can be conducted:

• Card present transactions (via the card itself)
• Card-not-present transactions (e.g., via a digital wallet)

2. Allow international payments and increase sales

Merchant accounts allow business owners to accept customer payments in different currencies. This provides a more convenient payment experience.

And a multi-currency merchant account can expand a business's customer base and increase sales. Meanwhile, customers can see the price of the product or the services they want and pay in their local currency.

3. Streamline cashflow and avoid delays

A business cannot access the funds in its merchant account. However, the authorization of funds happens almost immediately - the money will be transferred to the business bank account within 1-2 business days.

Merchants can use this waiting period for reconciliation purposes. Ensuring that there are no discrepancies or errors in the payment processing and the funds match their sales.

Customers can also use the waiting time to dispute any potential transactions. For example, when money has been taken out of their account, but they do not recognize the payment.

For credit card payments, merchant accounts allow a business owner to receive money from the transaction immediately. There is no waiting for the customer to pay off their credit card bills.

Without this rapid authorization process, a customer would need to rely on checks or direct bank transfers. These can take weeks to process.

Examples of merchant accounts

Merchant accounts usually fall within the following two categories:

• Dedicated merchant accounts: the account provided has established an exclusive merchant account for the business owner.
• Aggregate merchant accounts: the business owner shares the account with other vendors.

What is a payment gateway?

A payment gateway is an interface used to collect, verify and transmit payment information from the customer to the merchant.

Payment gateways also inform the customer and the merchant on whether the transaction has been authorized or declined.

How does a payment gateway work?

After a customer enters their payment information into the checkout of an eCommerce website, the payment gateway takes on the information and starts encrypting it.

A customer can also use a digital wallet or tap the credit/debit card on the POS machines at a retail store.

The payment getaway then sends the encrypted information to the customer’s bank via a payment processor and the card network.

Once the funds have been authorized or declined by the customers’ bank, the payment gateway will inform the merchant and the customer of the outcome.  

What is a 3D Secure (3DS) payment gateway?

A 3D Secure payment gateway is a payment gateway that utilizes the 3D Secure or 3D Secure 2.0 protocol to authorize online transactions.

This type of payment gateway enhances security with an additional encryption layer, particularly useful for merchants processing "card-not-present" payments.

When using this type of gateway for online purchases, cardholders must verify their identity. This is done through methods such as entering a fixed password, a temporary PIN, a one-time password, or employing biometric verification.

Benefits of a payment gateway

1. Maintain data security

Any business operating in the world of eCommerce and online payments will need a payment gateway to verify the validity of a card and ensure the safety of the payment information.

A payment gateway protects the customer payment data through encryption and strict compliance protocols.

Payment gateways follow strict PCI-DSS (‘Payment Card Industry Data Security Standards’) protocols and SSL encryption tools. These protocols protect a buyer’s sensitive account information before it is sent through the customer’s card issuer or bank.

Before being transmitted further, the data is encrypted. This means that the customer’s card information is coded in such a way that makes it difficult for fraudsters to access it.

2. Convenience

When a business integrates a payment getaway, customers can make online purchases, no matter if they are in store or out of store.

Payment gateways also allow customers to pay on the spot, without the need to make further transactions via bank transfers or checks.

Examples of payment gateways

Payment gateways have most commonly been used to accept credit or debit card payments for goods and services through online transactions.

However, modern gateway technology has expanded across multiple sales channels and devices. In addition to card transactions, a gateway can also be used to process payments at a POS system (via QR codes for example) or on a mobile device.

What are the differences between a merchant account and a payment gateway?

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Role in the payment processing system

A payment gateway acts as the interface of the payment processing system, which transmits the payment information (e.g. card details, approval of payment) between the customer and the business.

A merchant account enables the transfer of funds from the customer’s bank to the business owner's bank account. Unlike a traditional business bank account, money cannot be moved in and out of a merchant account. The funds remain in the merchant account until the payment has been approved and verified.  

Integration

Merchant accounts are usually easier to integrate. Business owners can employ a third-party service provider to manage the entire process of the merchant account, including the authorization and transaction of funds.

Payment gateways are also deployed via a third-party provider, but they require an additional type of integration with the merchant’s website. The different types of integration are discussed below.

Should you choose a merchant account or a payment gateway?

You need to incorporate a merchant account and a payment gateway in order to process any electronic payments safely and efficiently.

Without a merchant account, the transaction of funds cannot be finalized. Whereas, without a payment gateway, the transaction of customer data would be at risk.

How to choose a merchant account

Analyze your business needs

A merchant account can be assessed via a bank or a third-party service provider. No matter which option you choose, a merchant account must satisfy your business needs and requirements.

Key considerations include:

• Your transaction volume
• The product or service types you offer
• Revenue streams from either an eCommerce website or a brick-and-mortar store.

Understanding these factors will narrow down merchant account providers that fulfil your business needs.

Some providers are oriented towards a specific industry. Others specialize in a particular transaction type – such as online purchases or retail sales.

eCommerce businesses can also choose a high-risk merchant account, which is tailored for a high percentage of chargebacks and returns.

Consider the main features of the merchant accounts

A business owner should choose a reputable merchant account provider. They will have a strong reputation in the industry and established relationships with major banks and credit card companies.

The provider should also have excellent customer service, in order to handle any potential discrepancies in the payment processing system.

For companies operating internationally, the merchant provider must enable multi-currency transactions and support multiple card types. For example, customers from Europe may use Mastercard, whereas US based customers rely on American Express.

Compare the pricing of the merchant accounts

The pricing of a merchant account can vary, depending on the provider and the specific services offered. The more features a merchant account offers, the higher the price usually tends to be.

Generally, merchants can expect to pay a combination of fees, including transaction fees, monthly fees, and processing rates.

Some payment service providers have started to introduce more transparent and simplified pricing models for merchant accounts. These models often offer flat-rate pricing. Here merchants pay a fixed percentage of each transaction, regardless of the card type or transaction size.

A business owner should analyze all these pricing options and choose the one that is the most suitable to their business needs. They should also be careful about any hidden fees, which could occur in the case of early contractual termination with the payment service provider.

How to choose a payment gateway

Determine your technological capabilities

There are different types of payment processors and gateways, which integrate differently with a merchant’s website. A company should understand the basic features of their website and their compliance abilities.

Below are some of the options available.

Hosted payment gateway

This option is ideal for merchants who do not want to manage the integration and maintenance of the website’s payment gateway.

A hosted payment gateway redirects the customers away from the eCommerce website to introduce their card details and complete the payment on the payment gateway of the service provider.

Self-hosted payment gateway

This option allows merchants to accept payments directly on the eCommerce website site, but the payment information is first encrypted and submitted to the third-party payment gateway for authorization.

API Hosted payment gateway

This option also allows merchants to accept payments directly on their site, but it requires a more complex website development. This is because the entire payment cycle is completed on the merchant’s website (including the authorization). It also involves a higher PCI compliance burden on the merchant.

Local bank integration

This option redirects customers from the merchant site to their online banking portal, where the payment is authorized. This is an entry-level solution that is easy and quick to implement, but it does not help with international payments.

Choose a reliable payment gateway provider

A provider of payment gateways must be reliable and comply with the required PCI and encryption protocols.

Small and medium sized companies can also choose the same payment service provider for the merchant account and the payment gateway. Larger companies may opt for a separate service provider to handle the payment gateway and the merchant account.

Analyze different pricing options

There is no one-size-fits-all fee for payment gateways. This is because multiple payment providers offer this service, each charging different fees.

There is a combination of:

• Initial setup fees
• A flat monthly fee
• A small fee for each transaction

And some may also charge a fraction of each purchase. Each merchant should analyze different options and choose the most convenient one for its business.

Conclusion

Understanding the roles of merchant accounts and payment gateways is crucial for businesses looking to accept electronic payments securely and efficiently.

A merchant account serves as the intermediary for funds transfer between a customer's bank and a business bank account. A payment gateway encrypts and transmits payment information and card details.

Selecting the right merchant account involves considering your business's specific needs. These include the type of transactions you handle and your customers' preferences. Pricing models can vary, so it's essential to compare fees and hidden costs carefully.

Choosing a payment gateway depends on your website's technical capabilities and integration preferences. Whether you opt for a hosted payment gateway vs. a self-hosted solution, reliability and security compliance are paramount.

In both cases, partnering with reputable service providers is key to a smooth payment processing experience. By taking these factors into account, businesses can streamline their operations and offer customers a secure and convenient payment experience.