In today's article, Matthieu our colleague from ProcessOut, who's a payment expert will help you understand how the payment process works in the e-commerce industry and will give you a guide on how to make payment a growth lever for your e-commerce store.
The payment industry is often regarded as a complex and quite opaque ecosystem. For someone who has not been initiated to the payment world, it can be pretty hard to understand who are the different players involved in transaction processing, what are their roles and how the different pricing models are built. In this article, we are going to answer these questions and we will see how you can actually build a payment structure that drives revenue and supports your growth.
Let’s start with the basics. To be able to optimize your payment performance, the first step is obviously to understand how transactions are actually processed. There are multiple players involved in an online transaction to make the money transfer from the customer’s bank account to the merchant’s. There are two steps in the transaction: the Authorization Process and the Settlement Process. During the Authorization Process, the bank of the customer is queried on the capacity of the customer to pay the amount corresponding to the purchase. Note that during the authorization, the transaction’s value is deducted/put on hold from the customer account. The settlement (capture) can be requested up to 7 days later by the merchant. The diagram below presents the different actors and how they cooperate:
What is important to understand is that the communication between the Acquirer and the Issuing Bank is the critical part of the whole process. As a merchant, you obviously want the Issuing Bank to authorize the transaction. We will see later that some Acquirers have better connections with some Issuers, which increases the chances of the transaction being accepted. One of the key KPI of your payment performance is your Authorization Rate (successful transactions / total transaction requests).
Before thinking of any optimization actions, the first thing you have to do is to find the most relevant Payment Service Provider(s) for your business.
Payment Service Providers (PSPs) allow merchants to accept a wide range of Payment Methods, most of the time in several areas.
The services provided by Payment Services Providers mostly differ on:
The first step is thus to analyze your customers, or potential customers, to make the best choice. You also have to take into account your development strategy if you plan to open new markets and to accept payments in more areas in the future.
Broadly speaking, keep in mind that Payment Service Providers are more likely to deliver a good performance with issuers the most represented in their domestic market as they have better technical connections with local issuers than a foreign player. To have more complete information on the parameters to take into account, you can read this article about how to choose your Payment Service Providers.
You can split PSPs into 2 different categories. On one hand, you have historical players of the payment industries: the banks. They will often provide good pricing for acquiring and processing services but they don’t have the agility to provide the best level of user experience or the most features. From our experience, integrating their APIs can be challenging because they tend to be a bit archaic. On the other hand, you have the “new generation” of payment providers. They are focused on their payment service and often provide a more “developer-friendly” integration and easy-to-use dashboards. They will also be more willing to provide good acceptance performance on multiple markets and to better manage cross-border transactions. These newcomers can however be more expensive, as you may assume!
Talk to your industry peers
A good way to gather insights about which Payment Service Providers will meet your expectations is to talk to your counterparts. There are plenty of world-class conferences that bring together all the stakeholders of the industry (payment teams, PSPs, banks...). Among the most famous ones, with several dates per year all around the world: Merchant Payments Ecosystem Conference, Money 2020, Merchant Risk Council. Here is a list of the best events you can go until the end of 2019, you can also check The Paypers.
2 great tools to benchmark the PSPs:
The price you pay to a PSP for processing a transaction can be hard to understand and quite opaque. There are two major kinds of pricing: tiered pricing and interchange pricing.
Tiered pricing is pretty easy to understand. You define with your payment provider what is a standard transaction for your business and each of these transactions will be charged the same way, with, most of the time, a flat fee + a percentage (entry tiered pricing is 2.9% + 0.3cts per transaction in the US and 1.4% + 0.25cts in EU).
Interchange Plus pricing is a bit harder to obtain from a provider and addresses companies with a high or a fast-growing volume of transactions. In a few words, your PSP will take a markup on the fees charged by the other players involved in the transaction. You can read Interchange Plus pricing vs. Tiered pricing to understand ‘who charges what’.
If you want to start optimizing your payments, it’s essential to work with, at least, 2 Payment Service Providers. Some big players in the e-commerce industry are using more than 50. All the idea of payment optimization is to identify some patterns of transactions and to find the best partners to process these different groups of transactions. Apart from a few very specific businesses, it’s impossible that one PSP can deliver very high performance on each of your transaction patterns. Their performance will vary according to the areas, the payment methods, the issuing banks, etc…
Moreover, one of the biggest optimization leverage is the pricing of your providers. Similarly to the technical performance, you can find out which of your providers will charge you less for each kind of transaction.
We’re going to see later that working with multiple providers will allow you to “retry your transactions”, using a third-party provider. It means that if your ‘PSP A’ can’t get the approval from the issuing bank for processing the settlement, a ‘PSP B’ and even a ‘PSP C” may try, maximizing significantly your Authorization Rate.
Depending on your industry, business and transaction parameters, you have to identify what are your most strategic payment KPIs. PSPs give you plenty of data, a good way to analyze this data with relevance is to aggregate it in a single place. Some payment analytics platform will provide this service. At ProcessOut, we have built Telescope this way: an audit and monitoring tool you can start using for free without any technical integration.
Here are 3 examples of KPIs you could start monitoring and improving:
= Successful transactions/total transaction requests
By analyzing your Authorization Rate per country, per card network, per gateway, etc., you will understand which transactions fail and can start to work on it. If you want to go deeper to this topic, you can read Money's on the table, check your Authorization Rates!
This is authorization rate when removing duplicated transactions (automatic retries or users retrying at a later time). It is not easy to compute, but Telescope does it automatically.
= Overall amount of fees paid on transactions/number of transactions
In the same way, you can analyze it in different timeframes, according to your different PSPs, the amount of the transactions, etc… And start to think which patterns of transaction you should process with which PSP.
= Number of chargebacks/number of transactions
If you’re not familiar with what is a chargeback, you can read what is a chargeback. This KPI helps you identify how much your business is impacted by fraud.
As the payment challenges of companies selling online continue becoming more and more strategic over the years, payment teams have started to do what is called ‘Static Routing’ and ‘Dynamic Routing’ (also named Smart Routing) to improve their payment performance. The global idea is to route your transactions to the PSPs that will deliver the best performance at the lowest price according to their parameters.
The purpose of Static Routing is to define Routing Rules to send your transactions to different payment providers. In practice, Data Teams work with Financial teams to determine these rules according to the strategy and the KPIs the merchant wants to improve.These routing rules could be:
Smart Routing is about using data and algorithms to reach the highest level of performance.
The algorithms will learn from the transactions of the past and from how these transactions have been processed to identify patterns and smartly route transactions to the best processor.
You can find third-party providers, FinTechs that do not actually process the payments but are focused on building the most powerful Smart Routing technology.