A merchant service provider is not simply a business that provides a service. Well, it is, but, it’s a business that provides specific services to other businesses so that they can collect payment for their products and services from their customers.
First, let’s clarify who a merchant is: it’s you, the business owner. For a long time, “merchant” described someone in the business of buying and selling goods for profit.
That’s still the nature of such pursuits today. These days, “business owner” is a more common term. But “merchant” is still a term in the payment processing industry that refers to business owners accepting payments.
That said, “merchant” could include a business owner providing services, and not just one selling goods. Whatever they’re doing, they’re collecting payments via debit and credit cards. To payment processors or merchant service providers, merchants are restaurateurs, shop owners, and even lawyers.
Types of Merchants: Retail and Wholesale
Retail merchants sell items they purchase from manufacturers. Target and Walmart are large, recognizable examples of retail merchants. But they are just one part of the one million (plus) retail merchants across the United States.
Think of some of the local chains or small business owners in your own community. A shoe store, a bookstore, and a supermarket are all examples of retail merchants.
Wholesale merchants sell items to retail merchants. Some wholesale merchants are manufacturers themselves, selling directly to consumers. Think of car companies selling vehicles to local dealers, or Ralph Lauren selling apparel to Macy’s.
Some wholesale retailers are not manufacturers themselves. For example, chains like Smart & Final sell equipment to restaurants. Office Depot sells office supplies to professional service providers and educators.
Where exactly Costco fits into this scheme is a matter of much internet debate. While some Costco shoppers are business owners, many are just consumers looking for lots and lots of toilet paper.
Types of Merchants: Affiliate, DTC, and eCommerce
Next on the list is affiliate merchants. These merchants use networks to sell goods, often arranged in a multi-level marketing (MLM) structure. In this arrangement, a salesperson will build a team under them.
Ideally, they tap people who have used the product themselves and seen success with it. Beauty products, diet products, and healthcare supplements are a few common items that affiliate merchants may peddle.
And then there are direct-to-consumer or DTC merchants, who sell what they make directly to consumers. Think of artists and other creative types who are selling their creations on Etsy or similar marketplaces. But DTC merchants also include manufacturers who sell their products directly to consumers, without a middleman.
After that, we have eCommerce merchants. These merchants sell goods (sometimes services) online. There are over 9 million such merchants around the world and 2.5 million in the United States alone. That means roughly 1% of the adult population of the United States is selling something online.
Merchant Category Codes
You might be wondering where services and food fit into all of this. Bundeled into their own categories are food services, which include retail food services and catering services. And other service providers are not—in everyday parlance—called merchants. But (as mentioned), to payment processors, banks, and card networks, they are.
In fact, there are actually hundreds of categories of merchants, as defined by these financial institutions. Card networks like Visa and Mastercard assign each business an MCC or merchant category code into which it best fits. The MCC is based on the business’s own description of its primary activities.
Some of these merchants are corporations, others are LLCs, and some are even sole proprietorships. No matter what structure a business has, or what they’re selling, if they’re taking payments, they are a merchant.
So What is a Merchant Services Provider?
This brings us now to merchant account providers and merchant service providers. The two terms have been interchangeable in common speech, but technically speaking, they are different.
Merchant account providers typically help businesses set up accepting credit and debit cards. But that’s about as far as it goes. Merchant service providers, in addition to credit card processing, provide lots of other services.
These services include (but are not limited to) different:
- point-of-sale terminals
- gateway integrations
- consumer-facing financing
- loans for your business
Some merchant service providers also provide banking services themselves, and ATMs and servicing. You might find it surprising to learn how much your merchant services provider actually does.
The main thing merchant service providers do is accept credit, debit, and other types of electronic payments. In brick-and-mortar settings, a POS or point-of-sale system can accomplished this. In online settings, a virtual payment gateway would do the trick.
Merchant service providers may sell or lease you the hardware needed for collecting payments. The good news about this in-house purveyance of hardware is that they also service the software.
There is a multiplicity of payment methods that consumers can use without cash. In addition to the fact that debit and credit cards are different, there are different ways for a customer to tender payment. To elaborate, debit links directly to the customer’s bank. While credit cards link directly to their line of approved credit from a financier.
In times past, the main method was swiping the magnetic strip of the card through the POS. But by 2030, magnetic strips will have disappeared from cards. EMV chips and contactless, and mobile payments are the main ways that consumers pay today. But there are also mobile wallets, where consumers can store card data in their smartphones, and wave them over the POS at the time of payment.
As such, POS devices are always needing an upgrade. As payment methods have changed, merchants may experience a lack in functionality with older POS devices. Which means they will have to upgrade to newer devices. Thankfully, a merchant services provider can lease or sell you the devices and provide a service contract to keep them going.
It’s good to work with a merchant services provider that manages all ends of the payment process, including the devices themselves. This minimizes the amount of headache you have to go through if you have a problem with the hardware or software. This is because you can discuss all troubleshooting with the same person.
But merchant services don’t stop there. They can also integrate payment terminals and the software that animates them with other types of back-end services to run your business. And sometimes merchant service providers will also provide these services.
Analytics: The Nuts and Bolts
When a merchant services provider helps you accept debit and credit cards, they can also provide data-driven insights. Merchants can pull these insights from the credit card terminal itself (and the virtual terminal for online sales) to assess customer behaviors and study inventory patterns.
There’s a reason that more than 97% of businesses are investing in data. Companies that use data solutions to study consumer spending habits have increased their profits by around 8% and reduced their costs by 10%. But wait…there’s more: retailers (specifically) can use data to increase their operating margin by as much as 60%.
Conducting this kind of study is impossible without technology, even if you pay someone full-time to do it manually. Your payment processor may offer or be able to integrate with software that tracks every purchase. Providing you insights that can help with decision making.\
What Can You Do With Insights?
For instance, your merchant processing insights might tell you that customers are flocking to buy a certain item on Thursdays. You might choose to rotate this item to the back of your store. Since it’s so popular already, pushing less popular items to the front will create better exposure. Or, you might build on the popularity of that item by giving it a prominent display and ordering more.
The insights from your merchant processing might tell you that customers are often pairing one item with certain other items. Since a profitable trend is clear, you might choose to display these two items tougher and boost your sales. This is a practice Amazon and other internet vendors have used to increase the order size of online transactions. They will display “people also bought” at checkout, or upselling (as it’s called in sales).
Big data is the key to turning these insights into profitable actions. But you can’t get the amount of data you need, or the level of nuance it can provide, without technology. And the technology used to collect that data—for sales and inventory management—is at the point of sale.
Buy Now, Pay Later
Extending credit is far older than the idea of a payment service to accept credit cards. But fintech (financial technology) has evolved into a new form of installment loans or installment payments called BNPL. This consumer-facing purchase option is typically offered by lending and tech companies like Klarna, Afterpay, and Affirm.
At the point of sale, customers can choose to split their payment into a more manageable segment. This is different from the traditional installment payments that many types of businesses have been leveraging for years. Furniture stores are a great example. With BNPL, the lending institution pays the merchant off in full. Then the customer owes the lender their monthly (or periodic) installment. Sort of like a mortgage for your Amazon shopping spree.
These BNPL options have been shown to drive consumer spending. Around 56% of consumers prefer BNPL to credit cards because they offer more flexibility and lower payments. Most BNPL platforms do not charge consumers interest. And around 33% of polled consumers use BNPL because the approval process is easy. It typically involves just putting in a few pieces of information that the merchant may already have on file. This can include items such as name, address, and email.
But merchants will shoulder the bill for using third-party BNPL integrations, even if they help them capture sales. The Afterpay processing fee is a whopping 6% + $0.30 for each transaction.
Klarna charges up to 5.99% + $0.30, which is essentially the same as Afterpay (although it can go down to 3.29%). Affirm also charges up to 3%. The idea is that merchants will make up for these losses with increased sales.
Merchant Services to Facilitate BNPL
But a better way to go for many businesses is to have your merchant services provider conduct point-of-sale loans or POS loans. These loans can be set up to pay you off for the purchase within a few days (or even a day) and the customer will then owe their payments to your payment processor. The loan itself will either be repackaged and presented as if it’s offered by the payment processor, or presented as a third-party lender to the customer at the point of sale.
Having your merchant services provider screen, manage, and service these loans can save you a significant amount in transaction fees charged by big-name lenders like PayPal, Affirm, Afterpay, and Klarna.
Merchant Cash Advance
A merchant services provider can provide you (the business owner) with loans as well, specifically a merchant cash advance. This type of cash advance is different from a normal hard money loan in that repayment is drawn from your sales volume. The payment processor will take a percentage of your sales on a monthly or weekly basis, or draw a fixed amount out of your business bank account.
Either way, you will not have to use cash reserves or drum extra money to repay the advance, because your sales volume is factored into its origination. In fact, only businesses that have merchant services credit card processing can obtain a merchant cash advance, because card sales are used to gauge your ability to repay the loan.
Outside parties that do not have an ongoing relationship with you will likely offer less favorable rates than your own merchant processor. As they don’t have a relationship to maintain, they will care more about the interest rate than about how comfortable you can repay the advance. By contrast, since your merchant services provider has a vested interest in retaining your business, they will originate a better quality advance that can adequately match your ability to repay.
Merchant Services Include ATM Machines
Merchant service providers can also provide you with ATM fees. If you have a business that needs to run on cash (at least partially) an ATM can bridge the gap between you and the customers who aren’t carrying cash. Arcades, laundromats, batting cages, and other coin-and/or cash-operated businesses with legacy equipment may benefit from a well-placed ATM (and perhaps a coin or change machine to complement it).
Online Merchant Services
On the other end of the spectrum, merchant service providers can provide and service online payment gateways. These will differ from payment gateways that redirect customers to a secondary website, in that they can be smoothly integrated with your website. This results in a better customer experience and more sales, as internet shoppers are likely to abandon their shopping carts if the checkout process becomes cumbersome.
Online payments are subject to more fraud than card-present transactions made in front of you. For these reasons, online payment gateways require extra fraud monitoring and proactive security measures such as proxy-piercing (to make a long story short, a method of detecting where a payment is being made).
Paying for, installing, servicing, and maintaining these software components can be time-consuming and costly, especially from the security end. Working with a merchant services provider can take these costs and this headache off your shoulders.
Recurring Payments for Subscriptions
Some merchants have a business model based on recurring billing. This might include a monthly fee for access to a cloud-based platform (think of Salesforce in terms of B2B and Netflix in terms of B2C). It might also include the delivery of tangible products like food, supplements, or bespoke niche gifts.
To collect payment for subscription business models, you need the right payment gateway and the right way of securely storing customer information. A merchant services provider can assist you in collecting payment details from customers, and securely storing them while meeting compliance standards.
Small business merchant services also include PCI Compliance or Payment Card Industry Compliance. This is a set of operational standards around collecting and storing customer payment information securely. There are 12 key requirements, 78 sub-requirements, 400 test procedures, and a partridge in a pear tree.
These requirements are set by the PCI Council, and known as the PCI DSS or Data Security Standards. They include (1) implementing firewalls, (2) password protection, (3) protection of cardholder data, (4) encryption of transmitted data, (5) antivirus software, (6) software updates regularly, and other measures that cost time and money to implement.
Gone are the days of rubbing an imprint of embossed card numbers on carbon paper. Today’s criminals don’t need to get their hands on any physical forms of stored data. They can just use sophisticated online tools like so-called trojan horse malware to enter a business through the backdoor.
For instance, in 2013, criminals tricked an HVAC employee into clicking on a phishing email, which gave them a backdoor into Target’s servers, where they appropriated the details of 40 million credit cards, and presumably purchased a lot of pizza.
PCI compliance is expensive. For example, an audit alone can cost up to $15,000 or more. Then there is the cost of maintaining an IT expert or team of experts to constantly monitor the security of your data.
If you want to eliminate tens or even hundreds of dollars from your payroll and your operating expenses, you can outsource PCI compliance to debit and credit merchant services. As they service other merchants in addition to you, they will be able to bundle the cost of PCI compliance into their fees, saving you lots of money.
Invoice Management and Accounting
Your merchant services provider may also offer invoicing software for your B2B transactions, or if your end clients are invoiced for services rendered. These invoices may have different payment terms than those typically presented to consumers, such as Net-30, or 2/10 Net-30 (where the client can get a 2% discount if the invoice is paid in 10 days).
Wholesalers can also benefit from invoicing software since pretty much all their transactions will be B2B, and many of the merchants they work with will prefer Net-30 to COD (cash on delivery). Even if you like cash on delivery (who doesn’t) offering Net-30 pricing will greatly expand your business footprint, as most consumer-facing retailers prefer the convenience it affords.
The invoicing software, or even the consumer-facing payment processing hardware and software, may integrate with accounting suites and inventory management software. This type of integration can streamline and nearly automate the process of responding to sales on the back end. But it’s impossible without the right technology to integrate the two software. A merchant services provider can facilitate that backend connection.
Merchant Services Pricing
Of course, merchant service providers do charge fees for helping you accept payments and providing ancillary services around that. But there are different pricing plans for merchant services: flat-rate, interchange-plus, direct-interchange, and tiered rates.
First, a brief overview of the different fees in the payment processing landscape is in order. The overall fee that a payment processor charges a merchant is called the merchant discount rate. This rate includes the interchange fees and assessment fees charged by the card networks and the acquiring bank (your bank).
Card networks have a very nuanced fee structure based on several factors, but generally speaking VISA charges 1.29% to 2.54%, Mastercard charges 1.29% to 2.64%, Discover charges 1.53% to 2.53%, and American Express charges 1.58% to 3.3%. In addition to these, there may be fees that your own merchant bank charges to accept payments and settle cash.
How Merchant Accounts Work: Pricing Models
Flat rate pricing is usually acceptable for businesses that have a low sales volume, such as businesses that just got started. This is a fixed percentage that’s applied to each sale. It’s a quick and easy pricing model that’s easy to set up, which is probably why big-name processors offer it—like Shopify and Venmo. The downside to this pricing model is that once your sales volume increases, the flat rate pricing will not benefit your margin as much as a more nuanced pricing model.
Interchange-plus pricing takes the interchange and assessment fees charged by each card network (Visa, Mastercard, American Express, and Discover) and adds a markup from the payment processor. Card networks actually have very nuanced pricing based on the type of transaction that occurs, such as card-present, card-not-present, credit, or debit.
This type of pricing structure is often best for businesses with a substantial sales volume because there is no flat rate adding padding onto lower fees. For instance, a card-present debit transaction (with a PIN input) has a much lower fee than a card-not-present credit card transaction—but you wouldn’t know the difference if you’re being charged a flat rate.
Direct interchange may benefit some merchants with high sales volume. In this pricing model, the payment processor charges a flat monthly fee and does not add any markup to the fees charged by the card networks and banks. There may also be pricing models where the direct-interchange monthly fee includes card interchange and assessment fees. However, for many small and midsize businesses, this may not be an advantageous fee scheme, especially during a low-volume month.
Tiered Pricing and its Problems
Tiered rates apply different groups (tiers) to different types of transactions: qualified, mid-qualified, and non-qualified. These tiers have more to do with the type of card than anything else. The qualified tier has the lowest rate of all and comprises debit cards and non-rewards credit cards.
Mid-qualified rates apply to reward cards and keyed-in payments (where the merchant codes are in the information). And lastly, non-qualified tiered cards include corporate cards, international cards, and card-not-present transactions.
The problem with tiered pricing is that you won’t have control over how transactions are charged. Part of this issue is that the merchant can recategorize the tiers, which makes for some inconsistency.
Tiered pricing often ends up being very costly for merchants because some of the most common transactions fall into the most expensive categories—for example, card-not-present transactions, which include online purchases.
Some payment processors, especially payment processing services managed by banks, like tiered pricing because it does a better job of covering their risk in terms of fraud and chargebacks. But for merchants, tiered pricing can be disadvantageous.
Remember there may be other fees in the landscape of taking payments: account fees, minimum processing fees, statement fees, setup fees, chargeback fees, NSF fees (fees for when customers have insufficient funds), and termination fees. It goes without saying that you should get transparent disclosure from your potential merchant services provider about what they charge for and how much.
Opening a Merchant Account
Merchant service providers allow you to take cashless payments, but they can also provide other ancillary services. However, in conclusion, we should add that one of the most important considerations is customer service. You want to work with a merchant services provider who will pick up the phone when you call, or reply to your emails.
As a business owner, you know that challenges are just part of running a business. And some of those challenges will include payment processing, accounting, inventory, or the software that unites them all. Large, monolithic merchant service providers like PayPal and Square are notoriously poor on the customer service end, as well as having one-size-fits-none pricing.
If you’re looking for the best merchant services provider for your business, I urge you to check out ECS payments. We pride ourselves on being a merchant services provider with a full range of services and dedication to our customer base, merchants like you. Give us a call or contact us via the form below to learn about which merchant services we could provide for your business.