Introduction to the World of Digital Payments
The world of digital payments can be daunting to the uninitiated. While there are many solutions available today that make it easy to add payment options to a website or create a storefront, these setups are typically aimed at smaller merchants. The needs of large enterprise merchants and companies active internationally go far beyond simply allowing customers to add products to a cart and accepting payment. In this article, we will cover the basic life cycle of a typical transaction.
Being able to accept payments online requires integrating a payments solution. Small merchants may find that an off-the-shelf integration from a single provider is sufficient for their needs. There are numerous ready-to-go solutions designed to be easy to add to a website as well as hosted storefronts that eliminate the need for a separate website and corresponding infrastructure.
Larger merchants, especially those operating internationally, have more complex requirements that go beyond the simple ability to accept online payments. These can include the need for accounting at the regional or country level, the ability to offer preferred payment methods for different regions (e.g. SEPA in Europe, AliPay in China) or fallback options in case a PSP is unavailable. A payment orchestration platform like IXOPAY offers numerous features designed to help large merchants tackle these challenges, such as smart transaction routing, dynamic method selection for hosted payment pages and cascading.
How Online Transactions Work
Online transactions involve multiple parties who all need to work together to ensure a seamless checkout experience. An online transaction starts with a buyer (the consumer) and seller (the merchant). The consumer adds items to their cart and then proceeds to the checkout - either on the merchant’s website or a hosted service. After choosing a payment method (e.g. credit card, bank transfer or PayPal) and confirming the purchase, additional parties become involved in processing the transaction. We will assume the consumer has chosen to pay by credit card as we look at the transaction flow, but a similar process applies to other payment methods as well. We will also assume that a payment service provider is being used, although other setups are possible.
The first player to become involved is the merchant’s payment service provider (PSP). The merchant passes on the payment information (amount, currency, customer details etc.) to their PSP for processing. The first step in processing the transaction is to authorize it. This step involves checking that the payment details are correct and the customer has enough funds to cover the cost of the transaction.
In order to authorize the transaction, the PSP contacts the merchant’s acquiring bank. This is the bank that will receive the funds once the transaction is complete. However, the transaction needs to be authorized by the customer’s bank, referred to as the issuing bank or issuer (the bank that issued the credit card). The acquiring bank (or acquirer) therefore submits an authorization request to the issuer.
The issuer verifies that the card details are correct and that the customer has sufficient funds, as well as analyzing the transaction for possible signs of fraud. If there are no issues with the transaction, it is authorized; otherwise the transaction is declined. This response is then passed back along the same chain until it arrives back at the merchant. At this point, no funds have been transferred. Instead, a hold is placed on the transaction amount on the customer’s credit card, reducing their credit limit by the same amount.
The actual transfer of funds takes place during the settlement process, which can happen at various intervals, e.g. daily or weekly. The PSP used to process the transaction deducts any processing fees from the transaction amount and deposits the remainder in the merchant’s account.
Beyond Credit Cards: Alternative Payment Methods
The first payment method for online transactions that comes to mind for many is the credit card. There are however many other payment methods that have gained in popularity as e-commerce has grown. These include digital wallets (e.g. Venmo, PayPal, Apple Pay), prepaid cards, bank transfers and cryptocurrency payments. These methods are collectively known as alternative payment methods, or APMs.
Different APMs are popular in different countries and regions. For example, WeChat Pay is a popular payment method in China, whereas PayPal is more popular in Europe. This means that merchants operating globally want to offer APMs based on the geographic region the consumer is located in. Access to credit cards and bank accounts can be difficult in some regions; according to the Paypers Cross-Border Payments and Ecommerce Report 2022-23, 1.7 billion people worldwide do not have access to bank accounts. Offering alternative regional payment methods is key to making sales in these regions.
While APMs may have an impact on the transaction flow described above - a digital wallet already loaded with funds does not need authorization from the consumer’s bank, but only from the digital wallet’s vendor - the basic principles are the same. The transaction still needs to be authorized, the consumer still needs to be debited the transaction amount and the funds still need to be transferred to the merchant’s account.
Settlement and Reconciliation
Accepting payments and implementing a checkout process is what allows a consumer to complete a purchase. For merchants however, the transaction does not end once the consumer has completed the checkout process. The merchant still needs to receive the funds (minus any processing fees) and verify the amounts received alongside any other accounting processes.
Reconciliation is the process by which merchants verify that the amounts received correspond to the expected payment. Payment service providers will provide merchants with reconciliation data, though the time taken to provide this information and the format and granularity will differ between providers. Automating the reconciliation process requires information on the transaction fees and transaction data to be stored by the merchant, so as to identify discrepancies and missing transactions in the reconciliation data. As each provider uses a different format for these reports, processing them represents another challenge for larger merchants that have integrated multiple PSPs (called a multi-acquirer setup).
The process of transferring funds takes some time to complete, depending on the provider and terms of the contract. Once the funds have been deposited in the merchant’s account, the provider will include this information in a settlement report. This data will again be compared to the expected values stored in the merchant’s transaction database. As with reconciliation data, the format of the settlement statements differs between providers, posing a challenge for merchants with multi-acquirer setups.
The final stage in the process is to transfer the transaction data to other systems, such as the merchant’s ERP system. The data will need to be translated into a format that is compatible with the target system.
Multi-acquirer setups will benefit most from a payment orchestration platform like IXOPAY in this regard. IXOPAY takes the various disparate formats supplied by various providers and unifies them within the platform, providing a consolidated view of all reconciliation and settlement data across all providers. The data from various providers can also be exported from IXOPAY in a single data format that can be imported into external systems. This eliminates the need for merchants with multi-acquirer setups to individually transform the different data formats supplied by each provider into one that is suitable for the target system. Instead, only a single export format needs to be defined in IXOPAY, vastly simplifying this process.
Beyond The Basics
Merchants face a number of other challenges that go beyond the need to offer various payment methods and handle reconciliation and settlement data. Complex setups involving multiple regions and local payment providers naturally bring a greater number of challenges than a basic setup with a single provider. In a later article, we will look at these challenges and potential solutions in more detail. If you want to be notified of future articles and keep abreast of developments in the world of payments, subscribe to our monthly newsletter.
IXOPAY is a payments orchestration platform enabling independent, flexible and global payment processing. As a highly scalable and PCI-DSS certified “fintech enabler”, IXOPAY fulfills the needs of large merchants as well as those of “white label” clients: payment service providers (PSPs), acquirers and independent sales organizations (ISOs). The modern, easily extendable architecture offers smart transaction routing & cascading, state-of-the-art risk & fraud management, fully automated reconciliation and settlements processing, comprehensive reporting as well as plugin-based integration of acquirers, payment service providers and alternative payment methods (APMs).
IXOPAY is part of the IXOLIT Group, founded in Vienna, Austria in 2001. With local entities in Austria and the USA, IXOLIT supports national and international customers across various industry verticals. The owner-led and -financed company has grown from 2 to more than 80 employees and is focused on building innovative solutions for eCommerce.
Please find more information about IXOPAY here: https://www.ixopay.com