3rd Party Processing, PayPal and Others

    September 15, 2003

3rd party processing is a service provided by a third party for facilitating a credit card transaction between customer and merchant. Before the Internet, third party processing was seldom used. With the lure of the Internet, small and home businesses going on-line have had to find ways to take credit cards in order to remain competitive.

Rather than going to the expense and hassle of getting a merchant account from an acquiring bank, Internet merchants frequently use a third party to provide the credit card transaction part of their business activity. The third party collects the funds from the customer’s credit card account and at some subsequent time makes them available to the merchant.

There are advantages, disadvantages, and pitfalls to using a third party processor. The major advantage is cost. It’s only reasonable for new on-line merchants, facing an uncertain amount of business activity, to avoid overhead until seeing how things go. Third party processing offers this opportunity. Add to cost the daunting tasks of setting up a financial gateway, providing a customer credit card information form with error checking, implementing secure storage of sensitive information, and integrating all of this with the storefront, and for many new merchants, getting a merchant account isn’t a viable alternative.

Typically, the monthly out of pocket fixed expense with a merchant account will be around $50.00 at the low end and can run to several hundred dollars. This includes statement fees and a gateway charge. In addition, there will be a per transaction fee of about 35 cents and a discount charge on sales of around 2.9%. Make 100 sales for a total of $5,000 each month and your out of pocket cost of taking credit cards will be at least $230. That’s about 5% of sales. You should expect to pay a third party processor a little more because, after all, you’re avoiding all of that nasty administrative and maintenance stuff. A good, reasonably priced, third party processor will make sense on sales up to about $10,000/month and in some cases, much more. It’s common for a merchant to stay with a third party processor even though the business grows beyond the level that would justify getting a merchant account.

The disadvantage of using a third party processor is entirely dependent on the level and quality of service that the processor provides. Every card transaction involves a merchant account at an acquiring bank and a customer’s account at the bank that issued the card. This is no different when using a third party processor; you are using the processor’s merchant account. Before going further though, it’s instructive to review one of the hazards of taking credit cards.

As a card holder you probably know that it’s pretty easy for you to call your bank and question or dispute a charge. If you dispute a charge, for instance you claim the charge wasn’t authorized or you claim the merchandise was never received, was not merchantable, or was misrepresented, and your bank thinks your claim is reasonable, your bank will immediately reverse the charge, deducting the amount from the relevant merchant account before the merchant account owner even knows there is a dispute. This is called a chargeback. The merchant account owner must dispute this claim in order to get their money back. Disputing the claim will require documentation in the form of a purchase order, a shipping invoice, proof of delivery, and possibly product data sheets. If this evidence isn’t forthcoming, the merchant account owner is out the money and a chargeback fee of around $18. On Internet transactions, many banks will not even entertain a dispute response where a claim of “charge not authorized” is made and there was no address verification in the credit card process.

You can probably see where this review is leading. The cards are stacked in the customer’s favor in credit card transactions. If you are processing ten or more orders a month and haven’t had a chargeback yet, over the next ten months you will! It is incumbent on the owner of a merchant account to have available good and complete records of every transaction or else face the consequences of a disputed charge.

This means when you select a third party processor and use their merchant account, you want to be darn sure that they are able to and will dispute claims because you know that they are not going to eat the loss. They’re going to deduct the sales amount and fees from any monies owed to you and possibly freeze your account. You’ll be out the money and the merchandise. If this sounds familiar, you might want to take a second look at your processor. Here are some of the services to look for.

  • Availability of a good and complete record of all credit card transactions
  • Where available, a verification of the address given when taking a customer’s credit card information: This is an automatic service provided by the major financial networks during a card authorization in the US and Canada.
  • A facility for allowing the merchant to respond to chargeback claims or a service that responds for you
  • A virtual terminal on-line where you can make returns related to a credit card charge: This ability can quickly head off potential chargeback claims.
  • A two stage system for processing a credit card: Credit cards are always processed by first obtaining a charge authorization where no monies have yet changed hands. Subsequently, the funds are captured; that is, transferred to the merchant account owner’s account. Capture is usually done on command from the merchant when the order is shipped. The ability to process cards in two stages gives the merchant a chance to look over the order and avoiding charging a credit card for orders not shipped, bogus orders, and orders paid for by an unauthorized use of or a stolen card.

I know of few entrepreneurs and small business owners that don’t find record keeping an enormous waste of time and energy that should be spent on more productive endeavors. Simply put though, maintaining records of any business activity is just a given part of the business environment. If you don’t have your own merchant account, you want to make sure that someone is keeping transaction records for you.

PayPal is a third party processor, albeit indirect, service that I’m sure maintains good transaction records but, doesn’t provide the merchant access to a simple process for resolving claims. In many instances it may be less expensive for PayPal to simply allow a chargeback and deduct the money from your account. Don’t get me wrong; PayPal can be a very good and efficient service when used for the intended purpose: to facilitate a person to person transfer of funds for the occasional sale, where both parties are intent on successfully concluding the transaction. Still today, PayPal remains the lowest out of pocket cost, third party processing services on the Internet. However, one chargeback claim a year can change that out of pocket cost dramatically.

So be sure to look around for a service that best suits your needs and provides access to records essential to a professional business operation. Go to Google and do a search on “3rd party processing”. You’ll find a lot of choices. One group of 3rd party processors will be very expensive because they take high risk subscription accounts such as pornography sites. Some processors will only work with credit card sales for shipped merchandise while others specialize in downloadable products.

Most third party processors will redirect a customer to their own site to make payment on orders. This can impede sales because it confuses the customer who is leery of giving their credit card information to yet another company. Legitimate processors, however, will be very careful about protecting this information and will not use the info to promote other goods and services.

Some third party processors provide a turnkey system that includes the storefront. These processors serve a more general function and are know in the trade as ASPs (Application Service Providers) where third party processing is only one part of their service. Here you can expect tight integration between storefront and payment processing as though you set up the whole system yourself. Your customer won’t be redirected to make payment so you’ll look like any of the big retailers. The disadvantage with an ASP is that you may have limited storefront choices and there will usually be a subscription fee. On the other hand an ASP, because of the tight integration, has the ability to provide much higher levels of service, including a variety of business records, statistical reports, and a virtual terminal for conducting subsequent credit card transactions.

Again, be sure to look around. You want a provider that you can expand your business with while not breaking the bank. This is a growing field of service so you should have no trouble finding someone suitable.

Mel Davey is the creator of ImagineNation (http://imaginenation.com/), a full service E-Commerce Application Service Provider, offering Storefronts, Order Management Utilities, and 3rd party credit card processing.