It is no secret that the e-commerce business is growing insanely fast these days. According to the estimated value of global retail sales from 2021 onwards, e-commerce retail sales are expected to reach 8.5 trillion U.S. dollars on a global scale by 2025. Such a huge market growth implies a demand for the software infrastructure that will allow accepting payments on their websites.
A Payment Gateway or a Payment Aggregator is a piece of vital infrastructure in the payment process that provides for the transfer of sensitive data from the client and the acquiring bank. The gateway is connected to an API inside e-commerce or payment accepting company. The aggregator charges a Merchant Discount Rate (MDR) on each transaction that goes through it. In this article, we present a full guide to a payment gateway infrastructure and its business model.
Payment gateway: the basics
A payment aggregator is an infrastructure company that provides software on a SaaS (Software as a Service) distribution model. To put it simply, the aggregator is a bridge between the client and the merchant. Its role is to transfer data between the major players involved in transaction processing: the customer, the merchant, the acquiring bank, the issuing bank, and the card network.
Another important point is that the transfer of such sensitive information must be flawless and secure. Ensuring fast speed and security of data transfer is one of the payment aggregator’s main tasks. After checking card information for security, the gateway authorizes a payment.
The operating principle of the payment aggregator proceeds as follows: a person places an order and enters his payment details either directly on the merchant’s website if he is PCI DSS certified, or on the payment aggregator’s page. Then, the aggregator receives them, encrypts sensitive data, and transfers it to the acquiring bank. Afterward, the information goes to the card issuer, followed by the issuing bank, which approves or declines the transaction, and then the message with the approval or rejection goes back to the site.
How payment gateways make money
In simple terms, a payment gateway earns income from each transaction by taking a percentage and/or fixed fee that is called Merchant Discount Rate (MDR). However, it is much more complex than that. To figure out what exactly a MDR is, you need to understand the Card Networks business model since it is the major player in online payments.
Usually, when we talk about Credit Card Networks or Card Issuers, we mean either Visa or Mastercard. Have you ever wondered how they earn on their transactions? The majority of credit and debit cards all over the world are issued by Visa’s or Mastercard’s Network Participating Banks. To use the benefits of, let’s say, Visa, the bank should pay the Network Participation Fee, which is fixed and only paid once. The bank also pays the card network a fee for each transaction made.
Payment aggregators earn money in a similar way. Let’s take a look at the example. To accept payments online, an e-commerce merchant needs payment providers. The services that enable that are the acquiring and the issuing bank, card network, payment processor, and the payment gateway. All of them have a fixed amount fee paid per $1 transaction. The total of these fees is called MDR.
Calculating Transaction Discount Rate
On average, the merchant is charged 1-3% of MDR for each transaction processing. MDR is a general amount of fees that a merchant pays for the transaction processing. Assuming that the whole amount of MDR a merchant should pay is 1,0%, how do we split it? It looks like this:
- 0.35% fee to the card network;
- 0.35% fee to the acquiring bank.
- 0.20% fee to the payment gateway service provider;
- 0.10% fee to the payment orchestration platform;
For instance, a customer makes a $1,000 purchase at the online store by Visa credit card. From this amount, the merchant will pay $3,50 to the card network, $2 to the payment gateway, $1 to the payment orchestration platform, and $3,50 to the acquiring bank. Thus, a merchant would receive 990$ out of 1000$ paid by the customer.
Payment Gateway Business Model
Payment gateways generate most of their revenue from MDR, but the amount of charge varies depending on the mode of transaction. During the payment phase, the client chooses the preferred way to pay for the purchase. Depending on whether the client chooses a credit card or a debit card, an e-wallet, Internet banking, or a prepaid wallet, the MDR charge will differ.
There is also a difference between the business models that the aggregator chooses. For enterprises that make large volumes of transactions, a payment gateway may charge a fixed fee per month in addition to the MDR (although the MDR will be lower in this case). If the payment aggregator has a business model with no fixed fee, the amount of MDR charge is higher.
Additionally, international transactions that involve multiple currencies are charged an extra fee. If the merchant accepts the payment from the client in the same currency that he receives, there is no extra charge. But in case the currency in which the customer pays differs from the one that the merchant receives, there will be an extra conversion fee. Typically, the extra charge is about 1%.
Also, the fee is determined by the country in which the acquiring bank is located and the client’s country. If the client and the bank are located in the same country, the fee is lower. If their countries are different, but they are located within the same region (Europe, for instance), the fee is higher. And, if the client and the acquirer are located on different continents, then the fee will be a lot higher.
A setup fee is one more source of income for the payment gateway. It is a fee that a merchant pays only once for setting up a merchant account. All the costs associated with setting up a merchant account are included in the fee. However, not all payment gateways charge merchants a setup, some aggregators waive it.
Another service a merchant is charged for is the maintenance and support of the gateway. The aggregator charges an annual fee to cover the operational cost and the costs needed to maintain the software, security, and technology of payments, although it is up to the payment gateway providers whether to charge a maintenance fee.
Lastly, there might be an additional charge for InstaPay or One-click Payment. By choosing it as a preferred payment option, the client receives a link for payment in an e-mail or phone number in real-time. Clicking on the link or scanning a QR code, the client pays for the purchase without entering his payment data.
Nowadays, it is impossible for a merchant to accept payments on a website without payment gateways. The business model of a payment gateway is based on the percentage and/or fixed fee that the merchant pays from each transaction. The amount of charge depends on the transaction mode. Therefore, businesses that have ongoing transaction flow generate constant profits for the payment gateway. Additionally, payment gateway providers generate profit from setup and maintenance fees, and extra charges for international and InstaPay/One-click transactions.
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