The way businesses accept payments is changing rapidly. With the explosion of e-commerce and digital payments, mobile payment transactions alone are expected to surpass $10 trillion by 2027. As a result, merchants have more options than ever when choosing a payment processor. One increasingly popular choice is using a third-party processor.

But what exactly are third-party processors, and are they the right choice for your business? In this definitive guide, we'll explain everything you need to know, including:

• What third-party processors are, and how they differ from other payment options
• The benefits and potential drawbacks to consider
• How the third-party processing model works behind the scenes
• An in-depth comparison of top providers
• Key factors to help you decide if a third-party processor is right for your needs

Let's dive in.

What Are Third-Party Payment Processors?

At the most basic level, a third-party payment processor is a service that allows businesses to accept credit card and digital payments without setting up their own merchant account.

Traditionally, for a business to accept card payments, they would need to establish a merchant account with an acquiring bank. Setting up a merchant account involves an extensive application and underwriting process and usually comes with various fees.

Third-party processors provide an alternative to this model. Instead of the merchant having their own dedicated account, the third-party processor aggregates payments from multiple merchants into a single merchant account. The processor then handles the distribution of funds to each individual business's bank account.

Some key characteristics of third-party payment processors include:

• Allow merchants to outsource payment processing through a payment gateway
• Manage PCI compliance and other regulatory requirements
• Aggregate payments from multiple merchants into pooled accounts
• Often have more straightforward pricing and faster setup than dedicated merchant accounts

So, in essence, third-party processors act as middlemen between the merchant and the acquirer. This allows even very small businesses and sole proprietors to accept credit and debit card payments without jumping through the hoops of setting up their own merchant accounts.

How Third-Party Payment Processors Work

Now that we've defined third-party processors, let's look at how they function. What happens behind the scenes when a customer makes a purchase using a third-party processor? Let's break it down step-by-step.

1. The customer initiates a payment by providing their credit card details on the merchant's website or app.
2. The payment information is securely transmitted to the third-party processor's system.
3. The processor captures the payment details and sends them to the customer's issuing bank through the card networks.
4. The issuing bank verifies that the customer has sufficient funds and approves (or declines) the transaction.
5. The processor receives the response from the issuing bank and relays it back to the merchant. If approved, the merchant can then complete the sale.
6. The funds are transferred from the customer's account to the third-party processor's pooled merchant account.
7. The processor then deposits the appropriate amount (minus their fees) into the individual merchant's bank account, usually within 1-2 business days.

This is similar to how the process works with a traditional merchant account, but with one key difference. With a regular merchant account, the business owner has their own dedicated account with the acquirer. The funds move from the customer's bank, through the card network, to this dedicated merchant account, and finally to the business owner's operating bank account.

With a third-party payment provider, the merchant account is shared among multiple businesses. The processor aggregates payments into this shared account before distributing the funds to each individual merchant.

Benefits of Using Third-Party Payment Processors

So why do so many businesses choose to work with third-party processors? Several key benefits make them attractive, especially for smaller businesses and startups.

Speed and simplicity

Most third-party processors can have you up and running within a day or two. Compare this to a traditional merchant account's lengthy application and underwriting process, which can take weeks.

No long-term contracts

With a third-party processor, you typically pay on a month-to-month basis with no long-term commitments or cancellation fees. This flexibility can be especially valuable for seasonal businesses or those just starting out.

Simplified pricing

Third-party processors often have very straightforward flat-rate pricing models. You pay a set fee per transaction, usually around 2.9% + $0.30, regardless of the type of card used. This can be easier for businesses to understand and budget for compared to the more complex interchange-plus pricing many merchant account providers use.

Predictable costs

With flat-rate pricing, there are usually no separate fees for things like chargebacks, PCI compliance, or account maintenance. Some processors charge for additional services like invoicing or recurring billing, which are generally optional.

Multichannel support

Most third-party payment service providers support payments across multiple channels, including online, in-app, and in-person. This can be helpful for businesses that sell through multiple avenues and want to use a single provider.

Potential Drawbacks to Consider

While the benefits are significant, using a third-party processor isn't the right choice for every business. There are some potential downsides to keep in mind.

Higher transaction fees

That simple flat-rate pricing comes at a cost. Third-party processors' rates are usually higher than what you'd pay with a dedicated merchant account, especially for card-present transactions. For businesses with high transaction volumes, even a small difference in rates can add to significant costs over time.

Account stability risks

When you use third-party payment processing, you trust them with your ability to accept customer payments. If the processor decides to freeze or terminate your account due to suspected fraud or violation of their terms of service, you could suddenly be unable to process any credit card payments. While this is relatively rare, businesses that are considered high-risk, such as those in the adult entertainment or gambling industries, may have a harder time getting approved by third-party processors.

Customization limitations

Third-party processors are designed to work for a wide range of businesses right out of the box. This means there's often less room for customization than a dedicated merchant account. Businesses with very specific needs, like the ability to store card information on file for recurring billing or support for certain alternative payment methods, may find the options from third-party processors limiting.

Comparing Popular Third Party Processors

With dozens of providers available to process payments, how do you know which one to choose? While many of the core features are similar, the major providers have some key differences. Here's an overview of three of the most popular options.

PayPal

As one of the pioneers of online payment processing services, PayPal is a familiar name to many consumers. They offer a suite of business services, including online and in-person payment processing.

• Rates start at 2.9% + $0.30 per online transaction
• In-person rates of 2.7% for card swipes and 3.5% + $0.15 for keyed transactions
• Includes invoicing, recurring billing, and donation acceptance at no extra charge
• Integrates with a wide variety of shopping carts and business software
• Trusted by consumers, with 361 million active accounts worldwide

PayPal can be a good choice for small to medium-sized businesses, especially those just starting out with online sales. Brand recognition and trust can help boost conversion rates. However, account stability issues seem to be more common with PayPal than with some other providers.

Stripe

Due to their powerful and flexible APIs, Stripe has quickly become a favorite of developers and tech-savvy businesses. They offer a wide range of features and customization options.

• Online rates of 2.9% + $0.30 per successful card charge
• Additional products available like Stripe Terminal for in-person payments, Stripe Billing for subscriptions, and Stripe Connect for marketplaces
• Excellent developer documentation and support
• Predictable flat-rate pricing, but some features incur additional fees
• Customizable checkout and option to store card information for future purchases

Stripe can be an excellent choice for businesses with a strong online presence and more complex payment needs. However, their fees can add up if you utilize a lot of their extra features and add-ons.

Square

Square is best known for its compact card readers that plug into a smartphone or tablet, making them a popular choice for mobile payments and low-volume businesses. They've since expanded to offer a full suite of payment services.

• In-person rates of 2.6% + 10¢ for contactless payments and card swipes
• Online rates of 2.9% + 30¢ per transaction
• Free POS software included with the ability to add more advanced features for a monthly fee
• Wide selection of hardware options, from basic card readers to full POS terminals
• Ideal for businesses with a mix of in-person and online sales, particularly in retail and food service

Square's user-friendly hardware and software make them a top choice for small businesses that need a simple, all-in-one solution. However, their online rates are slightly higher than some competitors.

Making the Choice: Is a Third-Party Processor Right for Your Business?

With an understanding of how third-party payment processors work, their benefits and drawbacks, and some of the top providers, you're well-equipped to decide if this payment model is a good fit for your business. Here are some key factors to consider:

• Your monthly transaction volume: If you process a high volume of transactions each month, usually $10,000 or more, you may save on fees with a dedicated merchant account instead of a third-party processor.
• Your average transaction size: The flat-rate pricing for processing payments can be more cost-effective for businesses with small average tickets. A third-party processor may be the more economical choice if your typical transaction is $20 or less.
• The types of payments you accept: If you rely heavily on card-not-present transactions online, the pricing difference between third-party processors and merchant accounts may be minimal. However, if most of your sales are in-person, you can likely get lower rates with a dedicated merchant account.
• Your business model and industry: High-risk businesses may have a more challenging time getting approved by third-party processors and might be better served by a specialized high-risk merchant service provider. B2B businesses may also find a merchant account's more sophisticated invoicing and reporting capabilities better suited to their needs.
• International sales: If you do business globally, look for a provider that supports multiple currencies and has experience with cross-border transactions. Some third-party processors may have limitations in this area.

In general, third-party payment providers can be an excellent choice for small businesses, startups, and those just starting to accept credit card payments. The easy setup process, pay-as-you-go pricing, and included features like reporting and invoicing make them a convenient, full-service option.

Payment Processing With Zen Payments

As your business grows and your needs change, it's worth periodically re-evaluating your payment processing setup. You may reach a point where the savings from a dedicated merchant account outweigh the simplicity of a third-party processor. Many businesses find that combining the two offers the best mix of convenience and cost-effectiveness.

Regardless of your chosen path, carefully compare your options based on your business needs and transaction patterns. And don't be afraid to negotiate or shop around - with the wide variety of payment processors available today, you have more power than ever to find the right fit for your business.

Ready to get shopping? Start with Zen Payments, a trusted merchant account and service provider. Our experience in e-commerce, retail, and high-risk merchant accounts allows you to get processing quickly. Contact us today to get started.