An Investor’s guide to the ever-changing payment processing landscape.
Spring 2021 Edition.
This topic can become rather long-winded. So if you want the readers-digest version, look for the headings and bolded text. Drill in if you want more.
This afternoon I had a wonderful conversation with a potential investor in our company Whym. When you build something so unique, it’s understandable why investors may need help understanding where it fits in the puzzle.
I’ve not historically been one to pull out my “blogger hat.” However, to this investor’s ultimate credit, they strongly encouraged me to put my knowledge into a blog post because they felt I had taught them valuable information worth sharing. So, by request, let’s walk through the payment processing landscape as it exists today.
Remember. This is a lot to take in. So I’d focus on the headings and bolded text first. Then drill in to specific sections if you want to get deeper.
If you have payments knowledge, you may be more interested in the second half of the article where I talk about “what’s new”.
Let’s start with the layers of the stack that have not changed shape for a very long time. There may be new providers, but they don’t innovate much.
There are two “Banks” in every transaction.
Banks move the money.
When you boil everything else in the stack down, one thing is sure: money needs to move. Banks have been, and always will be, the engine powering the actual movement of funds. Every card in consumer pockets has an “Issuing Bank,” and every payment processing solution (physical or digital) has an “Acquiring Bank.”
But banks make more money when they partner with brands.
Issuing Banks regularly partner with “Issuing Partners” like Amazon or Delta Airlines to create specialty cards with unique benefits. That said, do not be fooled. Banks are still the issuers of these cards. The deals banks make with partner brands are less knowable, but they share profits that can come from a few sources:
- Interest from the credit card loans,
- Membership and other Fees, and
- Interchange fees. (more on this below)
The “Payment Networks” are the glue.
Networks issue card numbers, track fraud, set network rules, and more…
0% of merchants and 0% of consumers work directly with the Payment Network Providers like Visa, MasterCard, or American Express. Yet, these companies power the vast majority of payment transactions that happen today. Every credit card terminal (both physical and digital) carries their logo, and every card you have in your pocket has their logo too. But neither the merchant nor the consumer does direct business with these brands.
These brands compete by building the most extensive (Visa) or the most specialized (American Express) networks of partners worldwide. They issue card numbers, retire old numbers, track fraud, provide security, verify transactions, and operate the linking infrastructure that decides if your payment is valid or not.
Remember, money moves at the banking level. This means networks must build contracts with each partner bank on how they will get paid. I’ve not personally negotiated these deals, but my reading indicates that you can boil down how they get paid to the following:
- Banks pay the networks based on volume processed.
The “Payment Processor” builds the terminal.
The terminal can be physical or digital.
This moment is where some investors become confused. I understand; many banks ALSO offer (poorly implemented) alternatives to famous processor solutions today. An example of how this becomes messy is “Wells Fargo Banking” vs. “Wells Fargo Merchant Services.” The former is the banking arm; the latter is the “Payment Processor” arm.
Square is an excellent example of an innovative (physical) payment processor. They make a credit card terminal that allows your phone to “swipe” a card.
Stripe is another popular (digital) payment processor that offers the digital equivalent. Stripe’s innovation makes it far simpler to process a payment with less compliance headache for merchants online.
Credit card processors must pay their partner Acquiring Bank for each transaction, and they need to make some money themselves. So they charge the merchant a credit card processing fee often referred to as the “interchange fee:"
- On average 2.9% + $0.30.
Banks want a cut of this action and so do the Payment Networks. Processors need to establish deals deciding how much to shave off for each partner.
One little side-note, the Payment Networks call this layer the “ISO”.
The “Payment Application” uses the terminal.
The above-mentioned “processor” can take money, but it can’t explain WHY money needs to move or WHAT is in the order. That’s the job of the “Payment Application.”
The Payment Application is often a messy collection of software (and hardware) that we collectively refer to as the “Payment Application”. You encounter the “Payment Application” in both the physical world and the digital world.
When you “self-checkout” at the grocery store, that big screen in front of you IS THE “Payment Application,” and the little credit card terminal plugged into the side IS THE “Payment Processor” terminal.
On the web, this software is a bit more complicated. The user ultimately sees a “checkout experience” that shows them the items in their order, the sales tax, the shipping, the discount, and more. The function of the “Payment Application” is thus: provide a record of the “reason” and “requirements” that drove the price of the payment. Then exploit an integration with a processor to take the payment.
The “Pay with PayPal” button is a great example of how the “Payment Processor” is a separate component from the “application” that calculates shipping, taxes, and subtotals. There’s a lot of “magic” happening here, and it’s where we need to educate many investors.
Historically, this layer’s primary means of making money was to charge
- a subscription fee, or
- a software license fee.
This has changed recently because processors like Stripe have begun offering a feature called “application fee.” The processor will auto-charge a percentage of each order on behalf of the application. Given the opportunity, many applications are moving to a model where they take a percentage of each order.
This is why merchants have become accustomed to paying between 4–7% of each order for all online purchases these days. Merchants who want to bypass the extra fees must hand-build their payment application or find a provider still charging subscription fees only. Providers that operate without taking a percentage are becoming increasingly difficult to find.
Time to talk about what’s been changing
It might be challenging to understand why so many companies are receiving investment in this space, especially when every company begins their problem statement by describing the moment of the transaction. Frankly, the moment of transaction is the only moment when most people will ever encounter this infrastructure. Everything else happens behind the curtain. So let me pull back the curtain for you a bit.
Here’s a breakdown of what’s new in payments.
Mobile phone providers focus on card safety.
The merchant, payment application, and processor no longer handle your real card data; when Google and Apple pay are involved.
This is a fantastic upgrade to the system. It makes card theft (like the famous hack at Target) nearly impossible. But only for buyers using this method of payment. Google and Apple create “merchant-specific” tokens or even “one-time-use” tokens for each unique merchant every time you make a purchase. That means every merchant only sees a card number that works for that merchant in that transaction. If the data is stolen and taken to another merchant, it won’t work!
These solutions get paid by
- back-end contracts with the banks and credit card networks.
That’s why it costs nothing to the consumer to use these services. It also explains why Apple Pay and Google Pay are “friendly players” with everyone in the payment infrastructure stack. The more providers integrated, the more these companies get paid.
Let me deal with some confusion here. When you see an “Apple Pay” or “Google Pay” button at the bottom of your e-commerce screen, that does not indicate that Google or Apple is the payment processor for this transaction. No merchants make direct relationships with either of these companies. Those buttons are supplied by the payment processor (like Stripe) because they have enabled this payment method on their payment solution. Stripe still gets their 2.9% + $0.30 in an Apple Pay payment. Apple gets paid down-stream.
This is further demonstrated when you see an Apple Pay logo on an existing credit card terminal at the store (rather than a separate terminal made by Apple).
Alternative payment solutions innovate on the method of payment entirely.
Pay with installments. Pay with a loan. Pay using escrow.
All of these “alternative payment” solutions integrate with the payment application. They aim to change the algebra around the consumer’s mental decision for the purchase. “I can’t afford to spend $500 right now, but I can afford five payments of $100.”
These companies make money in a variety of ways, some of which include:
- Embedding extra cost for the consumer,
- Charging the merchant a similar fee to credit cards, and
- Charging credit card fees + additional solution fees.
Faster checkout providers aim to speed up onboarding and share onboarded customers from merchant-to-merchant.
Customers onboard one time; as quickly as possible. And carry their “wallet” from merchant to merchant.
PayPal pioneered this model a very long time ago. It’s arguable that they are THE reason you feel comfortable buying “that widget” from a random guy selling out of his garage in Kentucky.
Each of the new players in this space is directly competing with PayPal. Companies like Fast have the opportunity to exist because PayPal made a poor business decision years ago. Or maybe PayPal could not get the partnerships?
PayPal chose to restrict their services exclusively for merchants who use BrainTree as their payment provider. Do you use Stripe? No PayPal for you. Do you use Authorize.net? No PayPal for you. You get the idea. PayPal had a corner on the market but chose NOT to spread as big and as far as they possibly could. This left room for competitors to jump in. It was only a matter of time.
Fast is “a better designed PayPal” for Stripe and Big Commerce because PayPal left Stripe an “open field” and Shopify can’t move into Big Commerce payments.
Alternative marketplaces aim to be the “big box stores” of commerce online.
Retail is nothing new. Storefronts pop up where the crowds are. If you have traffic, you’re likely trying to build a marketplace.
A little history is important here. D2C commerce companies became possible thanks to e-commerce and the internet. Brands became extremely excited about having an “over the top” solution to get around the massive margin loss they experienced at big-box retailers. Big-box retailers often took 40+% right off the top and charged even more for better product placement.
Facebook shop, Etsy, Amazon, Walmart.com… All of these companies are variations on the “Big Box” model. But now that D2C is a competitive environment, online markets are forced to ask for smaller margin slices to attract merchants. So they must find new ways to bolster their income and get around the margin limitations.
All of them have found a cash cow in selling “Ad Space.” Think “promoted products.” The more sophisticated and targeted the advertising, the better. The problem with retailers is that Merchants don’t want to pay Facebook to sell an Ad to a customer they have already closed before. They want a direct connection to their customers. So they spend a lot of money trying to eject the customer from the marketplace and direct the customer to their D2C channel.
These marketplaces are often the “Merchant of Record” for the transaction. So they make money when they:
- charge the sub-merchant a percentage on the price of the product.
These companies often operate as the “Payment Application” in the stack you learned above.
Whym stands out from all of these newcomers.
Whym is taking a strong position that shopper behaviors are changing.
The next generation of shoppers believes e-commerce is too messy. Do better and transact with your customers where you meet them.
No more Ads to “reacquire” a customer you already delighted. Ensure every customer converts back to an over-the-top channel where you have direct access to that customer in the future.
Whym works on EVERY channel and EVERY platform you meet your customer WITHOUT an integration. There are some limitations, but not as many as you fear.
Whym works in the physical world, and Whym works in every digital channel.
Whym can be FASTER than a credit card terminal. Whym is FASTER than e-commerce. Whym is even FASTER than “fast checkout” solutions (in many cases).
More than that: Whym delights your customer by meeting them where they are. From there, the customer always has a fantastic checkout experience; every time.
Want to learn how? Schedule an investor call and find out.
And here’s something you don’t hear every day: Our solution is in-market, self-serve, and onboarding merchants and partners after a 20-minute conversation.