Their Role in Business, How They Work, and Benefits

What Is a Merchant Service?

A merchant service is any one of a group of services that businesses can use to accept and process electronic payments from their customers. Merchant services facilitate these transactions and may involve a combination of point-of-sale (POS) systems, credit card readers, payment gateways, and online transaction processing, among others.

Key Takeaways

  • Merchant services make it easier for businesses to accept electronic payments, such as credit and debit cards.
  • Services are available for both in-store and online transactions, including point-of-sale (POS) systems and credit card readers at brick-and-mortar stores and online payment gateways for websites.
  • Merchant services can offer benefits such as enhanced payment security, increased sales opportunities, and streamlined payment processing.
  • There are many merchant services providers to choose from, but it’s important to make sure they follow accepted security protocols.

How Merchant Services Work

Merchant services encompass a number of processes involving merchants, their customers, and their respective banks. They include:

The Customer Payment Process

Customers encounter merchant services when they initiate a transaction using a credit card, debit card, or other electronic means. This may happen through a point-of-sale (POS) device at the merchant’s physical place of business, such as a shop or restaurant, or through an online payment gateway or portal on the merchant’s website.

In a typical scenario, the POS device or online portal will collect the pertinent details from the customer’s card, then forward that information to the card-processing network associated with that card, such as American Express, Discover, Mastercard, or Visa.

The information will include the account number and other data identifying the cardholder. During in-person credit or debit card transactions, the POS device obtains it by reading the card’s magnetic stripe or EMV chip, where the information is embedded.

In some cases (such as American Express and Discover), the network will also be the company that issued the card, known as the issuing bank. It can either accept or reject the transaction and relay its decision back to the merchant’s terminal. Mastercard and Visa are simply networks or associations, and not card issuers, so they will seek approval from the issuing bank.

If approved, the transaction will go through.

Most of this process—often referred to as authorization—happens behind the scenes and virtually instantaneously, making it largely invisible to the customer.

The Merchant Payment Process

The merchant doesn’t receive its money right away. That involves a separate, multistep process.

When a transaction is given the green light, the merchant will receive an authorization code from the card issuer. The merchant will forward that code to its payment processor (often along with other transactions it completed that day, a procedure known as batch processing).

The processor will send the information to the appropriate card network, which will then forward it to the issuing bank, if different. The issuing bank will then begin the settlement process, in which money finally changes hands.

The Settlement and Funds Transfer Process

In the settlement process, the issuing bank will transfer funds to the merchant’s bank, the acquiring bank. That bank will then deposit the funds in the merchant’s merchant account. This process typically takes 24 to 48 hours.

The issuing bank will also add the amount to the cardholder’s balance, which will be reflected on their next billing statement. In the case of a debit card, the issuing bank can simply withdraw the money from the cardholder’s account.

Components of Merchant Services

Merchant services rely on a combination of hardware and software. Some common components:

Point-of-Sale (POS) Systems

In their most basic form, point-of-sale (POS) systems are computers that allow a consumer to use their credit or debit card to purchase something at a merchant’s place of business. They then transmit the information to a card-processing network, initiating the payment process.

However, these systems have become increasingly sophisticated and allow merchants not only to conduct transactions but also to monitor their inventory, record sales data, and perform other useful business functions. Some POS software can also link to accounting software, making bookkeeping easier.

Credit Card Readers

A credit card reader, or payment terminal, is a piece of hardware that allows the POS to collect the data it needs. Card readers work in different ways, some relying on the older magnetic stripe technology, others allowing for the newer EMV chips or wireless NFC technology for contactless payments from smartphones and other devices.

Payment Gateways

A payment gateway is the virtual equivalent of a POS system, performing the same basic functions but for online transactions. Because the physical card isn’t involved—these are often referred to as “card-not-present transactions”—the gateway must verify its legitimacy in other ways. This typically involves asking the cardholder to provide a validation code. Technically known as a CVV, CV2, or CVV2 code, it’s a three- or four-digit number found on the front or back of today’s credit and debit cards.

Online Transaction Processing (OLTP)

Used in conjunction with a payment gateway, online transaction processing allows merchants to process large numbers of transactions in real time, while also recording that information for accounting and other purposes. OLTP is a vital tool in ecommerce, where speed is key.

Benefits of Merchant Services

Merchant services cost money, but they also provide benefits beyond what merchants would be able to do on their own. Those include:

Enhanced Payment Security

Merchant services have a number of built-in safeguards to protect both the merchant and their customer (as well as the card networks and banks) from fraud and theft.

Payment gateways, for example, provide a secure online connection between the merchant and the customer, making it very difficult for hackers to infiltrate the system. For in-person transactions, POS systems and the security features embedded in credit cards work in tandem to protect consumers’ information and thwart potentially fraudulent transactions.

Merchants that accept card payments must typically comply with industry standards set by the PCI Security Standards Council, known as PCI DSS, the “DSS” standing for data security standard. The rules vary depending on the size of the business, based on the number of transactions; the bigger the business, the more complex the requirements. Merchants that don’t comply are subject to fines.

Because most merchants have other work to attend to, they often delegate maintaining their PCI DSS compliance to merchant services providers. The PCI council itself advises merchants, “In most cases, using a wholly outsourced third party to capture and process payments is the safest option.”

Increased Sales Opportunities

While some consumers still prefer to use cash and some merchants may not accept any other form of payment, trends continue to move in the direction of electronic payments. A Federal Reserve study found that in 2022, credit cards accounted for 31% of all transactions and debit cards for 29%, while cash trailed at 18%.

Clearly, merchants that aren’t set up to handle electronic transactions put themselves at a disadvantage when it comes to sales.

Streamlined Payment Processing

In addition to greater security, state-of-the-art payment systems speed transactions both online and off, reducing time and labor costs. The less time that customers have to wait in line and the less effort they need to expend in completing an online transaction, the more likely they are to come back.  

How to Choose a Merchant Services Provider

Businesses today have numerous merchant services providers to choose from. Some are specialized businesses; others are divisions of major banks or corporations. Both Mastercard and Visa publish online lists of services providers that comply with their security requirements.

To choose among services providers, the PCI Security Standards Council suggests a list of 12 questions worth asking. Among them:

  • “Does your solution/product ensure the secure capture and transmission of cardholder data?”
  • “Does the vendor/service provider carry insurance to cover data breaches related to their product/solution?”
  • “Does the vendor/service provider assist with notification of my customers in the event of a data breach and your product solution is the root cause?”

A number of websites provide ratings of merchant services providers. Providers that are cited as among the best on multiple lists include (in alphabetical order):

  • Dharma Merchant Services
  • Helcim
  • Payment Cloud
  • Payment Depot
  • Stax
  • Square
  • Stripe

Several of the providers above also appear on Investopedia’s latest list of the best credit card-processing companies.

Most merchant services providers offer a variety of plans and pricing tailored to different types and sizes of businesses.

For example, Helcim charges no monthly fee. It says its processing fees average 1.93% plus 8 cents for in-person transactions and 2.49% plus 25 cents for online ones. Stripe’s standard per-transaction fee is 2.9% plus 30 cents for domestic cards, also with no monthly fee. Both of these providers and others charge extra for hardware such as POS terminals and card readers, as well as for any additional services that the merchant may choose.

What’s the Difference Between a Merchant Account Provider and a Merchant Services Provider?

A merchant account is a bank account that can accept the proceeds from credit and debt card transactions. Merchant services refers to a wider array of specialized hardware and services to facilitate such transactions. It may include access to a merchant account as one of them.

Who Pays Merchant Fees?

Merchants have to pay fees on every card transaction, sometimes referred to as swipe fees or interchange fees. These fees go primarily to the card issuer, although the payment processor may also get a small cut. Ultimately, the merchant may pass the fees along to the consumer in the form of higher prices.

How Are Merchant Fees Calculated?

Merchant fees are typically calculated as a percentage of each transaction. Credit card fees total about 2% of the transaction amount, on average. Debit card fees are limited by law to “$0.21 plus 0.05% multiplied by the value of the transaction, plus a $0.01 fraud-prevention adjustment, if eligible,” as the Federal Reserve explains it. Merchant services providers will typically pass the swipe or interchange fee along to the merchant, while adding a small margin for themselves.

The Bottom Line

As electronic payments have become integral to retail commerce, merchants have come to rely on merchant services providers to assist them in making sure that transactions are completed swiftly and securely. A wide variety of such services are available, and they can be tailored to the size of the business and the type of risks it may face.

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