Payment Processing 101: What’s the Difference Between a Payment Processor, Payment Gateway & Merchant Account?

Payment processing 101: What's the difference between a payment processor, payment gateway & merchant account?

Payment processing is probably the most intimidating element of the whole “selling online” puzzle when you're just getting started. And that's perfectly understandable.

After all, this is the part of the job – as you're launching a new online store – where you start dealing with your customers' financial info, such as credit card numbers, sensitive personal data, and etc. And as an eCommerce store owner, it's your full responsibility to make sure that your customers' data is kept safe above all else.

Luckily, payment processing isn't that difficult to figure out once you start looking into it. For the most part, the difficult heavy lifting is handled by other companies so that you can focus on the core of your business. But we'll get to that…

In this guide, we go step by step through the basics of payment processing and also explain the difference between a payment processor, a payment gateway, and a merchant account.

In a hurry? Here's a summary of the key differences between payment processors, payment gateways, and merchant accounts:

  • Payment gateway – connects your eCommerce store to the payment processor; sends a transaction request to the payment processor
  • Payment processor – processes the request from the gateway and executes it – takes the money from the customer and deposits it in your merchant account or an account managed by a third-party
  • Merchant account – this is where the funds get deposited after a successful transaction; merchant accounts are optional, you don't need to have one as an eCommerce business

Table of contents:

👉 When does payment processing come into play?
👉 How all three work together
👉 What's a payment gateway?
👉 What's a payment processor?
👉 What's a merchant account?
👉 Summary

When does payment processing come into play?

The core items you'll need to get as an eCommerce professional include the following:

  • 📛 A domain name (such as xyzbusiness.com)
  • 🏗️ A quality eCommerce website platform (like Shopify or BigCommerce)
  • 💻 Quality (not just the cheapest) web hosting (hosting is included with platforms like Shopify, but not with systems like WordPress/WooCommerce)
  • 💳 A way to accept payments from customers – aka. payment processing

That last part is what we're going to discuss today.

The first surprising thing about payment processing is that it works kind of independently of your eCommerce store. It's basically a whole separate thing/system that only gets activated when your customer is ready to pay.

Think of it this way:

payment processing

In this model, the payment processing layer operates separately and only comes into play when needed.

When running a standard eCommerce store, you have your main store platform/system (like Shopify or WooCommerce) to take care of making your store website run – showcasing your products, letting customers browse them and place orders. Then, the actual processing of the payments usually takes place off site. Your store only connects to the payment processing mechanism and sends all the essential details to get it executed.

This is done this way for a couple of reasons. Firstly, it's a much more secure model. In it, it's the payment processing platform that needs to worry about the security issues and making sure that the transactions are kept safe. If it wasn't for this external payment processing, it would have to be you doing all this work.

The second reason is that various payment processing mechanisms, rules and regulations tend to change every once in a while, and it would be hard (if not impossible) to keep up with them if you did this yourself. Again, you have the payment processing platform doing this job.

Lastly, it's also a more trustworthy setup from the customer's point of view. For example, I'm sure you're going to be much more confident entering your credit card information via PayPal than on some random online store that you don't yet trust.

Now, with all things considered, the biggest advantage of this off-site setup with payment processing is that you – the store owner – simply don't have to worry about any of this credit-card stuff and can just leave it to the pros.

You can focus on doing business and actually generating sales, while someone else makes sure that all payments are processed correctly.

With that said, there are three main elements of a payment processing system. Yes, you've guessed it; they are:

  • payment gateway
  • payment processor
  • merchant account

So what exactly is the difference between a payment gateway, payment processor and merchant account?

All three elements work together to transfer money from the customer to the merchant (you), but it helps to understand what each of them does throughout the process:

How all three work together

Here's how the magic happens when a customer places an order in your eCommerce store and then proceeds to pay for it:

payment processing steps

Once the customer has picked a product and is ready to pay, each of the three elements handles its own unique task:

  • The payment gateway takes care of sending the transaction request to the proper payment processor or credit card company issuer.
  • The payment processor, as you would expect, processes the payment – making sure that it's submitted correctly, that the customer has funds at their disposal, and that all the payment details have been submitted correctly.
  • The merchant account is where the funds get deposited when the processing ends successfully.

It essentially all goes from payment gateway → payment processor → merchant account.

While I'm at it, it's also good to keep in mind that in some setups, all three elements are hidden under one umbrella company. In other words, the store owner doesn't usually have to deal with three separate entities individually, but can instead work with a single company that acts as all three.

Now in a bit more detail:

🚪 What's a payment gateway?

A payment gateway is a middleman between your online store and the payment processor that receives the payment from your customer.

When a customer enters their payment details on your site (this can be their credit card number or any other method of payment), the payment gateway sends that data securely to the payment processor.

Here are some of the main benefits of using a payment gateway:

1. Security is not your job:

This most significant advantage of payment gateways is the security they offer your eCommerce store, which in turns ensures that your customers can buy with confidence.

When it comes to cyber attacks, eCommerce is a highly vulnerable industry due to the sensitive information exchanged on websites. In fact, 32.4% of all cyber attacks are carried out on eCommerce websites.

What a payment gateway does is takes care of all the security-related aspects of the transaction and makes sure that the funds get to their destination safely without anything leaking along the way.

The gateway encrypts all data and sends it via SSL. Then, it works with the payment processor to determine whether the payment is legitimate.

2. Easy integration:

Payment gateways are easily integrated with popular eCommerce platforms such as Shopify, WooCommerce, BigCommerce, and Magento.

Shopify, for example, integrates with over 100 payment gateways including Stripe, PayPal, Authorize.Net and 2checkout among others. They also have their own out-the-box payment system which is powered by Stripe, avoiding the hassle of you having to sign up for a third-party gateway.

Amazon Payments is also a fantastic addition to your eCommerce store, as it automatically pulls payment and shipping information that is stored in Amazon, therefore speeding up the checkout process and increasing your conversion rates.

3. Works 24/7:

The great thing about selling online is that you don't have to be present in front of your computer when sales take place. This all works basically on autopilot – but you know all that already.

The story is similar with payment gateways. They do work round the clock and can process a customer's payment no matter the hour they make the purchase.

4. Multiple payment options available:

At the base level, your payment gateway should accept both debit card and credit card transactions. However, you may want to look for something more sophisticated that can support PayPal payments, as well as gift vouchers and perhaps other methods.

Check also if your payment gateway supports “point of sale.” You may have the opportunity to receive a free card reader so that you can accept payments on the go at events, or in your retail store.

5. Works with multiple currencies:

If you have plans to sell to customers overseas then it's worthwhile to consider a gateway that supports and accepts foreign currencies.

However, it's worth noting that these transactions can cost you more than payments in your own country.

6. Insightful reporting:

Payment gateways can offer you reporting in real time, so you can gather insights on how your business is doing, right up to the minute.

This is great when you want to see how a given promotion of yours has turned out or what you can do to increase seasonal sales. But that's just the tip of the iceberg; good reports are invaluable in themselves!

The cost of using payment gateways

Unfortunately, the cost is the most complicated aspect of using a payment gateway. Basically, there's no single price tag. Instead, you usually have to deal with a number of smaller fees connected to different parts of how the payment gateway functions.

Most commonly, there are three components of the final price tag:

  • Set-up cost – varies from $0 – $250. If you haven't picked your eCommerce platform yet then look for ones that already have an integrated payment gateway, such as Shopify.
  • Monthly cost – $10 – $50.
  • Transaction fees – those are two-fold. Usually, it's $0.00 – $0.25 + 1% – 5% per each transaction. Just to make it clear, you have to pay both the fixed fee and the percentage of the transaction.

Most gateways offer discounts based on the volume of sales you're getting.

👉 We discuss the topic of payment gateways more in-depth in another post where we also list the top 5 payment gateways in the market. Check it out. Here's the shortlist in case you're curious:

  1. Payline
  2. Stripe
  3. Authorize.Net
  4. PayPal
  5. 2Checkout

Again, you can learn more about them and the prices of each in our in-depth resource.

⚙️ What's a payment processor?

Payment processors are the financial institutions that work in the background to provide all the payment processing services used by an online merchant. These companies usually have partnerships with other companies that directly deal with consumers or merchants.

The payment processor connects to both the merchant account and the payment gateway, quickly passing information back and forth, keeping it secure and almost instantaneous to the end user.

In simple terms, the payment processor takes the info about the transaction from the payment gateway, validates it, executes it, and then deposits the funds into the merchant account. It also notifies the payment gateway if the transaction was successful.

As we've touched on previously, choosing your payment processor isn't a decision that is solely down to the person who'll be in charge of the finance. A payment processor is vital for ensuring you have a good conversion rate, so it's a decision you don't want to take lightly.

A quick list of the top payment processors

There's an abundance of payment processors to choose from, but we've narrowed it down to just the very best:

1. PayPal

Since its inception in 1998, PayPal has become the biggest player in the payment processing game. The company now operates in more than 200 countries/regions and supports ~25 different currencies.

PayPal can be directly integrated with your website, and because of its familiarity with customers all around the world, it's highly trusted. The flexibility of PayPal is truly great. You can process payments not only via your eCommerce store but also inside an app and even in your physical store.

paypal

2. Stripe

Stripe describes itself as “developer-centric” and it's a very fitting term as Stripe's biggest advantage is how customizable it is. Stripe's API allows you, or your developer, to experiment and create an experience that fits your business perfectly.

Stripe is available in 20+ countries and lets you accept more than 135 different currencies! This means that you can charge your customers in their local currency while still receiving funds in yours.

stripe

Of course, Stripe lets you process both debit and credit card payments.

3. Square

Square is a fantastic option for a store looking to sell online as well as offline.

Square offers a range of devices you can set up in your physical store, from simple clip-on magstripe readers that you put on your phone, to contactless mats, terminals, stands, and even full registers.

Square is also incredibly intuitive and easy to understand for beginners. Its point of sale system (which is free) is the real added benefit. Advanced features such as digital receipts with integrated feedback forms, card splitting costs, as well as inventory management for tracking stock are all free.

square

👉 If you want to learn more about what payment processors are, here's our in-depth definition.

But wait, there's more!

Even though it's not a payment processor per se, we also recommend getting on board with TransferWise if you're going to be dealing with any payment processor and especially if you want to accept payments in multiple currencies.

In such a scenario (accepting multiple currencies), you're usually going to lose a sizable amount of money to different conversion fees when you try to withdraw funds. This is where TransferWise comes into play.

TransferWise provides you with local bank details for the UK, the Eurozone, Australia, and the US. And you don't need a local address (which is usually a serious challenge if you want to obtain those accounts on your own).

transferwise

This setup means that you can request payments like a local no matter where you are. Then, you can withdraw money with low fees, thus minimizing your currency conversion costs.

💰 What's a merchant account?

A merchant account is a special type of bank account. This account allows your business to accept payments by credit and debit cards that come from a payment processor.

It's worth noting that merchant accounts are often called MIDs (or merchant IDs).

When a transaction clears at the payment processor level, the funds then can be deposited into the merchant account. From there, they can be moved to the main bank account of your business.

The difficulty with merchant accounts is that it's not always easy to get approved for one with your bank. There's a lot of paperwork involved, and the requirements change massively from region to region.

There are a variety of firms, financial institutions, and banks that offer merchant accounts. However, which ones are going to be available to you depends chiefly on your location and country. Research your local market before deciding on a merchant account if you really need one – as I said, in many cases, you don't – you can have your payment processor handle all the work.

Yes, many payment processing and payment gateway companies provide merchant accounts as well. The only downside here is that there will be additional fees involved when you try to withdraw your funds from the processor to your normal business account. Speaking of which:

Merchant account alternatives

As I said, you don't need to have a merchant account in order to operate your online store effectively. In fact, you can collect payments from your customers and then get them deposited to your normal business bank account without a merchant account in between. To do that, you have to sign up with a payment processor that offers this kind of services.

The most popular options in the market are:

As you can see, these are the “usual suspects” all over again. These companies do offer the whole package – everything from a payment gateway, to payment processor, to full payment processing system. By picking either of them, you basically get all of your store's payment processing needs taken care of.

👉 If you want to learn more about what merchant accounts are, here's our in-depth definition.

Merchant accounts, payment processors and payment gateways summarized

Earlier on, I showed you a simplified model of how payment gateways, payment processors and merchant accounts work together. This one:

payment processing steps

But now that we've explained the difference between each element in detail, we can flesh out their roles a bit more. I'm going to walk you through a standard transaction in a hypothetical eCommerce store:

1. A customer purchases an item:

A customer steps into an online store, finds a cool product and decides to buy it using their credit card. They click on the Buy button and wait a few seconds. As those seconds pass, the following steps are rapidly occurring:

2. The customer's transaction details are sent through the payment gateway:

The customer's personal and credit card information is sent over via the payment gateway. The transaction details are securely passed from the gateway to the payment processor, referencing the merchant's ID number and passing along the transaction details of the merchant account.

As you can see, all three (gateway, payment processor and merchant account) are utilized in this step.

3. The merchant's payment processor also gets the transaction details:

Besides sending the transaction details to the merchant account, the payment processor also has the job of contacting the issuing bank of the credit card used. That check is meant to make sure that the customer has enough funds and that it's a legitimate card.

To be more exact, there's actually a credit card network that serves as an intermediary between the payment processor and the issuing bank. The credit card network is what locates the bank needed.

4. The customer's card issuing bank accepts or declines the purchase:

Regardless of whether the payment is accepted or denied, this information goes back through the credit card network and to the payment processor.

5. The merchant's payment processor sends the results back to the payment gateway:

Let's say the transaction was approved. The payment processor relays that information to the payment gateway, which then stores the results so that the merchant's website can complete the transaction.

6. The merchant gets paid:

The bank that issued the customer's card releases funds to the merchant's bank. After a short settlement period, the merchant's bank drops that money into the merchant account.

Alternatively, the payment processor drops the funds into their own merchant account and then lets the merchant withdraw those funds to their standard business bank account.

Any questions on payment processing?

Understanding the basic details of how payment processing works is essential if you want to run an effective eCommerce store.

The exact differences between payment processors, payment gateways and merchant accounts are not that clear at first. However, the visuals and the outlines above should give you a decent idea as to how the whole process works.

If you're still confused or would like to express your opinion on the matter, let us know in the comments section below.

Karol K

Karol K. (@carlosinho) is a WordPress figure-outer, blogger, and published author of "WordPress Complete". His work has been featured all over the web on sites like: Ahrefs.com, Smashing Magazine, Adobe.com, and others.