Common Payment Processing Entities
The term payment processor is a general term used to describe the many types of organizations capable of providing you a merchant account including Banks (Acquirers), Independent Sales Organizations (ISOs), Third Party Processors (TPPs), Internet Payment Service Providers (IPSPs), Agents, etc. Payment processors perform all or some of the tasks needed to keep the acceptance side of the credit card systems working. This includes:
- Accepting liability for bad or fraudulent transactions (Underwriting)
- Acquiring merchants (Sales)
- Processing Transactions
- Providing Customer Service
The following stack diagram illustrates the general hierarchy of dependency incumbent upon the different entities with respect to business relationship.
As one would expect, the lowest layer in the stack represents the foundation, a role that the other layers require to function properly. For example we know that without the Visa and MasterCard networks, the system would not work. Above MasterCard, we find the Member Banks, ultimately responsible for the actions of the entities above it. Generally speaking, each layer requires the support of the layers below it to operate. We will see that the physical flow of transactions does not necessarily have to follow organizational boundaries.
Member Banks or Merchant Banks are the easiest entities to define. Member banks are the actual members comprising the Visa and MasterCard Associations. Because they were “born” first, some member banks perform all of the business functions associated with the payment processing spectrum. These full service banks sell merchants, operate transaction processing platforms, provide customer service, and underwrite the risk. With the exception of risk, the majority of banks outsource one or more of these functions. In particular, most small and medium banks outsource the actual transaction processing function to TPPs. It may be more difficult to obtain a merchant account form a bank because they have highly developed underwriting skills and potentially more stringent guidelines.
Third Party Processors are the workhorses of the industry. According to MasterCard, these organizations manage amongst other things, “terminal operation, authorization routing, voice authorization, call referral processing, electronic data capture, clearing file preparation and submission, settlement processing, merchant statement preparation, and chargeback processing.” Third Party Processors generally have direct physical connections to the Association networks. TPPs also process a great percentage of all transactions from Member Banks. TPPs that are contractually sponsored by Member Banks may also acquire merchants, provide customer service, and accept some portion of the liability for fraudulent transactions. Many believe that full-service TPPs are the most cost effective and flexible solutions because they have the most direct physical entry-point into the networks. TPPs may employ ISOs and Agents to solicit merchants on their behalf. Obtaining a merchant account from a TPP may be easier as they often have less strict underwriting standards than banks.
Independent Sales Organizations represent the principal sales arm of the payment processing industry in terms of total merchant accounts sold. These organizations are primarily responsible for soliciting new merchants for Member Banks and/or Third Party Processors. In order to operate legitimately, ISOs must have a contractual arrangement with a Member Bank, a TPP, or both. They must be registered with Visa and MasterCard. ISOs may represent one or more banks or processors, so they can offer more variety to their merchants. Although most ISOs process their merchants’ transactions through TPPs, some offer rudimentary processing services and reporting. As ISOs grow, they may also begin to take on other responsibilities like customer service. Large ISOs may employ other ISOs, Agents, or Merchant Level Salespeople (MLS) to acquire merchants. Because this sector of the industry is so fragmented and prolific, merchants should be sure that they are working with a seasoned, reputable ISO.
ISOs are at least one step away from Member Banks. This means that ISO underwriting guidelines tend to be less strict and sometimes more focused on particular business sectors. This can translate into easier account approval from a provider that is more experienced in your business category. The downside is that ISOs must pay a transaction fee to their bank or TPP, which generally makes them more expensive than the latter two types.
Internet Payment Service Providers
are a specialized form of ISO focusing on the support of Internet merchants. According to Visa, IPSPs are “an online entity that contracts with an acquirer/payment processor to provide payment related services to sponsored merchants. The IPSP interfaces with an acquirer/payment processor on behalf of its Sponsored Merchants and must ensure that its Sponsored Merchants are contractually obligated to operate in accordance with
.” Because IPSPs support Web merchants, they operate their own commerce platforms which have some level of transaction processing capability. They tend to service small to medium sized merchants, thereby assisting the networks in aggregating a large number of small merchants.
IPSPs generally solicit merchant using online promotional techniques. Because they operate their own commerce platform, they tend to provide merchants with all technical support. This comes at a cost. The associated overhead coupled with the fees IPSPs must pay their sponsor often makes IPSPs more expensive than banks or TPPs.