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Before diving into payment details for different business models, it’s helpful to have a high-level understanding of how payments work: how money moves from a customer to your business, how banks facilitate these payments, and the costs involved in the system. Learning about these fundamental building blocks of online payments will help you better understand the nuances of the payments setup for your own business model.

Online payments flow

There are four major players involved in each online transaction:

1. Cardholder: The person who owns a credit card
2. Merchant: The business owner
3. Acquirer: A bank that processes credit card payments on behalf of the merchant and routes them through the card networks (such as Visa, Mastercard, Discover, or American Express) to the issuing bank. Sometimes acquirers may also partner with a third party to help process payments.
4. Issuing bank: The bank that extends credit and issues cards to consumers on behalf of the card networks.

To accept online card payments, you need to work with each one of these players (either via a single payment service provider or by building your own integrations).

First, you’ll need to set up a business bank account and establish a relationship with an acquirer or payment processor. Acquirers and processors help route payments from your website to card networks, such as Visa, Mastercard, Discover, and American Express. Depending on your setup, you may have a separate acquirer (often a bank that maintains network relationships) and processor (which partners with the acquirer to facilitate transactions), or a single relationship that includes both services.

In order to securely capture payment details, you may also need a gateway, which helps properly secure information. Gateways frequently use tokenization to anonymize payment details and keep sensitive data out of your systems, helping you meet industry-wide security guidelines called PCI standards.

A single provider can offer gateway, processing, and acquiring services, which can help streamline your online payments. Sometimes, the payments provider will build direct integrations with the card networks, helping to reduce third-party dependencies.

When you accept a payment online, the gateway will securely encrypt the data to be sent to the acquirer, and then to the card networks. The card networks then communicate with the issuing bank, which either confirms or denies the payment (bank rules or regulatory requirements may sometimes require additional card authentication, like 3D Secure, before accepting a payment). The issuing bank will relay the message back to the gateway or acquirer so you can confirm the payment with the customer (by displaying a “payment accepted” or “payment declined” message on your site, for example).

This describes the online payment process for one-time payments using US dollars in the US. If you want to expand internationally, you may need to find a bank partner and set up relationships locally. Or, if you introduce a new product and want to start charging customers on a recurring basis, you would need to not only accept the credit card number, but also accurately initiate and collect payments at a set time interval. You would also need to build logic to accommodate different pricing models, figure out how to recover failed payments, manage prorations when customers switch plans, and more.

Transaction fees and costs involved in online payments

There are a variety of fees that accompany each transaction processed through this four-party system. Visa, Mastercard, Discover, American Express, and other card networks set the fees, referred to as interchange and scheme fees.

Interchange typically represents the bulk of the costs involved in a transaction. This amount is given to the issuing bank because it takes on the greatest amount of risk by extending credit or banking services to the cardholder.

Scheme fees are collected by the card networks themselves and can include additional authorization and cross-border transaction fees. Fees can also be assessed for refunds and other network services.

Together, these fees make up the network costs. These vary depending on the card type, transaction location, channel (in-person or online), and Merchant Category Code (MCC). For example, a transaction made with a rewards credit card would incur higher network fees than a transaction with a non-rewards card since banks often use these fees to subsidize the cost of the rewards program.

This section covers three important topics for all businesses accepting payments: how the online payments funnel can increase your conversion, how adding the right payment methods can expand your pool of potential customers, and how to simplify tax compliance so you can focus on growing your business.

How the online payments funnel can increase your conversion

Transactions go through three steps: checkout completion, fraud protection, and network acceptance. Conversion happens when a transaction is successfully completed.

Through each stage of online payment processing, your pool of potential customers can gradually shrink. If you have a long or complicated checkout process, a fraction of customers will fall off. Then, when you factor in fraud and average transaction acceptance rates, the pool shrinks even more.

Understanding the interaction between these steps is important to optimizing your entire funnel. This is especially true for businesses that have separate teams owning checkout, fraud, and network acceptance, with each one optimizing for their own metrics. For example, if the team working on checkout completion solely focuses on reducing cart abandonment rates, they may ask for less customer information to reduce friction. However, this can result in more fraud since you’re not always capturing details like the full billing address and ZIP code to help validate the transaction.

In this section, we’ll give you an overview of the online payments funnel and share best practices to increase conversion.

Designing the best checkout forms

The online payments funnel starts with the checkout experience, where customers enter their payment information to purchase goods or services. At this stage, you want to collect enough details to be able to verify that customers are who they say they are, but avoid adding too much friction to the checkout process—which can cause customers to abandon it altogether.

If your checkout form is too complicated, you risk losing sales from the most likely buyers—customers with items in their cart and every intention to make a purchase. In fact, 87% of customers abandon a purchase if the checkout process is too difficult.

To improve your checkout completion rate, the first step is to go through your own checkout process from the customer’s point of view and look for any friction that could lead to drop off. Pay attention to how long the site takes to load, how many fields are in your form, and if your checkout process supports autofill.

The best checkout forms adapt to the customer’s experience. For example, it’s best practice to offer responsive checkout forms that automatically resize to the smaller screen of a mobile device and offer a numerical keypad when customers are prompted to enter their card information. You should also consider supporting mobile payment methods, such as Apple Pay or Google Pay, to bypass manual data entry.

If you choose to expand internationally, your checkout form should cater to each market. Allowing customers to pay in their local currency is a start, but you also need to support local payment methods to provide the most relevant experience. For example, more than half of customers in the Netherlands prefer to pay with iDEAL, a payment method which directly transfers funds from a customer’s bank account to the business.

The card number can also indicate where a customer is located geographically, allowing you to dynamically change the form fields to capture the right information for each country. For example, if your form recognizes a UK card, you should add a field to capture the postcode. If your form recognizes an American credit or debit card, you should change that field to ZIP code.

Managing risk online

The next step is to evaluate whether a transaction is fraudulent. The majority of illegitimate payments involve fraudsters pretending to be legitimate customers by using stolen cards and card numbers.

For example, if a fraudster makes a purchase on your website using a stolen card number that hasn’t been reported, it’s possible the payment would be processed successfully. Then, when the cardholder discovers the fraudulent use of the card, he or she would question the payment with his or her bank by filing a chargeback. While you have the chance to dispute this chargeback by submitting evidence about whether the payment was valid, card network rules tend to favor the customer in most disputes. If your business loses a dispute, your business would lose the original transaction amount. You, as the business owner, would also have to pay a chargeback fee, the cost associated with the bank reversing the card payment.

While chargebacks are a part of accepting payments online, the best way to manage them is to prevent them from happening in the first place. There are two primary approaches: rules-based logic and machine learning.

Rules-based fraud detection

Rules-based fraud detection operates on an “If x happens, then do y” logic created and is managed on an ongoing basis by fraud analysts. Examples include blocking all transactions from a certain country, IP address, or above a certain dollar amount. However, because this logic is based on strict rules, it doesn’t recognize hidden patterns nor does it adapt to shifting fraud vectors by analyzing information beyond these defined parameters. As a result, analysts are often playing catch up—manually creating new rules after they detect fraud rather than proactively fighting fraud.

Using machine learning to detect fraud

Fraud management based on machine learning, on the other hand, can use transaction data to train algorithms that learn and adapt. Some machine learning models mimic the behavior of human reviewers, while others are trained by millions of data points. These models learn how to discern legitimate transactions from those that are potentially fraudulent. Some of these models can even train themselves, making them more scalable and efficient than rules-based logic.

For example, let’s say a customer with normal browsing behavior and a suspicious IP address wants to purchase something from your site. Machine learning decides how much weight each of these signals should carry. For example, should the transaction be declined solely based on the IP address? A rules-based system may block all transactions from that location, but a machine learning model should be able to distinguish between good and bad transactions by weighting the location alongside all the other information available to determine the probability that a given payment will result in a chargeback.

Combining these two approaches—rules-based logic and machine learning fraud management—can be a powerful, customizable solution. You are able to leverage the sophistication of machine learning, but also customize the approach and encode logic that is specific to your business. For example, you can set custom rules based on the risk level of a subset of your users and what they are buying.

For more information, read our guide on machine learning for fraud detection.

Improving network acceptance

The last step in the online payments funnel is card network acceptance: having the issuing bank successfully process and accept the card payment.

When customers make a purchase, a payment request is sent to the issuing bank. Based on a variety of factors, ranging from your customer’s available balance, the formatting of transaction metadata, or even system downtime, the issuing bank will either accept or decline the request. The higher your acceptance rate, the more transactions you‘ve been able to successfully process.

You can help reduce unnecessary declines by collecting additional data or passing through details like CVC, billing address, and ZIP code during checkout. This information gives the issuing bank extra information about the transaction, helping improve the chances of acceptance for legitimate transactions.

Global payment methods

While cards are the predominant online payment method in the US, 40% of consumers outside the US prefer to use a payment method other than a credit or debit card, including bank transfers and digital wallets (such as Alipay, WeChat Pay, or Apple Pay). You may lose sales simply because you don’t offer the preferred payment methods of a global audience.

To capitalize on a global customer base, you need to offer the payment methods that are most commonly used in the countries in which you operate. There are the five common types of payment methods:

1. Credit cards allow customers to borrow funds from a bank and either pay the balance in full each month or pay the money back with interest. Debit cards make payments by deducting money directly from a customer‘s checking account, rather than using a line of credit.
2. Digital wallets, including Apple Pay and Google Pay, let customers pay for products or services electronically by linking a card or bank account. Digital wallets can also allow customers to store monetary value directly in the app with top-ups.
3. Bank debits and transfers move money directly from a customer’s bank account. Account debits collect your customers’ banking information and pull funds from their accounts (for example, ACH in the US). Credit transfers link to customers’ bank accounts and they push money to you (like wire transfers). There are also payment methods like Giropay in Germany and iDEAL in the Netherlands that operate as a layer on top of banks to facilitate transfers, but look more like digital wallets.
4. Buy now, pay later is a growing category of payment methods that offers customers immediate financing for online payments, typically repaid in fixed installments over time. Examples include Afterpay, Klarna, and Affirm.
5. Cash-based payment methods, from companies like OXXO and Boleto, allow customers to make online purchases without a bank account. Instead of paying for a product or service, customers receive a scannable voucher with a transaction reference number that they can then bring to an ATM, bank, convenience store, or supermarket and make a payment in cash. Once the reference number for the cash payment is matched to the initial purchase, the business gets paid and can ship the product.

For more information, read our guide to payment methods.

Simplify sales tax, VAT, and GST compliance

Internet businesses are required to collect indirect taxes in over 130 countries and in most US states; however, staying compliant can be challenging, especially as your business scales. Tax rules and rates change constantly and vary based on what and where you sell. If you ignore these complexities, you risk paying penalties and interest on top of uncollected taxes.

Indirect taxes have various names around the world. Indirect tax is called sales tax in the US, value-added tax (VAT) in Europe, goods and services tax (GST) in Australia and Canada, and consumption tax (JCT) in Japan. The process for collecting these taxes can vary significantly, but the outcome is the same: The end customer pays the tax.

Tax treatments depend on whether you sell a physical or digital product. For physical goods, the tax treatment depends on the ship-from and ship-to locations, plus how each jurisdiction categorizes the product. There are many differences across city, state, and country lines. Digital products (such as online courses or website memberships) can be just as complex. In the US, 40 states tax digital goods, and in the EU, digital products are taxable if they fit certain criteria.

No matter what you are selling, you’ll need to answer these questions to comply with sales tax, VAT, and GST:

• Where and when am I obligated to collect taxes?
• How do I register to collect taxes?
• How much tax should I charge on each product or service?
• How do I file and remit the money I collect?

For more information about these taxes, read our guides:

• Introduction to sales tax, VAT, and GST compliance
• Introduction to US sales tax and economic nexus
• Introduction to EU VAT & VAT OSS

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