December 19, 2003

Accepting Payments Online: Merchant Accounts vs. Third Party

If you want to sell online, you need to be able to accept credit card payments. The traditional way is to open a merchant account. However, opening a merchant account is expensive, especially for small businesses who are just starting.

In the last few years, however, a number of companies have entered the market with a new concept: third party credit card processing services (for example, Paypal). This option offers small businesses a quick and easy way to accept cretit card payments. It by-passes the need to open a merchant account, plus, the sign-up process is much easier and faster: you can literally sign-up, be approved and start accepting payments online in minutes.

Traditional merchant accounts are expensive primarily because they charge fixed fees that you will have to pay even if you don't sell anything.

For example, depending on the case, a merchant account will require that you pay:

An application fee (whether you are approved or not)
A set-up fee (once your application has been approved)
The discount rate: usually between 2% and 3% of every sale.
A per transaction fee.
A monthly minimum fee (if the dollar amount of the discount rate falls below the amount of the fee).
Statement, gateway and connection fixed fees.
Third party credit card services usually just charge a percentage of sales and, in some cases, a per-transaction fee, so you only pay when you sell something.

If your sales volume is not very high, a third party service can save you money.

For example, lets assume that you make 10 sales a month at $25 per sale, to compare the merchant account option vs. the third party option:

If a merchant account charges you a $25 montly minimum fee, $50 in gateway and connection fees, a discount rate of 2.0% of sales, and a fee of $0.30 per transaction (for simplicity's sake we're not factoring in any application fee or set-up fee), the charges you would have to pay your merchant account provider amount to $83.00.

If you use a third party service that, like Paypal, charges you 2.9% of sales plus $0.30 per transaction, it would only cost you $10.25.

However, the advantages of using a third party service start to diminish as your sales start growing. In other words, since the discount rate charged by traditional merchant account providers is lower than the percentage of sales charged by third parties, the higher your sales the more the fixed fees of the merchant account will be offset by its lower discount rate.

For example, let's assume that instead of making 10 sales per month, you make 1000 sales, at the same $25 dollars per sale (total sales per month: $25,000). You will then have to pay your merchant account provider $850.00 (the $25 minimum will be waived because the dollar amount of the discount rate will be greater than $25).

If you use the third party service, you will pay $1025 for the same $25,000 in sales.

Your break even point in this example would be 222 transactions (sales) of $25 dollars each: if you make 222 sales or less, you would be better off with a third party service. If you make 223 sales or more, your best bet would be a merchant account.

In summary, the more you sell the more you should consider opening your own merchant account. However, if you are a small business just beginning to market your products on the net, or if you want to start quickly and don't expect huge sales in the near future, you may want to go the third party route.

The two best known third party credit card services among web marketers are Paypal and Clickbank.

PayPal began in 1999 as a tool for transferring money for payment in eBay auctions and is currently the most popular online payment system of its kind, with over 35 million accounts at the time of this writing (December 2003), and a fee structure of 2.2% - 2.9% of sales plus $0.30 per transaction.

Clickbank specializes in serving web marketers that sell digital products, which are directly downloaded from the Internet. These products are offered through Clickbank's extensive network of over 100,000 affiliate sites. Merchants of digital products simply place a sales link on their site and Clickbank handles the credit card processing. At the time of this writing, Clickbank charged a one time $49.95 set-up fee, a processing fee of 7.5% of sales and a $1 fee per transaction.

In summary, check all your options first and choose the one that is most likely to fit your needs in the long run. Remember that cost is only one of the variables you should consider in your analysis. Spending some time visiting the websites of merchant account providers and third party credit card service providers, and doing your due diligence early, can save you thousands of dollars in the future.


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Mario Sanchez is a Miami based freelance writer who focuses on Internet marketing and web design topics. He publishes The Internet Digest ( ), a growing collection of web design and Internet marketing articles, tips and resources. You can freely reprint his weekly articles in your website, ezine, or ebook.

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