What Is A Payment Service Provider?

If you landed on this post, you’re probably checking out payment processing options for your small business. Understanding terms such as “payment service provider” or “merchant account” — phrases that are sometimes used incorrectly or even interchangeably — can be a bit overwhelming. We get it. That’s why in this post, we are not only going to define what a payment service provider is, but we are also going to compare it with a traditional merchant account. We hope this post helps you unlock the best decision for your business over the long run. After all, deciding on payment processing services is one of the most important factors in getting paid!

Defining Payment Service Providers

A payment service provider (also known as a PSP) provides merchants with the ability to accept electronic payments such as credit cards, debit cards, and digital wallets (e.g., Samsung and Apple Pay) during both online and in-person transactions. You probably have already heard of some of the most popular PSPs:

• Square (read our review)
• Stripe (read our review)
• PayPal (read our review)
• Shopify Payments (read our review)

These companies are some of the most well known, but there are many other PSP companies out there.

While payment service provider is the technical way to say it, these companies are better known by many merchants as third-party processors or even aggregators. And herein lies the critical distinction with a payment service provider. Unlike a traditional merchant account where merchants have a unique, separate account, a PSP combines all merchants accounts as sub-users under its umbrella merchant account.

Thus, a payment service provider takes on the full financial risk of each business under its account. For the most part, this scenario is beneficial to the merchant because it makes accepting credit cards more accessible — the sign-up and approval process is practically instantaneous! This arrangement also reduces some of the additional fees typically passed directly to the merchant. However, there are some issues with this model. We will go into those in further sections, but first, let’s take a closer look at the differences between a merchant account and a payment service provider.  

PSPs (Third-Party Processors) Vs. Merchant Accounts

As discussed in the section above, the biggest difference is that a payment service provider facilitates one large merchant account, with individual business users being sub-users. A merchant account provider is more traditional in the sense that every merchant has an individual account. It’s also important to note that the vetting process for each merchant is much more thorough in the merchant account model because the provider is dealing with the merchant directly. These are far from the only differences, however.

Generally, a merchant account is laser-focused on payment processing, while a third party processor takes a much different approach to serving the merchant. A PSP aims to be more of an all-in-one solution for merchant services. For instance, with most third-party processors, you also get hardware freebies such as a mobile reader to get you started. In most cases, your payment gateway and checkout are all covered for eCommerce selling, too. The other nice thing is that you typically don’t have to pay additional fees for payment security because PCI compliance is bundled in your account. And we haven’t even talked about the business tools yet.

Additional Merchant Tools Sweeten The Deal

With a payment service provider, you are typically buying into an entire platform of other types of business tools that complement payment processing. For instance, Square, Stripe, and Shopify offer reporting features, invoicing tools, and many add-on software options that are included for a reasonably low cost. They also provide their own gateways for users who want to sell online. So a merchant using Square could set up a loyalty program, utilize the free analytics reporting, and even send an email marketing campaign — all from a single account! 

While this example includes add-on software options that likely don’t automatically come with your account for free, you get the idea. The main point I’m trying to convey here is that these types of companies focus on providing reasonably priced, easy-to-use services to assist in much more than just accepting payments. And it’s common to get a lot of freebies you may not expect that sweeten the deal, too.

For a small business with a limited budget, using these add-on tools could be a great benefit, but they aren’t for everyone. If your company has a healthy marketing budget already, or you need greater customization and technical guidance overall, you may find the added tools unnecessary or even a hassle.

Customer Support & Stability Issues

One of the downsides of using a PSP is customer service. Some companies do really well at providing self-help technical resources so you won’t have to contact the company unless you have an account-related question. However, the experience of dealing with a live person can be inconsistent, and some PSPs are more notorious for this than others. 

In contrast, with a merchant account, you can expect more personalized service for any payment processing issues that come your way. In many cases, you’ll have a direct contact (an account representative) to talk to if you have any questions or troubles. Sometimes these are the sales people you initially talked to even before you signed up for an account, so they’ll be with you every step of the way. 

Here’s another biggie — because a merchant account thoroughly vets a business from the get-go, your risk of an account freeze or termination decreases, too. Specifically, the vetting process is referred to as underwriting, and it involves a specialist analyzing your business to understand specific trends related to your industry and determining what an acceptable threshold of risk is. As long as you fit in that profile and fall below the risk threshold, you’ll be approved. 

Because third-party processors don’t complete this underwriting step, they analyze individual transactions with much greater scrutiny after your account is established. That means that a single abnormally large transaction could trigger an account hold while the company’s analysts evaluate whether it’s genuine. Because PSPs aggregate all the accounts into one massive account, they have to be extra vigilant about staying within an acceptable risk threshold, and they will terminate accounts for merchants who engage in risky behavior or put the funds on hold while they evaluate your processing history.

This is, without a doubt, the source of the vast majority of complaints about any PSP — a sudden hold or even an account termination.  While this may sound unfair, it’s also important to know that PSPs generally include a clause in their user agreement that covers the possibility of a hold or termination. This clause usually says how long the company will hold funds for and states that the company can terminate a user account at any time for various reasons.

The reality is that no business is completely immune to account freezes or terminations, however. Here at Merchant Maverick, we like to encourage our readers to understand how to prevent this very unpleasant situation from occurring in the first place — whether you have a PSP or merchant account. Check out our post, How to Avoid Merchant Account Holds, Freezes, and Terminations, to find out how you can prevent this unpleasantness.

Next up, we need to discuss one of the most significant issues in the minds of merchants — cost! While cost analysis is going to vary significantly depending on what tools you take advantage of from your PSP, we will guide you through the consideration process in the next section.

Comparing Costs For Merchant Accounts Vs. PSPs

One of the most important things to consider when looking at the difference between a payment service provider and a traditional merchant account is what it’s going to cost you over time! Here is where it can get tricky. The best answer for your business isn’t going to be the same as it would be for the merchant down the street. That’s because it largely depends on the size of your business, as well as the size of your average transaction, and sometimes even your industry.

The pricing for a merchant account or a PSP can go for or against you when you consider your business volume, price per transaction, security compliance fees, hardware costs, gateway fees, eCommerce costs, and the pricing structure of the merchant account itself.

Payment service providers often use a flat-rate pricing structure, meaning that you pay the same amount for a transaction regardless of card type (something like 2.75% or 2.9% + $0.30 per transaction). Usually, PSPs have a low or no monthly fee, and no other costs beyond transaction fees. Usually, transaction costs are deducted from every single transaction, a model known as “pay as you go.” Very small businesses, in particular, tend to save money with this pricing model. But even higher-volume businesses can occasionally save more with flat-rate pricing.

All of the costs associated with a traditional merchant account tend to be a little harder to pin down, which is why it’s so important to read your contract and understand what you are committing to and what fees to expect — because more often than not, there is more than meets the eye. Merchant account providers usually use one of the following pricing structures:

• Tiered Pricing: Transactions are grouped into qualified/non-qualified categories, with qualified transactions costing the least. This model is supposed to simplify payment processing, but often leads to merchants paying more over time as a significant portion of transactions are treated as non-qualified. Pricing might be listed as 1.85% + $0.15 for a qualified transaction and 2.65% + $0.20 for a non-qualified transaction.
• Interchange-Plus/Cost-Plus Pricing: The payment processor passes on the interchange fees mandated by the card networks, as well as a small markup. Pricing might be listed as cost/interchange + 0.2% + $0.10 per transaction.
• Subscription Pricing: Merchants pay a monthly “membership” fee in place of a percentage-based markup, usually along with a small flat fee per transaction. Pricing for this model might be listed as $49/month + 0% markup + $0.15 per transaction.

At Merchant Maverick, we recommend that you seek out a merchant account that uses interchange-plus or subscription pricing because they’re the most transparent models. However, some other fees you might encounter with merchant accounts include:

• Statement fees
• Batch fees
• PCI compliance fees

Pricing structures can make a massive impact on your bill at the end of the day, so be sure to understand what services are billed separately. Typically, smaller businesses do better with a PSP, and once revenue climbs, a traditional merchant account can give you a better deal. However, even now we see that nearly every third-party processor we review here also offers high-volume pricing. Most businesses processing somewhere between $10k and $15k/month in credit cards can start to see cost savings with a merchant account or qualify for a volume discount plan from a PSP. 

Want to know more about credit card processing costs? Check out our post, The Complete Guide to Credit Card Processing Rates And Fees.

Contract Length With Merchant Accounts & PSPs

When it comes to a contract, there is a big difference between a PSP and a merchant account. PSPs usually operate on a pay-as-you-go or monthly basis, and there’s no penalty for canceling the service. Merchant accounts, on the other hand, are a different story.

Here is a snippet from our post, What is a Merchant Account, to give you an idea of what I mean about leaving a contract and the headache that may ensue:

Unfortunately, the industry standard – and the only thing most [traditional merchant account] providers will offer you – is a three-year contract with an automatic renewal clause that renews for one or two-year period after the end of the initial term. Closing your account early will leave you liable for an early termination fee (ETF), which can run anywhere from $200 to over $600. Some providers will even hit you with liquidated damages, which will result in a penalty based on the anticipated processing charges over the entire remaining period of your contract. In some scenarios, liquidated damages can run into thousands of dollars.

That said, the industry is changing and trying to keep up with the times. Plenty of reputable merchant account providers offer month-to-month agreements that you can terminate without racking up expensive fees. However, there’s no shortage of less-than-stellar options that still rely on annual contracts and expensive ETFs. That’s why when it comes to merchant account contracts, we recommend you take the time to understand what you are getting into and be your own best advocate. Make sure you get any promises in writing on the contract (such as a waived early termination fee).

Don’t misread me here, though — there are also things with a payment service provider to watch out for as well. Let’s explore more about both the benefits and risks of choosing a PSP in the next section.

Why Use A Payment Service Provider?

Thus far, we have gone over many considerations that may not be inherently obvious to a merchant shopping for a payment processor. So why do so many small businesses opt for a payment service provider (aka third-party processor)? Much of the popularity of payment service providers has to do with the sweet spot of cost and convenience. Payment service providers woo micro-businesses, pop-up shops, mobile businesses, and growing entrepreneurs with additional tools and payment security.

When it comes to convenience, it doesn’t hurt that you can fill out an application and begin accepting payments the same day! Also, there is no underwriting and no intimidating contracts with a PSP. While merchant account providers are getting a bit friendlier to new businesses, it’s often hard to get your foot in the door. Keeping the balance of cost, convenience, and added tools in mind, it isn’t too hard to see why a payment service provider is so attractive to merchants.

Disadvantages To Using A PSP

While accessibility, speed, and bundled tools can prove to be beneficial for a merchant, nothing comes without a price. A PSP is a third-party processor, and as we have explained in the post, there are some risks associated with this type of account. Because it is so easy to open up an account, there is less of a vetting process and third-party processors are more likely to terminate or freeze an account based on their risk analysis. Sometimes they get it right, and sometimes they do miss the mark.

The most common complaints brought against payment service providers are, without a doubt, early termination and account freezes. Keep in mind that while these are generally the most common complaints, they are still relatively uncommon issues overall. The majority of businesses will have no issues with their account, but that doesn’t mean it’s not a big deal — it is.

As stated previously in this post, we encourage any business owner to read and understand the contract they are signing — whether that is with a merchant account or a payment service provider. Many spell out that they can terminate your account with no warning. In that same vein, we encourage all of our readers to also educate themselves on what may signal a red flag for account termination. Our post, How to Avoid Merchant Account Holds, Freezes, and Terminations, can help you understand what to do (and not do) to avoid this situation in your business.

Is A Payment Service Provider Right For You?

We’ve shared a fair amount of food for thought in this post, and ultimately, it’s up to each merchant owner to decide if a payment service provider is right. Of course, keep in mind that this post is speaking in generalities, and each PSP is going to have its own set of pros and cons. We do a lot of digging and researching here at Merchant Maverick, so if you are looking for something particular, you’ll probably find a post dedicated to it among our reserves. To help support you on your journey, check out these articles:

• The Truth About Mobile Processing
• Stripe VS Square
• Square VS PayPal
• 6 Free Square Tools To Make Running Your Small Business Easier

In the meantime, we hope that this post gives you the information you need to go down the right path to entrepreneurial success!