Third-Party Payment Processor Explained

Digital payments have grown to over $10 trillion in transaction value in 2023, according to Statista - the number that is expected to reach $16 trillion in 2028. As online payments gain the momentum and cash is in decline, third-party payment processors have become more important than ever.

Therefore, it’s key for merchants to understand how third-party online payment processing works. Choosing the right payment processor can enhance customer experience, make operations smoother, and open up new markets. Here's everything you need to know about third-party payments and how to select the best processor for your business.

What Is a Third-Party Payment Processor?

Third-party payment services allow businesses to accept different online payment methods without needing to establish and manage their own merchant account in a bank.

A traditional third-party merchant account is a special bank account that allows businesses to receive payments. Third-party payment processors combine all their clients' transactions into one merchant account. This allows businesses to use the features of a merchant account without the lengthy process of setting up an individual one.

This is especially valuable for small businesses and start-ups. Using a third-party payment network provides a faster and easier way to start accepting online payments.

Online Payment Processing

The core function of a payment processor is self-explanatory – it’s the payment processing itself.

When a customer inputs their payment details, the information is securely sent to a third-party payment gateway. The payment processor then collects the transaction data from the gateway, checks and confirms the details, and then communicates with the acquiring bank linked to the merchant's account.

Next, the acquiring bank sends the transaction details to a card network like Visa or Mastercard, which then contacts the issuing bank. The issuing bank verifies the account status and balance.

It's important to note that card networks do not participate in open banking payments, often referred to as Pay-by-Bank or Account-to-Account (A2A), as these transactions happen directly between the accounts involved.

Once the issuing bank reviews the transaction, it either approves or declines it. Approved transactions are compiled by the merchant at the end of the day and sent to the payment processor for settlement.

Fraud Prevention

Payment processors would typically also offer fraud-prevention services such as anti-fraud transaction monitoring.

There are typically two main methods for this: rules-based logic and machine learning. Rules-based fraud detection follows a straightforward "If x happens, then do y" approach, which is constantly overseen by fraud analysts. The downside of this method is that it might miss hidden patterns or fail to adapt to evolving fraud tactics, as it only examines data within set parameters.

In contrast, machine learning-based fraud management uses transaction data to train adaptive algorithms. Some models mimic the actions of human reviewers, while others are trained on millions of data points. These models learn to identify the difference between legitimate and potentially fraudulent transactions.

Improving Payment Conversions

Another extra service that a third-payment processor may offer is improving your payment conversions. That’s essentially the percentage of payments that were completed successfully.

There are number of factors that may cause lower conversions. For example, shopping cart abandonment is fairly common in e-commerce. According to Baymard Institute, 70.19%  of online shopping baskets are typically left uncompleted. This could happen due to complicated checkout forms and poor user experience.

Therefore, its key to choose a third-party processor that can offer smooth payment experience and a variety of payment options. The most popular payment methods worldwide include digital wallets like PayPal, Apple Pay, GooglePay, credit and debit cards, open banking-led A2A payments and Buy Now Pay Later (BNLP). Keep in mind that customers from various regions and demographics might favor different payment methods.

Payment success also depends on network acceptance, where the issuing bank processes and approves the payment. This decision is influenced by factors like the customer’s balance, transaction details, and system availability.

To reduce issues at this stage, gather extra verification data during checkout, such as CVC, billing address, or postcode. However, avoid making the checkout process overly complex, as it can frustrate users. Your third-party payment provider may be able to advise you on this.

How to Choose Third-Party Payment Processor

Define Your Business Needs

Begin by assessing your payment needs and those of your clients.

Some of the key questions to ask yourself: what channels are you planning to accept payments via? These could range from an online store to invoices with payment links or QR codes to mobile in-app purchases.

Are you offering subscriptions? Then a recurring payment feature is a must.

Another key question is how do your customers prefer to pay (payment methods) and in what currencies. It’s crucial to ensure that the chosen provider can meet these needs.

Define Your Budget

Then, it could be useful to determine how much you are willing to pay and how it fits into the pricing plan provided by a provider. For example, they may suggest commissions, flat rates, subscription-based pricing.

Consider a typical number and value of transactions your business is processing. For example, if it’s fairly large, a subscription model may be beneficial. On the other hand, if your transaction volume is lower, flat-rate­ pricing may prove more cost-effective.

Compare Providers

You can start by talking to sources and reading online reviews. After compiling a list of potential providers, look at their track record in supporting businesses like yours. Look out for the required third-party payment systems and features you identified in the very first step. Focus on those with a strong reputation in your industry.

Test

Now that you've narrowed down a list of providers that fit your business needs, reach out to test their solutions. Many payment companies offer a trial period without requiring a commitment. Pay attention to the UX, the quality of customer support, compliance and security.

Payments & Open Banking with Noda

​​Noda is a global open banking provider that assists online merchants with end-user KYC, payment processing, LTV forecasting and UX optimisation. We partner with 16,500 banks across 27 countries, spanning over 30,000 bank branches. Noda supports a wide range of currencies for globally-minded clients. We offer scalable plans to fuel your business growth and e-commerce plugins for easy integration.

With Noda's advanced Open Banking API, online businesses can easily integrate direct bank payments, offering their customers a seamless and secure payment experience with lower fees. Whether you're looking to enhance customer verification processes, optimise payment systems, forecast long-term value, or refine the user experience, Noda is your partner in growth.