As e-commerce has taken off over the last couple of decades, so has the range of choices in how to accept payments online. Where the checkout was once dominated by credit card payments and Paypal, a variety of wallets, BNPL, and other online payment methods have become common. And more payment methods are springing up every year.
With all these choices, it may be tempting to offer the biggest range of payment methods possible to ensure no matter what your customers want, they will always have their preferred choice. But the reality is more complex. Multiple online payment methods at the checkout translate into too much choice, which negatively affects conversion. Also, your customers may fit a certain profile. If some come from other countries, they may expect their own preferred wallets or BNPL options, but offering all these to all your customers is just not realistic.
With that in mind, we will walk through the pros and cons of key online payment options you may consider offering for your customers.
How it works
A credit card works by letting your customer borrow money from the credit card issuer to buy your goods and services. The customer then pays the borrowed amount back either in full or in monthly installments. If they don't repay in full, they will also be paying interest.
Why it's important
As the most established way to pay online, credit cards need little introduction. They are one of the most popular online payment methods and — since consumers expect them — a key payment option for merchants to offer.
However, they do have some significant drawbacks for merchants and customers alike.
For merchants in the US, card fees are typically 2.87% to 4.35% of each transaction, excluding merchant service provider fees and costs. These so-called swipe fees are the highest credit card fees in the world. And on top of that, depending on your business size and profile, you may also need to invest in fraud management solutions, driving the cost of offering credit cards as an online payment method higher still.
For customers, since making an online payment with a credit card involves manually entering a string of numbers, it can negatively impact the customer experience, leading to poor conversion at the checkout. Credit cards also have a range of issues; from interest, fees, the risk of theft or loss, and expiry dates that interrupt purchases at inconvenient times, to the fact that the credit card points system — long seen as a reason to have one —just isn't worth it.
Credit cards will remain a go-to choice for merchants to accept online payments for the foreseeable future, due to consumer expectations. Furthermore, they are embedded into the plumbing of other payment methods such as wallets. Nonetheless, they do have some significant drawbacks, and it is important to be aware of the pitfalls that come with them.
How it works
Digital wallets are apps that securely store payment information. They come in two flavors.
The first group — think Apple Pay and Google Pay — are those which are a proxy for credit or debit card purchases. These wallets store a user's card details and security information within the wallet, which then acts as the go-between in a traditional card transaction.
By contrast, the second group of wallets actually holds funds itself — think PayPal, or the popular Chinese wallet WeChat Pay. Users load the wallet with funds in order to make a purchase (or in some situations the necessary funds are loaded automatically when a transaction is made).
Digital wallets typically offer built-in two-factor authentication and well-defined security protocols, making them arguably a more secure online payment method than credit cards alone. And as there is no physical card involved, digital wallets offer a more seamless payment experience to the consumer.
Why it’s important
These security and experience advantages are probably why wallets account for a large and growing share of e-commerce transaction volume — according to some estimates, they will be responsible for over half of all transaction volume globally by 2025. And they can help reach younger demographics. Over 80% of 18-24 and 75% of 25 to 34-year-olds reportedly use debit cards in payment wallets — figures which drop rapidly in older age groups.
While digital wallets have several important advantages over credit and debit cards, they are a layer over the top of them rather than a fundamental reimagining of the outdated plumbing behind credit and debit card transactions. This means that in spite of the convenience to customers, swipe fees and other issues still lurk beneath the surface.
Digital wallets are an important online payment method for many merchants to offer. They frequently have better security and greater convenience than credit or debit cards, and are very relevant to younger consumers. Nonetheless, it unnecessarily embeds cards into the payment plumbing, along with their associated costs, and there is often a fee on top of the card processing fee, which can be expensive.
How it works
Buy now, pay later (BNPL) services offer short-term installment loans that allow consumers to finance their purchases over a set period of time, interest-free.
When a consumer chooses to pay with a BNPL payment method for the first time, they are asked to enter some personal details, such as address and Social Security number, after which the BNPL provider runs a soft credit check. Once a customer is approved they typically make an upfront payment toward the purchase, then pay the remainder off in a predetermined number of installments.
The BNPL vendor charges a fee — such as a percentage of the transaction — which is billed directly to the merchant. The fee gets deducted from the sum the BNPL lender remits to the merchant.
Customers often have different options for paying off the loan balance, which depend on the company used and the amount borrowed. Some payment options incur interest, but others do not, and some BNPL providers charge late fees or fees for missed payments.
Why it’s important
BNPL is an interesting choice of payment method for several reasons:
They are growing fast. Between 2019 and 2021, the number of BNPL loans originated in the U.S. by the top five lenders grew by almost ten times, and the dollar volume of BNPL loans grew by over ten times, from $2 billion to $24.2 billion.
BNPL use is dominated by Gen Z, a generation starting to question credit cards. A significant number of users do not have credit cards, meaning it is a complementary payment method to offer alongside cards and wallets.
Consumers love their convenience and the fact that they often don’t get charged any fees. Nearly 60% of consumers say they prefer BNPL over credit cards due to the ease of set payments, the simple approval process, and lack of interest charges.
In addition, if you are a retailer, it is good to know that many retailers report that customers who use BNPL spend more on average than those who do not.
While customers love its convenience, regulators are paying attention to a number of risks associated with BNPL products. These include opaque fees, data harvesting, lack of disclosure, the risk of consumers racking up unsustainable debt that can affect their credit scores, and so on. Therefore, they are likely to regulate the space more in the coming years, which could potentially make it less attractive to customers.
Aside from that, the costs of offering BNPL for merchants are high — anywhere from 3.5%+ to 6%+. While some of this may be offset by greater average transaction value when compared to other online payment methods, you need to be sure that this compensates for the significant costs per transaction.
BNPL can be an attractive payment method, particularly for retailers, who want to reach younger demographics. But they come at a cost, are likely to face greater scrutiny and regulation in the near term future, and are not suitable for many types of businesses (subscription-based businesses, utilities, and lenders to name a few).
ACH Direct Debit
How it works
An ACH (Automated Clearing House) Direct Debit payment is a type of account-to-account (A2A) payment. A2A payments do not go via card networks such as Visa or Mastercard. Instead, they use other networks — in this case, the ACH network — and therefore avoid card network fees.
With ACH Direct Debit payments, merchants are responsible for collecting customer authorization, in which the bank account holder consents to the merchant debiting their account. The authorization must specify the account and routing numbers, amount (which can be variable), date, frequency, and instructions for revoking the authorization.
Why it’s important
Two key advantages of ACH Direct Debit payments as an online payment method for merchants are cost and retention. As mentioned above, since an ACH payment is not routed through the card networks, it tends to be a cheaper method for transferring funds. And because it comes from your bank account directly, there is no risk of your customer’s credit or debit card expiring. If you are a subscription merchant, this means your customer retention is not at risk from involuntary churn — where a customer leaves unwillingly because their credit card expires or fails.
The ACH network moves an enormous volume of transactions because it includes government, payroll, and business-to-business transactions, as well as international payments. In fact, in 2021 an incredible $72.6 trillion moved over the network. If even a fraction of this transaction volume was moved as a payment method for online purchases, it is still worth keeping in mind as an online payment method for your customers.
However, ACH payments do have a number of drawbacks, especially for consumer-to-merchant transactions. For consumers, ACH payments can involve a lot of friction since the standard process involves manually entering their account and routing numbers, which is tedious and can negatively affect conversion. Furthermore, ACH isn’t a “smart” payment method. Merchants and even the network itself can’t tell from the account and routing numbers alone whether the consumer has sufficient funds for the transaction.
ACH payments have some significant advantages over the previous online payment methods mentioned. However, the technology has been around since the 1970s, and has some key drawbacks that make it sub-optimal for many merchants. Nonetheless, if the key issues of convenience and intelligence could be overcome, ACH would be a viable — even compelling — alternative to cards and wallets. And that is what we will look at next, with open banking payments.
How it works
Open banking payments is a new type of online payment method that is already popular in Europe and other parts of the world.
Like ACH payments, they are a type of account-to-account (A2A) payment, and even run over the ACH network. This means funds are transferred directly from a customer’s bank account to a merchant’s, with no intermediaries such as credit card companies, risk management solutions, and so on in between. But there are several important differences, too.
First, open banking providers such as Link Money redirect customers to initiate the payment in their own trusted bank environment, meaning it is far easier, more secure, and more convenient, leading to a higher conversion rate. Your customer may authenticate the payment with their PIN or biometric credentials such as thumbprint or face, rather than manually entering a string of numbers (which can also be stolen or stored). This has the extra benefit of further reducing the chance of fraud.
And second, the innovation curve in open banking payments is just beginning. Improvements such as faster settlement times — eventually leading to real-time payments, verification solutions that ensure your customers are utilizing real bank accounts with enough funds in them to make a purchase, and more, are already in the pipeline.
Why it’s important
Open banking payments have several advantages over comparable online payment methods such as cards and wallets.
Reduced cost. Open banking payments are 70-80% cheaper for businesses when compared to credit cards.
Lower fraud. ACH fraud is an order of magnitude lower than credit card fraud.
The key issue around open banking payments currently is that they are not yet well-known by merchants, and therefore not well-known by customers. But that is a situation that can change rapidly — bear in mind how quickly BNPL has come to prominence over the past few years.
Open banking payments offer a number of compelling advantages over established online payment methods such as cards, wallets, and BNPL. And since they are a bank transfer initiated from within the customer’s bank app, they tend to be trusted by consumers too. Innovative merchants have an opportunity to lower the costs of doing business while improving the customer experience by offering open banking payments alongside other key payment methods.
Accepting payments online is a strategic consideration
Merchants come in all shapes and sizes, and since it has a huge impact on conversion, so should their payment strategies.
Many merchants – particularly retailers — should offer a range of online payment methods, including a mix that takes into consideration the ages, geographic locations, and general payment preferences of their customers. These merchants should be looking at conversion rates and costs in terms of fees, fraud, and so on, keeping an eye on innovation and how they can develop a competitive edge through payments, and continually fine-tuning their checkout experience to ensure the optimal mix between conversion, costs, and experience.
Other businesses — think utilities, lenders, and some subscription providers — should zero in on the single payment method that offers the lowest cost and highest conversion, and do away with the complexity of offering others.
The key thing to keep in mind is that thinking about payments as a strategic lever of growth can pay huge dividends and that what is best for other businesses may not be best for yours.
If you’d like to learn more about how open banking payments may be able to reduce your swipe fees by 70% and lower the costs of doing business, get in touch.