Differences Between a Payment Gateway and Payment Processor

The Federal Reserve asked consumers directly – and found that 60% of payments are made with a credit or debit card.

This leaves businesses with little choice – if you want to maximize your revenues going forward, you need to provide seamless digital payment options to customers. And when you are in the market for payment solutions, you will come across these two terms – payment gateway vs payment processor.

While they may sound similar, gateways and processors cannot be used interchangeably. While equally vital for online payments, each has a unique role. Watch the video below for a basic introduction to payment gateway vs payment processor, and an explanation of the differences.

The Basic Anatomy of an Online Transaction

To explain these two services, first, we need to establish the basics of an online transaction. On the surface of every eCommerce payment, there are four parties. The first two are self-explanatory:

• the customer
• the merchant
• the issuing bank coordinates payment from the customer. Usually, it will partner with a card company like VISA/MasterCard to link a credit/debit card to the customer
• the acquiring bank coordinates accepting payment into the merchant’s bank account

In a typical online transaction, these four entities interact with each other:

1. The customer initiates an online payment at the merchant’s website
2. Payment is processed after secure authentication
3. The funds are debited from the customer’s bank account by the issuing bank (when they pay their bill; in the interim the “credit” is extended by the processor)
4. The acquiring bank accepts the funds and deposits them in the merchant bank account

These steps cannot take place without the transmission of data among the four entities. This is where payment processors and payment gateways enter the equation. Let us explore their separate roles.

How a Payment Processor Works

The original role of payment processors was to help facilitate offline transactions like credit card payments. With the advent of the internet and electronic payments, they continue to perform this role. Payment processors are the ones who provide credit card terminals or other Point of Sale (PoS) systems to merchants. In this offline system, the payment processor plays the role of the messenger while the PoS acts as the security/gatekeeper.

The purpose of a PoS terminal is to verify that the transaction is being conducted with an authentic credit card, presented by a genuine owner of the card/account. Authentication in these situations relies on a combination of an EMV chip embedded in the credit/debit card, and approval from the customer.

Next, the payment processor will send the payment information to the issuing bank. One of two things can happen at this point – if the bank approves the transaction, the processor sends the transaction details to the acquiring bank and communicates the success of the transaction to the customer at the PoS terminal.

If the bank declines the transaction for any reason, like lack of credit balance/funds, the payment processor will relay the details to the customer via the PoS terminal. 

How Do Payment Processors and Payment Gateways Work Together?

Now that you understand the differences between payment gateways and payment processors, it’s essential to understand how the two work together to facilitate payments. Here’s a typical step-by-step example of the role payment gateways and payment processors play when a transaction occurs:

1. Initiation of Payment: A customer initiates a payment by selecting products or services on your business’s website and proceeding to checkout. Here, they enter their payment details. 
2. Payment Gateway Interaction: The payment gateway collects and secures this data through an encrypted form on your website’s checkout page.
3. Transmission to Payment Processor: Once the customer submits the payment data, the payment gateway sends this encrypted data to the payment processor.
4. Authorization: The payment processor forwards this data to the relevant card networks such as MasterCard or Visa, or directly to the customer’s bank seeking authorization.
5. Transaction Approval: The customer’s bank performs several tasks before approving or declining the transaction such as conducting fraud checks and verifying if funds are available.
6. Communication Back to Payment Gateway: The issuing bank sends the transaction response (approval or decline) back to the payment processor through the card networks.
7. Response to Merchant: The payment processor relays the authorization response to the payment gateway.
8. Customer Notification: The payment gateway informs your business’s website or app whether the transaction was approved or declined.
9. Transaction Settlement: If approved, the payment processor initiates settlement by transferring funds from the issuing bank to your organization’s acquiring bank.
10. Funds Transfer: Finally, the acquiring bank deposits the funds into your account, which marks the completion of the transaction process.

What Are the Types of Payment Processors?

There are two primary types of payment processors:

Payment Aggregators

As the name suggests, payment aggregators combine multiple merchants under one large merchant account to collect and distribute their payments. This is the most common type of payment processor because it allows small businesses to accept credit and debit card payments without setting up an individual merchant account. Examples of payment aggregators you might know about include PayPal and Square.

Traditional Merchant Account Providers

When you choose to go with a traditional merchant account provider, this payment processor gives your business an individual or dedicated merchant account. This typically means that when you accept card payments, the funds are deposited directly into your business account. Famous traditional merchant account providers include companies like Chase Paymentech, First Data (now Fiserv), Worldpay, and TSYS. 

How Do Payment Processors Make Money?

There are several ways that payment processors get the money to keep running. These include:

• Transaction Fees: This is the most common way that payment processors raise money to cover operational costs and meet other financial needs. When your business accepts payments through cards or other digital methods, payment processors charge a fee to process each payment, usually between 1.5 to 3.5 percent. Others may charge a flat fee per transaction – a common occurrence in industries with high transaction volumes but lower average transaction values.
• Setup Fees: Another type of fee that payment processors use to make money is the initial fee that you pay when signing up for their services. While not all payment processors charge this fee, many do.
• Annual/Monthly Fees: Some payment processors also charge a monthly or annual fee for maintaining your account with them.
• Equipment Leasing and Sales: Payment processors often sell or lease POS terminals, card readers, and other hardware necessary for in-store transactions, which also contributes to their overall revenue.

Payment Gateways and Payments Online

A payment processor performs the same “messenger” role in an online transaction much like an offline one. But in an online setting, there is no secure PoS device to act as the authenticator. This is where a payment gatekeeper comes into the equation. 

The need for an electronic “gatekeeper” for transactions only arose in the 1990s, after online payments and debit cards became a reality. A payment gateway is like a virtual PoS terminal, tasked with the duty of authenticating a digital payment request by the customer.

Instead of inserting a physical card into a physical terminal, the customer has to enter credit card information and identifying details as proof of authenticity into the payment gateway’s customer-facing interface. If the credentials are correct, the gateway will forward the payment information to the payment processor.

From this point onwards, the transaction works just like in an offline, in-person card transaction where the payment processor securely transmits the transaction data between the merchant and customer banks. Upon successful completion of the fund transfer, the processor shares the details with the customer via the gateway.

What Are The Four Types Of Payment Gateways?

Payment gateways fall into four major types based on their hosting requirements and integration:

Hosted Payment Gateways

These gateways redirect customers away from your website to a secure payment page hosted by the gateway provider. Here, your customers enter their payment details and once the transaction is complete, the gateway redirects them back to your website. While these payment gateways have strong security and are easy to integrate, you (the merchant) may not have complete control over your customer’s checkout experience since the payment takes place off-site. 

Self-Hosted Payment Gateways

Instead of redirecting the customer to another page, these gateways facilitate payment data collection directly on your website. Self-hosted payment gateways provide your business with complete control over the payment process, which is essential for customer experience. Nonetheless, this type of gateway requires you to incorporate strong security measures for compliance with data privacy standards like the Payment Card Industry Data Security Standard (PCI DSS).

API (Integrated) Payment Gateways

Like self-hosted payment gateways, API payment gateways allow you to collect your customer’s payment details right from your site. However, they use APIs (Application Programming Interfaces) to handle the communication between your website and the payment processor. API payment gateways have similar benefits to the self-hosted ones but require advanced technical knowledge to effectively integrate and maintain. 

Local Bank Integration

Local bank integration gateways bypass traditional payment processors and connect directly to the acquiring bank or multiple banks. They are prevalent in regions where direct bank integrations are preferred due to regulatory requirements or operational efficiencies. While these gateways offer cost savings and faster settlement times, they require compliance with local banking regulations.

Understanding the Choice Between Payment Processors & Payment Gateways

As the payment landscape evolves, merchants have more choices than ever when it comes to taking payments. While some payment gateways are available as standalone platforms, many modern gateways come as an integrated service offered by a major payment processor. Authorize.net, CyberSource, and USAePay operate as standalone gateways that connect to several different processors on the back end. Worldpay / Vantiv, PayPal, and Stripe are examples of processors that also have in-house gateway solutions. 

Enterprise organizations may opt to use multiple processors and gateways to ensure maximum coverage in terms of payment volume, payment methods accepted, currencies, and global reach. For smaller merchants, a single integrated payment service is often the most reasonable choice.

If you use Salesforce CRM, Chargent provides you with the best of both worlds: a flexible Salesforce payment processing app that works with more than 30 different payment gateways, and leverages advanced tokenization features to save on processing fees while ensuring data security and business continuity. Payment process automation allows you to route payments to the optimal payment gateway based on customizable criteria, while multi-gateway tokenization enables you to use multiple gateways to meet your business needs.

Wondering which payment processing platform or gateway is right for your business? Let’s chat. Reach out to our sales team today.

Frequently Asked Questions

What is the difference between a payment gateway and a Point of Sale (POS)?

A payment gateway facilitates online transactions by securely transmitting payment information between a merchant’s website or app and the payment processor. On the other hand, a POS (Point of Sale) system is a physical setup used in retail stores and businesses where customers physically present their payment methods. It handles real-time transaction processing at the point of purchase and integrates with inventory management and other business operations.

Can a payment gateway be a payment processor?

Yes. A payment gateway can also be a payment processor, hence why some companies are referred to as payment processing gateways. If your business accepts payments through credit or debit cards, and other digital payments, you require both a payment gateway and processor. That’s why many providers offer bundle services for gateways and processors. Companies like Stripe and PayPal are great examples of providers that offer both services. 

Is a bank a payment processor?

No, this is a common misconception. In payment processing, banks only hold the funds involved in transactions, both on the customers’ and merchants’ ends. When a customer makes a payment, the bank either denies or authorizes the transfer of funds between accounts, but it does not handle the technical processes of transaction verification or communication between merchants and customers.