What Is a Payment Service Provider? How It Works & Alternatives

The digital payment industry is a massive industry in today’s digitalized world, and it is forecasted to reach US$10.64 trillion in 2024. 

According to Businesswire, 70% of customers prefer to pay using digital options, and McKinsey’s research shows that 62% of consumers are using at least two different digital payment methods. 

Payment service providers (PSPs) are a big part of the digital payment industry, so it makes selecting the right PSP is a crucial decision that most online businesses must make. 

This article explains what a payment service provider is, how it works, its benefits and drawbacks, and offers guidance on how to choose the right PSP for your business.

What Is a Payment Service Provider (PSP)?

A payment service provider (PSP) is a third party that aids businesses in accepting electronic payments, such as credit cards, debit cards, online banking, e-wallets, and more. 

They act as the liaison between the merchant and the broader payment networks, handling the complexities of routing transactions, securing data transmission, and ensuring compliance. This includes real-time communication with card issuers for authorization and settlement of each transaction.

That said, it oversees the entire process, from the payment initiated by the customer to the reception by the business.

PSP is widely available and commonly utilized. Notably, the global market size for payment service providers is projected to reach USD 20.9 billion by 2028.

How Do Payment Service Providers Work?

Payment Service Providers (PSPs) link with various card and payment networks and connect to different acquiring banks for flexibility.

They consolidate customer businesses into a single, large-scale merchant account, negotiating favorable processing rates based on their high transaction volumes.

When you join a payment service provider, it assumes responsibility for all aspects of your online payments, starting from when a customer initiates a payment until your business successfully receives the funds. 

The process breakdown is as follows:

• The PSP offers a secure and user-friendly interface for customers to input payment details.
• Following customer initiation, the PSP's payment gateway manages the authorization process, confirming the validity of payment details, verifying sufficient funds or credit, and ensuring the transaction's legitimacy.
• After authorization, the PSP transmits transaction details to relevant financial institutions, such as banks or card networks.
• The PSP then routes payments through established connections to acquiring banks.
• The PSP oversees the settlement, making sure money moves from the customer's account to yours.
• Post-transaction, the PSP furnishes comprehensive reports and analytics to the business owner.

Managing payments for multiple businesses requires payment service providers to navigate significant financial risks, leading to the implementation of robust security measures. 

During all steps, the PSP secures sensitive information through encryption protocols, fraud detection systems, and adherence to industry standards.

What Services Do Payment Service Providers Offer?

While services may vary among providers, some common offerings include:

• Accepting payments, namely card and bank-based payments  
• Payment gateway 
• Payment processing
• Currency processing 
• Reporting and analytics tools for transaction insights and customer behavior regarding payments 
• Security compliance with standards like PCI DSS
• Advanced fraud detection and prevention measures
• Customer or technical support for payment-related issues

To illustrate, an international online retail store can streamline its checkout process using comprehensive PSP services. The PSP accepts various international payments, providing a secure gateway and currency conversion. Plus, the retailer benefits from the PSP's built-in security measures to deter unauthorized purchases.

The retailer can also leverage analytical tools from the PSP to understand peak transaction times, preferred payment methods, and regional purchasing patterns. In case of any transactional issues, they can rely on the customer support offered by the PSP.

Examples of Payment Service Providers

• PayPal -Widely embraced for online transactions and mobile payments, PayPal stands out as a payment service provider with robust purchase protection and a global reach.
• Stripe - Tailoring its solutions for businesses of all sizes, Stripe is the preferred payment service provider choice for users aiming to build and scale their platforms or marketplaces.
• Square - A payment service provider specializes in providing payment processing and gateway solutions tailored for small and mid-sized businesses, especially in the food, beverage, retail, and beauty sectors. Square distinguishes itself with a customer loyalty program.
• Adyen - A payment service provider known for its strong international payment processing. In contrast to Square, Adyen may be more suitable for larger enterprises with intricate payment requirements. 

Payment Service Provider Versus Other Financial Entities

The terms payment gateway, payment processing, payment service provider, and merchant account are frequently used in discussions about online payments. Each of these terms refers to a service or application that serves as a financial intermediary between businesses, customers, and banks.

Although some of these terms are sometimes used interchangeably, there are differences between them.  

Let's explore these distinctions.

PSP vs Payment Gateways

Among the services provided by a PSP, a crucial component is the payment gateway. 

The difference between a payment service provider (PSP) and a payment gateway is that a PSP offers a broader entity of electronic transaction services, whereas a payment gateway specifically acts as a secure communication portal for transmitting payment information between businesses and payment systems.

In analogy, the payment gateway serves as an entry and communication point. Meanwhile, the payment service provider functions as a more comprehensive unit that incorporates the payment gateway along with other essential services such as security and reporting functionalities.

🔎 Tip: Looking for a payment solution for your online store? Explore the best payment gateways and payment methods for ecommerce.

PSP vs. Payment Processing

Payment processing is among the services provided by payment service providers.

In greater detail, payment processing is performed by a payment processor, which collaborates with a payment service provider.

Payment processing encompasses the technical process of transferring funds from customers' accounts to merchants' accounts, involving key steps such as authorization, capture, settlement, and clearing.

PSP vs Payment System Operator (PSO)

A payment system operator (PSO) oversees and manages a payment system, ensuring its efficiency, reliability, security, and compliance with regulations. 

Examples include card networks (e.g., Visa), clearing houses (e.g., ACH), and real-time payment systems (e.g., Faster Payments Service or FPS). 

On the other hand, a payment service provider (PSP) connects merchants to those payment systems, offering access to multiple methods through a unified platform. 

PSP vs. Merchant Account Provider

Both PSP and merchant account providers make it possible for businesses to accept online payments. 

A merchant account provider is a service that provides a dedicated account and issues a unique Merchant Identification Number (MID) to each business to accept online payments. In other words, it is a type of bank account or business account that enables businesses to accept payments.

In contrast, PSPs operate with a shared or aggregated merchant account, allowing multiple businesses to share a single account and MID for payment processing.

Why Use a Payment Service Provider?

Using PSPs and their payment systems has several benefits. The main advantage is that they handle all the payment tasks, letting you focus on your main business without stressing about payment infrastructure. 

Let’s see the breakdown. 

Ease of Setup 

Without a payment service provider (PSP), businesses would need to create merchant accounts separately and set up their payment gateway on their own. 

This can be a time-consuming and complex process involving various approvals and technical configurations.

Contrastingly, PSPs streamline this setup with easy-to-use APIs and integration tools. 

With a PSP, you get a merchant account through them, and they handle the payment processing, eliminating the need for finding or setting up a separate payment gateway.

Access to Various Payment Methods and Currencies

PSPs make it easy for businesses to receive and offer various payment methods, including credit cards, debit cards, digital wallets, and bank transfers—all in one place.

This convenience is made possible as PSPs establish partnerships, possess an adaptable infrastructure capable of handling diverse payment types, and leverage their negotiating advantages. 

Many PSPs can also streamline the settlement of cross-border payments, utilizing their extensive network of partners. This way, businesses can reach a global audience.

Robust Security and Compliance

Handling security and compliance on your own can be quite intricate. However, choosing a PSP simplifies the entire process, as PCI security compliance is typically integrated into their services at no extra cost.

Payment service providers prioritize secure transactions by adhering to industry standards like PCI DSS. 

Additionally, they employ encryption technology, tokenization systems, advanced authentication methods, real-time monitoring systems, and more.

Reporting and Analytics

Keeping track of transactions, whether through spreadsheets or in-house software, can be a time-consuming and costly process that complicates business management. 

Meanwhile, payment service providers typically include detailed and advanced reporting tools, offering insights into transactions, customer behavior, and overall performance.

For instance, PSPs can generate real-time reports that break down transaction patterns, assisting businesses in identifying peak sales periods and popular products or services. 

Furthermore, some PSPs offer advanced analytics tools that empower businesses to gain a deeper understanding of customer behavior by analyzing purchasing patterns, demographics, and preferences. This, in turn, allows businesses to tailor their products and services more effectively to meet customer expectations.

Payment Service Provider Limitations

Having discussed the advantages, let's move on to address potential downsides. 

While not universal, these are common issues that may arise with payment service providers. 

Challenges in Transaction Reconciliation

Reconciling transactions may get tricky when payment providers deduct fees from each transaction, which means the transaction proceeded, and the bank deposit may not match precisely. As your transactions grow, navigating these fees becomes increasingly complex. 

In contrast, providers of merchant services accounts typically invoice a consolidated sum, separate from your deposits, on a monthly basis. This straightforward approach can simplify bookkeeping processes.

Possible Transaction Limit

Payment service providers may establish account limits as a preventive measure against issues like fraudulent transactions. These limits often restrict the frequency of processing daily, weekly, or monthly transactions, potentially hindering the handling of large transactions.

These restrictions elevate the risk of false declines, which could result in annual revenue losses.

On a side note, you may be able to negotiate and adjust these limits directly with the payment service provider. To navigate this process effectively, offer a comprehensive overview of your transaction patterns, business model, and growth projections. Emphasizing your clear business purpose reinforces your legitimacy and might strengthen your case. 

How to Pick the Right Payment Service Provider

With many payment service providers available, let's look at key factors to guide your decision. 

Security and Compliance

When choosing a payment service provider (PSP), prioritize those that meet crucial standards:

• PCI DSS: Ensures cardholder data security for businesses handling card information.
• SSL/TLS: Guarantees encrypted communication between your website and the PSP, safeguarding data from being tampered with.
• PSD2: Governs EU payment services, ensuring regulatory compliance for services offered in the EU.

Supported Currencies

Supported currencies refer to the types of currencies a PSP can accept and process. 

To cater to diverse markets and customer preferences, it's beneficial to accept multiple currencies on your website. This enhances conversions, reduces cart abandonment, and boosts customer satisfaction.

When selecting a PSP based on supported currencies, consider the following:

• Currency Coverage: Choose a PSP that supports the currencies relevant to your business and customers. For global sales, prioritize major currencies like USD, EUR, GBP, etc. 
• Currency Conversion: Opt for a PSP that offers competitive and transparent exchange rates and fees for currency conversion. Ensure flexibility in controlling currency conversion options, such as choosing the base currency and settlement currency.

Supported Payment Methods

Selecting an online payment service provider involves understanding your payment requirements and finding the PSP that meets them. Among these requirements, payment methods are the most fundamental.

Essentially, you want a PSP that allows you to accept multiple payment methods, especially those preferred by your customers. 

For global online sales, prioritize the globally favored payment methods in ecommerce like digital wallets, cards, account-to-account transfers, and buy-now-pay-later services.

Integration Capability

Refers to how smoothly a payment service provider can connect with your website and systems. As a general guideline, opt for a PSP that offers plugins, APIs, or SDKs. Flexibility in customization is a bonus point.  

Additionally, prioritize a PSP that provides useful documentation, tutorials, and technical assistance through various channels.

Fees 

Understanding the fee structure is crucial when choosing a payment service provider. 

Look for transparent pricing models that detail payment processing costs and transaction fees, whether flat rate or a minimal percentage of the transaction amount. 

Possible hidden fees to keep an eye out for include statement fees, monthly minimums, monthly fees, chargebacks, international payments, terminal fees, gateway fees, and early termination fees.

To avoid surprises, review the terms and conditions and inquire the provider directly about any potential extra fees that may not be explicitly outlined on the provider's website or in their marketing materials.

Alternatives to Payment Service Providers

If you prefer having direct control over your payment processes or find payment service providers’ potential fees challenging, take a look at these alternatives: 

Conventional Merchant Accounts

They are dedicated commercial accounts designed for accepting payments and managing other financial aspects of a business. You can connect these accounts with payment gateways. 

Merchant accounts provide enhanced control and the potential for lower fees on debit card transactions. On the flip side, they may come with lengthier application processes. 

Additionally, there might be a requirement to maintain a minimum balance in the account.

Peer-to-Peer Payment Applications

Peer-to-peer (P2P) Payment Apps are mobile applications enabling users to send and receive money to one another. 

These apps are typically free to download and use, with no transaction fees, except for specific transactions like international transfers or credit card payments.

While generally geared toward individual transactions and with limited features, these apps may prove sufficient for small niche businesses, side hustles, solopreneurs, and small service providers.

Final Thought

Payment service providers (PSPs) play a crucial role in managing online payments for businesses. They handle the technical components of processing transactions securely and facilitate access to diverse payment methods. 

In essence, teaming up with a PSP allows merchants to offer their customers convenient payment options without needing to manage the underlying payment infrastructure themselves.

However, along with the benefits, PSPs also pose challenges, including navigating fees and transaction limits.