June 30, 2006, 12:00 AM

Payment Processing

Credit cards have reigned supreme since the early days of e-commerce, with good reason. They are a convenient payment vehicle for hundreds of millions of consumers worldwide and widely accepted by merchants. What’s more, the major card brands-American Express, Discover, MasterCard and Visa-have extensive processing and settlement networks unrivaled by other payment options.

An Internet Retailer survey of 276 web-retailing organizations in October 2005 found that 72% of the retailers accepted all four major cards-American Express, Discover, MasterCard, and Visa. Private-label and co-branded cards were less popular-only 3% of online retailers issued both.

Costly data protection

But credit cards and their first-cousins-signature-debit cards-have some major drawbacks for Internet retailers. First, they are the most expensive option when compared to other online payment vehicles, such as online invoicing, automated clearinghouse payments, personal identification number-based debit, and e-mail payments.

The Internet Retailer survey found that almost 60% paid a discount rate that averaged between 2% and 2.9% per transaction. Another 13% paid rates of 3% or more, while 22% paid a discount rate of 1% to 1.9%.

More than 81% of the retailers also paid their third-party processors additional fees, such as a monthly service charges or per-transaction fees. Small volume retailers typically pay higher fees.

In addition to discount and processing fees, retailers accepting the major credit cards are required to implement strict-and costly-database protection standards, the Payment Card Industry Standard, developed by the major card companies. Merchants failing to comply with the standards face hefty fines and possible loss of their card-accepting privileges.

And costs aren’t the only major drawback to card acceptance. Consumers’ fears of identity theft and other types of fraud make them reluctant to use their credit and signature debit cards for online shopping. Those fears persist even though security measures instituted by the card companies and retailers have succeeded in holding online fraud losses to about 1.5% of total sales.

Automated fraud prevention

The Internet Retailer survey found that 55.4% of the retailers surveyed had an automated fraud prevention program in place. Typically, automated risk management systems flag unusual orders and payments transactions and cross-check a shopper’s billing and shipping address. In addition, 81% of retailers used manual procedures, such as calling a customer about an unusual transaction to identify possible cases of fraud.

Nonetheless, many consumers balk at using their cards at an online retailer. “There are a lot of consumers who just simply will not make an online purchase because they are concerned their credit card data is going to be misused or intercepted,” says Dan Schatt, senior analyst at Celent Communications.

These high costs of card acceptance and consumer concerns about fraud are prompting online retailers to look for less expensive and more secure alternative payment methods. The Internet Retailer survey found that 52.7% of those responding thought it was “very important” or “important” to provide an alternative payments program.

“We’re starting to see competition with credit cards,” says Avivah Litan, vice president and research director at consulting firm Gartner Inc., adding that merchants are looking at such alternatives as financing, prepaid cards and gift cards. She says that alternative payments could account for between 10% and 20% of volume within three years.

Schatt says he expects that alternative payment options could account for up to 26% of all online payments by 2009, up from 14% in 2006.

In any case, retailers need to think hard and long before implementing new payment options, says Alicia Berry, director of operations for DVD Empire. “There are all different kinds of problems and issues,” she says. “You’re dealing with other companies, other servers, all different kinds of people, turnover in sales people. It’s not an easy process.”

Because of the massive effort needed to introduce any new payment option, retailers need to really understand their customer base, Berry adds. For example, customers who don’t qualify for a credit card might not be able to afford a retailer’s product. In that case, “to jump through these hoops, pay additional transaction rates, it’s not worth your time,” she says.

The taxing tax issues

Another payment-processing issue facing online retailers is the growing move by states and the federal government to recoup sales taxes from consumers who buy merchandise tax-free online. About 20 states are getting at least some of that revenue by including a line in tax-return forms asking taxpayers to estimate what they owe for interstate purchases for which the seller did not collect sales tax.

Currently, retailers with interstate sales are required to collect sales tax if they have a physical presence in their customer’s state, says Bruce Krumlauf, product manager at CCH Inc., provider of tax-collection software. “The rule is fairly complex,” he says.

CCH offers CertiTAX, a web-based sales and use tax calculation system that provides real-time address validation and tax calculations based on a comprehensive database of rates and tax rules covering thousands of products and services. When used with CCH’s ZIPSales Returns product, sales tax liability can be gathered from legacy, point-of-sale and general ledger systems and automatically transferred to the appropriate forms for each jurisdiction where taxes are owed. In states that accept third-party filing via EDI or E-File, returns can be automatically filed.

The sales tax issue is just one more indication of how payment processing for online retailers is becoming increasingly complex. As e-commerce continues to grow-and alternative payment options emerge-Internet retailers will find that choosing the right payment processor is crucial.

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