IPSP vs. Merchant Account

John Stuart
Internet billing has undergone a transformation over the past few years, with new stratagems emerging to give merchants a choice in how they want to collect. The two principal systems on the playing field today are Internet Payment Service Providers (IPSPs) — commonly known as third-party billers — and individual merchant accounts. Each system has distinct advantages, but for whom?

"IPSPs are great for start-ups," said Mitch Farber, president of NetBilling, a merchant account payment system. "For those who aren't able to get their own merchant account or who don't have the extra time that it takes to properly manage a merchant account or several merchant accounts, an IPSP is perfect. But once a merchant reaches a certain point in volume or involvement with the business, I feel it's most beneficial to have a merchant account in addition to third-party processing like an IPSP. Most merchants who switch from third-party processing see an increase in transactions and sales conversions, because they're able to have control over their scrubbing.

"One of the disadvantages of having your own merchant account is that you don't have somebody managing you. You don't have anyone looking over your shoulder to make sure you're running your business properly. That shouldn't be necessary, but when a merchant never has had that kind of control before, sometimes people take advantage of that by minimizing the importance of fraud scrubbing. Sometimes they'll set the threshold too low because they want to maximize conversions. That can result in higher chargebacks and a greater amount of fraud."

Despite the chargeback risk, one of the chief reasons why so many established merchants have moved to merchant account billing solutions over the past few years is simply that they get to keep more of their money. Typical third-party billing companies charge merchants between 13 percent and 20 percent for their services. The usual figure is 15 percent. By utilizing their own merchant account with a payment gateway, merchants can pay well under 10 percent, depending on their volume of sales and average ticket price. And if the merchant sells products instead of memberships, the percentage is even less, usually around 4 percent.

"I believe the IPSPs are a great option and will always be there," said Dan Steinberg, co-founder of Orbital Pay. "But to be perfectly candid, I've always been amazed at how many merchants leave as much as four or five percent of their revenue on the table for IPSPs when they are mature enough in their business to operate through their own merchant account. There are excellent, experienced gateways in merchant account billing that can handle the transactions, along with fraud scrubbing and billing support on a fee basis as opposed to paying the high percentages that an IPSP charges. There are excellent individual merchant account options in the U.S. and Europe, and it's a fairly straightforward process now.

"It's a relatively inexpensive process to set up a presence in another region for the purpose of establishing a merchant account. There certainly are advantages in Europe with a 2 percent threshold for chargebacks for Visa, as opposed to 1 percent for Visa North America. There may also be some tax advantages for businesses that establish subsidiaries in the EU.

"There are many mature gateway solution providers now that offer the same value-added tools in individual accounts as in IPSPs. Any competent ISO that places a merchant into an individual merchant account is able to help that merchant manage his business well. The ability to cross-sell, cross-promote, have excellent fraud scrubbing, chargeback prevention, have live 24-seven billing support, have cascading billing solutions, affiliate tracking, payouts for affiliates — it's all there in a merchant account on an à la carte basis."

So why doesn't every established merchant fly immediately into an individual billing account? Some have hesitated because they fear that they'd have to hire their own customer service department if they leave the IPSP umbrella. This is a misconception, according to Mitch Farber.

"That's a big factor for some people who don't have the staff or the time to handle customer service," he said. "Back around 2001, when we started seeing people migrate from third-party accounts to merchant accounts, we decided to open up a call center and handle customer service for them. This gives them all the services that an IPSP will offer, but at a much lower rate. It also gives them the flexibility to handle things the way they want to."

The emergence of the IPSP years ago sheds light on its present predicament. Before the system existed, people had their own merchant accounts with all the merchants beneath it, and they had to maintain those merchants. Then Visa defined the nature of an IPSP, and began making merchants with IPSPs register separately, while making the rules governing them and merchant accounts identical. It meant the chargeback ratios would be the same and the monitoring program would be the same, which leveled the playing field. Merchants no longer could hide behind a third-party processor, because they were seen as separate entities.

"Once people realized they no longer had the protection that a third-party processor gave them," Farber explains. "They asked why they should stay with them and pay more. Back in the Wild West period of the Internet, a lot of banks did merchant accounts, and a lot of people blew through those accounts because there weren't companies to help them manage things. A lot of people didn't have the facilities to manage their own database and do their own fraud scrubbing.

"Now that we've added so many offshore banks to the very solid domestic banking relationships we already had, it allowed us to give merchants their own accounts and to give them backup merchant accounts with other banks. When you work with an IPSP, they take care of the bank business. That's part of the 15 percent fee you pay, because they already have the banks set up. When you have your own merchant account, you can choose your own bank, or use one of the dozens of banks all over the world with which merchant account companies have relationships."

Fraud scrubbing is another important point of divergence between the two systems. An IPSP handles the merchant's scrubbing, making the fraud settings, and the merchant has no control over how they scrub transactions.

"It's not that they don't do a great job," Farber said. "It's just that you lose that flexibility. When you have your own merchant account, you usually have control over the level of your fraud settings. Our company offers scrubbing with 15 different fraud tools and the merchant can set the level however he wants."

But it's not all bad news for the IPSP system. Typically, IPSPs offer merchants an integrated affiliate program that also does affiliate payouts. Many individual accounts do not offer this service, although more are adding it as an option for an additional fee. In most individual accounts, the money is transacted directly between the merchant and the credit card holder. The payment gateway doesn't touch it. This tasks the merchants with handling their own affiliate payouts, which can be a major headache. But as it is with so many issues in the billing arena, this IPSP advantage here is beginning to disappear, as some individual account companies add affiliate payment to their menu of services.

But in the end, each merchant must choose which billing system best suits their needs. And despite the trend toward individual merchant accounts, both Farber and Steinberg agree that the IPSP system is solid and here to stay.