How Electronic Payment Works


Photo courtesy Darren Hester Pixel Perfect Digital

When it comes to payment options, nothing is more convenient than electronic payment. You don't have to write a check, swipe a credit card or handle any paper money; all you have to do is enter some information into your Web browser and click your mouse. It's no wonder that more and more people are turning to electronic payment -- or e-payment -- as an alternative to sending checks through the mail.

In this article, we'll look at the types of electronic payment, discuss its benefits and limitations and explain how to add e-payment capability to your Web site.

Methods and Types of Electronic Payment

Courtesy Amazon

An electronic payment is any kind of non-cash payment that doesn't involve a paper check. Methods of electronic payments include credit cards, debit cards and the ACH (Automated Clearing House) network. The ACH system comprises direct deposit, direct debit and electronic checks (e-checks).

For all these methods of electronic payment, there are three main types of transactions:

  1. A one-time customer-to-vendor payment is commonly used when you shop online at an e-commmerce site, such as Amazon. You click on the shopping cart icon, type in your credit card information and click on the checkout button. The site processes your credit card information and sends you an e-mail notifiying you that your payment was received. On some Web sites, you can use an e-check instead of a credit card. To pay by e-check, you type in your account number and your bank's routing number. The vendor authorizes payment through the customer's bank, which then either initiates an electronic funds transfer (EFT) or prints a check and mails it to the vendor.
  2. You make a recurring customer-to-vendor payment when you pay a bill through a regularly scheduled direct debit from your checking account or an automatic charge to your credit card. This type of payment plan is commonly offered by car insurance companies, phone companies and loan management companies. Some long-term contracts (like those at gyms or fitness centers) require this type of automated payment schedule.
  3. To use automatic bank-to-vendor payment, your bank must offer a service called online bill pay. You log on to your bank's Web site, enter the vendor's information and authorize your bank to electronically transfer money from your account to pay your bill. In most cases, you can choose whether to do this manually for each billing cycle or have your bills automatically paid on the same day each month.

Next, we'll discuss some of the benefits of electronic payment.

Benefits of Electronic Payment

Scheduled payments confirmation screen
Scheduled payments confirmation screen
Courtesy Bank of America

Electronic payment is very convenient for the consumer. In most cases, you only need to enter your account information -- such as your credit card number and shipping address -- once. The information is then stored in a database on the retailer's Web server. When you come back to the Web site, you just log in with your username and password. Completing a transaction is as simple as clicking your mouse: All you have to do is confirm your purchase and you're done.

Electronic payment lowers costs for businesses. The more payments they can process electronically, the less they spend on paper and postage. Offering electronic payment can also help businesses improve customer retention. A customer is more likely to return to the same e-commerce site where his or her information has already been entered and stored.

With all the benefits of electronic payment, it's no wonder that its use is on the rise. More than 12 billion ACH payments were made in 2004, a 20 percent increase from 2003 [ref]. The 2004 Federal Reserve Payments Study noted that from 2000 to 2003, electronic payments grew as payment by check declined, which suggests that electronic payments are replacing checks.

In order to better serve their customers, banks are swiftly moving to offer online bill pay services. Grant Thornton's 2005 survey of bank executives found that 65 percent of community banks and 94 percent of large banks offer 24/7 online bill payment [ref]. Most of these services are free to members and coordinate easily with personal software programs such as Quicken or MS Money. Alternatively, consumers can subscribe to online bill pay services such as Paytrust or Yahoo! Bill Pay. These services charge a monthly fee in exchange for the convenience of paperless bill paying.

In the next section we'll discuss the concerns that some people have about using electronic payment.

Concerns About Electronic Payment

The main drawbacks to electronic payments are concerns over privacy and the possibility of identity theft. Fortunately, there are many safeguards available to protect your sensitive personal information from falling into the wrong hands.

You can defend yourself against identity theft by using virus protection software and a firewall on your computer. You should also make sure that you send your credit card information over a secure server. Your Internet browser will notify you when a server is secure by showing a lock or key icon. In addition, the URL on a secure site is usually designated by the prefix "https" instead of "http." Retailers do their part by using data encryption, which codes your information in such a way that only the key holder can decode it.

Privacy concerns aside, some people simply dislike making electronic payments. They find the setup too time-consuming and don't want more logons and passwords to remember. Others simply prefer the familiarity of writing checks and dropping envelopes in the mail. Regardless of these concerns, electronic payment will likely continue to rise in popularity.

Next we'll learn how to set up e-payment for your small business.

How to Set Up E-Payment for Your Business

Courtesy Paypal

Let's say you have a small business and you want to set up online payments via your Web site. Your first decision is whether to outsource your payment solution or handle it in-house. For those who want an all-in-one solution, services like PayPal and ProPay make it easy for you to accept credit cards and other forms of electronic payment from your site. When a customer enters his or her information on your site, your payment service authorizes the transaction and transfers funds to your account. These services charge a processing fee per transaction.

If you prefer to process payments in-house, the first thing you need to do is set up a secure server. This is a computer that uses encryption to make it difficult for intruders to intercept confidential information. Secure Socket Layer (SSL) technology is used to encrypt the data. You can apply for an SSL certificate online.

Once you have an SSL certificate, you need to register your site with a digital authentication service. A digital certificate validates that the site receiving your customers' information is the correct one. It assures customers that your site is legitimate and that their information is encrypted.

Now that you've a secure server, you'll need to build or buy shopping software that allows a customer to choose products from your site and add them to a virtual shopping cart. When customers are ready to complete their orders, they click on a "checkout" link that takes them to your secure server, where they enter their credit card information.

Finally, you need a system to process credit card payments and an Internet merchant account with a bank. Credit card payment processing services are available through online companies such as Verisign. They provide you with software that validates your customer's credit card information over your secure server. Some businesses also choose to accept electronic checks from customers.

Another potential source of information is the National Automated Clearing House Association (NACHA), also known as the Electronic Payments Association. Let's look next at what this group does and the help it offers consumers and small businesses.

Electronic Payment Association

The Electronic Payments Association provides safeguards to ensure consumers that they're safe when shopping online.
The Electronic Payments Association provides safeguards to ensure consumers that they're safe when shopping online.
© Photographer: Monika Wisniewska | Agency: Dreamstime

The National Automated Clearing House Association (NACHA), also known as the Electronic Payments Association, has helped increase the use of e-payments and e-checks. NACHA governs the nationwide Automated Clearing House (ACH) network. Through this network, NACHA's 11,000 member banks and other financial institutions offer direct deposit, direct debit and e-checks for consumers and businesses.

That activity is fairly invisible as you check bank account balances online, make purchases from online stores with a debit card or pay bills from your bank's Web site. But NACHA's role is an important one. The not-for-profit association develops operating rules and business practices for the ACH network to make sure it stays efficient, reliable and secure -- keeping your electronic payments that way, too.

NACHA also offers tools and resources to help its member institutions facilitate electronic payments. And the association develops electronic payment practices beyond the ACH network for areas like Internet commerce, financial electronic data interchange (EDI) and international payments [source: NACHA].

As one of its services, NACHA tracks the growing use of electronic payment through quarterly and annual reports. For example, the ACH network handled nearly 16 billion payments totaling $30.3 trillion in 2006, a 14.5 percent increase over 2005, according to NACHA statistics. That includes payroll direct deposits, Social Security benefits, tax refunds, payment of 8 billion consumer bills and more. The rate shows that the volume of electronic payments continues to double every five years [source: NACHA].

While most of NACHA's offerings are targeted to its member financial institutions, the association offers help for consumers and small businesses through an interactive Web site.

On the Web site, you can watch virtual demonstrations of how direct deposit, direct payment and check conversion work. You'll also find explanations of the different types of electronic payment along with information on how to decide whether payroll direct deposit and direct payment of bills are good options for you.

The Web site's business section provides a cost benefit analysis of direct deposit and direct payment for businesses of different sizes, marketing tool kits for businesses' employees and customers, and suggested answers to customer questions about check conversion [source: NACHA].

Through its Pay It Green initiative, NACHA is encouraging consumers to receive and pay bills electronically instead of on paper to save trees, fuel and water. The alliance brings together NACHA, the U.S. Federal Reserve, and leaders of the financial and consumer billing industries.

The initiative cites a 2007 survey by Javelin Strategy and Research indicating that if all U.S. households received and paid their bills electronically, the United States would:

  • Save 16.5 million trees every year, providing enough lumber for 216,054 single-family homes
  • Reduce toxic air pollutants by 3.9 billion tons of carbon dioxide equivalents, the equivalent of taking 355,015 cars off the road
  • Reduce by 1.6 billion pounds the solid waste generated each year by 1.6 billion pounds, the weight of 56,000 fully loaded garbage trucks

Paper isn't the only item consumed through traditional bill paying, the alliance points out. The group is developing tools and resources that show the environmental benefits of choosing electronic options over paper [source: NACHA Pay It Green].

For lots more information about electronic payments and related topics, check out the links on the next page.

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More Great Links

Sources

  • The 2004 Federal Reserve Payments Study. Federal Reserve System, December 15, 2004. http://www.frbservices.org/Retail/pdf/2004PaymentResearchReport.pdf
  • "Bankers' Hours a Thing of the Past." WebMetro, August 8, 2005. http://www.webmetro.com/news1detail1.asp?id=1362
  • "Banks Ride ARC to Record Wave of ACH Payments." NACHA Press Release, April 11, 2005. http://www.nacha.org/news/news/pressreleases/2005/Pr041105/pr041105.htm
  • Brandt, Jim. "The Evolution of ePayment Services at UB."O'Reilly: Perl.com, December 9, 2004. http://www.perl.com/pub/a/2004/12/09/epayment.html
  • "EFTPS-Online Gets Major Upgrade." IRS. IR-2003-90, July 21, 2003. http://www.irs.gov/newsroom/article/0,,id=111757,00.html
  • Mosquera, Mary. "The IRS Wants Its Money - Electronically."Government Computer News, April 4, 2005. http://www.gcn.com/24_7/news/35431-1.html
  • Pawling, G. Patrick. "Online Billing Serves Millions." iQ Magazine, November/December 2003. http://www.cisco.com/en/US/about/ac123/iqmagazine/archives/ nov_dec_2003/departments/net_index/online_billing.html
  • Rosen, Anita. The E-Commerce Question and Answer Book. AMACOM, 2000.
  • Sindell, Kathleen. Managing Your Money Online for Dummies. Wiley Publishing, 2005.
  • "What You Need to Implement an E-Commerce Solution." http://www.cisco.com/en/US/netsol/ns339/ns444/ns447/ networking_solutions_white_paper0900aecd800eb57a.shtml