An Analysis on the Types of Online Payment of E-commerce

An Analysis on the Types of Online Payment of E-commerce
XIE Mianbi
Finance and Economics College, Jimei University, P. R. China, 361021
Abstract As online transactions become a significant part of the economy, the online payments become
more important for E-commerce. This paper analyzes and compares the current types of payments of
electronic commerce. Especially, we focus on the process and feature of prevalent online payment
methods, and try to put forward some guidelines of selecting an online payment method for e-commerce
firms and highlight the options that apply best to online businesses.
Keywords: Online payment systems, e-credit, e-commerce, payment gateway,
1 Introduction
The emergence of electronic commerce (E-commerce) over the past decade has radically transformed
the economic landscape. Trading via the Internet is increasing at a significant rate. It recently saw global
double-digit growth nearing 50% on a year-to-year basis, and within China alone the E-commerce
trading is reported to reach RMB 1.1 trillion in 2006. They can be expected to continue in the future.
The growth in trading via the Internet, together with the underlying need for secure transactions,
increases the importance of online payment systems. Online payment systems can be defined as the
means and processes involved in conducting transactions online; this description includes the online
monetary connections between sellers, buyers, financial institutions, and intermediaries.
The benefits provided by online payment systems include improved cash flow efficiency, guaranteed
transactions, reduced costs, and increased protection of sensitive information. However, payment fraud
is 30 times more likely in the virtual world than in the physical world [Valentine, 2003]. Accordingly,
consumers conducting business over the Internet are extremely concerned with the security of their
personal information [Wright, 2002]. Given that fraud is a prevalent concern with online transactions,
the security of online payment systems is particularly important.
Customers' confidence with respect to the trustworthiness of the payment system and its operator is
defined as trust. If customers are not confident with that a company will provide them with guaranteed
transactions, they may refuse to conduct business with the company. Companies that provide secure,
reliable online payment systems for customers should increase consumer trust and facilitate the growth
of e-commerce. So trust is considered a pre-condition for a blooming e-commerce.
Trust can be developed if users know that the payment system operator is bearing most of the risks. And
security techniques also increase the trust users feel. In some extent, online payment providers help
reduce some of the risks associated with online purchasing by guaranteeing transactions with proper
support and by protecting sensitive information [Wright, 2002].
Many payment methods can be used for online purchases. Of these methods, Meng and Xiong [2004]
categorize online payment options into three categories: e-credit (electronic credit cards), e-cash
(electronic cash), and e-check (electronic checks).Each category in this model represents can be
considered as methods of payment in the physical world applied to their digital use on the Internet
[Peffers & Ma, 2003]. Because of existing electronic infrastructure surrounding e-credit, these types of
processes have been the easiest for businesses to adapt for viable commercial use online.
Despite the growth and importance of online payment in the current economy, and relative literatures
grow quickly, little academic literature exists in the area that compares different online payment systems
currently used in practice and describes their implementation. In this paper, we will try it, and make
some suggestion for small e-commerce firms to select online payment method.
The discussion proceeds as follows. We firstly describe the components of the traditional e-credit
payment systems, third-party payment system and micropayment, analyze their implementation and
features. Next we discuss the guidelines for small e-commerce firms to select online payment method.
The final is conclusion.
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2 Major types of online payment
Online payment has various methods, but in Chinese e-commerce practice, online payment system can
be categorized to thee type, conventional credit card payment, third party payment and micropayment.
2.1 Conventional credit card payment
Before the third-party payments were developed, the only way to accept online payments for a business
was to obtain a merchant account from a bank, implement a virtual shopping cart, and program an
interaction with a payment gateway. During a typical transaction, these components interact with the
customer, merchant, merchant bank, and credit card issuer.
Shopping cart is a type of software which maintains a link between a particular client and a set of
selected items on the website. This virtual shopping cart allows a customer to select more than one
product at a time because all selected items are stored within the cart. It acts as a link between the
commerce website and the credit card processing network. Information entered by the user on the
website is transmitted to the payment gateway to begin a transaction. Upon approval from the
cardholder's bank, the payment gateway sends an authorization approval to the shopping cart. The
shopping cart then relays this information to the website so that the customer can see the transaction
approval.
A payment gateway connects the commerce website and shopping cart, the acquiring bank, and the
issuing bank (cardholder’s bank). It handles all communication messages between these entities. By
handling the two key parts of credit card processing, authorization and payment settlement, it is the key
link in an online transaction. During authorization, the credit card information from the website is sent
to the payment gateway by the shopping cart, which verifies the card information and then sends a
request to the cardholder's bank for the card to be charged. If the card information is valid and
customer's credit is sufficient, then the credit card company sends an approval to the payment gateway,
which in turn communicates with the shopping cart and confirms the authorization for the purchase.
Then the gateway initiates a payment settlement to allow the transfer of funds from the customer’s credit
card account to the merchant' s bank account.
Figure 1 shows a transaction process in this system. It is necessary that all the components of the system
are compatible with one another for the transaction to be approved by all the entities.
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1. Customer orders and
credit card Information Is
sent to the shopping cart
Customer
Shopping Cart
6. Notifies shopping cart to verify
the relative Information to
authorize the purchase
2. Sends credit card
Information to the
payment gateway
Payment Gateway
3. Check credit card
Information
4. Sends request for
payment authorization to
the card Issuing bank
7. Sends funds settlement
request and acquiring
account Information to the
card Issuing bank
Issuing Bank
Acquiring Bank
5. Reviews the credit
Information and checks the
credit limit
8. Funds are transferred
Figure 1 conventional credit card payment process
There are some merits of the payment approach. First, the credit card information is accepted by the
payment gateway which is maintained by the card issuing bank, and the merchant can not access this
information. So it can improve the security of payment. Second, this method uses the financial network
directly, so the fund is transferred instantaneously. However, on account of every credit card issuing
bank has its own payment gateway, when the e-commerce firms want to expand their customer basis;
they have to maintain a lot of links with different gateway. And it is not easy for a small firm. Finally,
just owing to its fund delivered instantaneously, and the fund return is difficult when mistake is made, at
the same time, customers can not check the commodity really during the online purchasing, it may the
decrease the customers' trust.
2.2 Third-party payment
The third-party payment systems are similar to conventional payment systems. In a third party process,
the third-party provider processes all the funds in the transaction. These funds can then be transferred to
the merchant' s bank account just as funds can be transferred to and from the merchant account in the
conventional approach. The system follows similar procedures as outlined in the conventional system,
with a few exceptions. Figure 2 illustrates a typical transaction in a third party solution.
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Figure 2 a typical transaction in a third party payment
As in the conventional payment system, the shopping cart in a third-party payment system is still
responsible for maintaining a connection between the customer and their selected items on commerce
website. Once the customer opts to pay for their items, the shopping cart forwards the customer to a
webpage maintained by the third-party to collect credit card information. The merchant’s website never
processes any credit or personal information.
However, the payment gateway within this system is quite different from the traditional system. In this
payment approach, only the third-party maintains the link with the financial network passing payment
gateway. The third-party provider receives authorization and holds the funds in trust for the subscribing
business.
With a third-party service, it is necessary for both the merchant and the customer to create an account
with the third-party. This duality greatly simplifies the payment process because all processing is
handled internally through the third-party. The external banking network does not need to be accessed
during transactions.
The simplicity of the system makes it a good method for low-volume sellers, or merchants who sell via
web auctions. Using an online payment provider such as PayPal, Payease or VeriSign allows businesses,
particularly small e-commerce firms, to conduct business online easily; because they need not maintain
links with different gateways by themselves.
Under the third party payment method, buyers and sellers trust each other via the third party. Before
funds are transferred really, the buyers can check the production, if they don’t satisfied with it, they can
withdraw their funds from the third party. This can enhance customers' trust and increases their
customer base. When the sellers are concerned, before the production is shipped, they can take the
promise from the third party. This also can enhance their confidence.
2.3 Micropayment
The concept of online micropayment has various definitions. A lot of systems claim to be micropayment,
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All of them are capable of handling arbitrarily small amounts of money and funds delivery occurs nearly
instantaneously.
Micropayments facilitate the payment for content online. For certain products, such as music, papers, art
or other non-tangible goods, when they are sold online, the payment system must be able to handling
arbitrarily small pieces and deliver instantaneously. So micropayments are seen as a way for content
creators to obtain revenue and avoid the free riding problem.
The main types of micropayment are e-cash, virtual currency and mobile payment. E-cash has been
theorized and debated for a long time, but only limited commercial success has been realized. Virtual
currency and mobile payment are more popular in practice, especially in china. The following we
discuss these two types of micropayment.
Virtual currency
Virtual currency started in China when companies like online game giant Tencent or QQ wanted to let
gamers buy virtual Q coins at 1 Q Coin per RMB to buy clothes and weapons for their game personas.
In general, it is issued by merchants themselves, in order to let their customers to buy their own
productions conveniently. In nature, it is affiliated payment method. Customers need to buy virtual
currency via other payment method. After the purchasing of virtual currency, the fund has been
transferred to the merchant. When customers use virtual currency to pay for their purchasing, it just a
trade confirming, there are not funds transferred.
China' s major internet portals have issued their own virtual currency. Aside from Tencent, SINA has
U coins, Netease has POPO coins, and Baidu (BIDU) also has its own currency. Virtual currency can be
used conveniently on the platform of the merchant’s website. Q coins can be used to buy virtual
products such as items to use in games, and allows users to play online games, purchase electronic
greeting cards, and use antivirus software. Baidu currency can be used to watch movies on Baidu’s
website and to download music, and Sina’s U coins can be used to purchase real goods from Sina’s
online mall. But the Interoperability or compatibility of virtual currency is low. It can only be used
within the platform which issued it.
Virtual currency is issued by merchant themselves, they can manage it conveniently; but it is not easy.
There have been accounts of hacking into other peoples accounts to steal virtual currency. So security is
a high challenge to the merchant. If they can do well, it will weaken the trust of their customers.
Mobile payment
Mobile payment is a point-of-sale payment made through a mobile device, such as a cellular telephone,
or a personal digital assistant (PDA). Using mobile payment, a person with a wireless device could pay
for items in purchasing online without delivering credit information via internet. Mobile payment
involves customer, merchant, server provider (SP) and communication operator (CP). When a customer
enters an order and select mobile payment, the website will request the customer to enter mobile phone
number; then deliver payment request to SP, SP sands a SMS to the customer for payment authorizing
via CP; if the customer confirms it, this bill will be recorded on the mobile phone number.
Mobile payment is convenient and secure for customers. They can pay everywhere and in every time.
But for merchants, they have to transfer their fund from CP via SP in a periodical time. Recent research
tries to make the integration of credit card and wireless technology and realize mobile payment, till now
it is not popular in practice, but it may be the future trend.
3 Selecting guidelines on payment methods for small firms
With so many options available for online payment, it may be difficult for the merchants to determine
which method best fits their business needs and business model. The key factors affecting payment
method decisions are convenience, security and cost.
Convenience was the greatest determinant for customers to use online payment. Convenience is
becoming an increasingly important issue in modern society. A major function of Internet business is to
provide convenience in information gathering and order processing. Shopping convenience plays an
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important role in the success of e-commerce. Therefore, an e-commerce firm should select the most
convenient payment method as possible. Online payment methods have various levels of convenience.
Among the above payment methods, micropayment may be the most convenient, and conventional
payment follows, the third party payment ranks rear. But they are all are more convenient than other
offline payment, such as a money order or a cashier’s check.
In general, online payment methods differ in terms of risk. Most of the risk associated with online
transactions arises from the physical separation between buyers and sellers. First, sellers and buyers
cannot see each other. Second, during online purchasing, customers cannot closely examine the product
before purchase. Thus online customers are exposed to potential risks and fraudulent transactions. The
risk is also affected by the payment method itself. For example, some customers are afraid that their
credit card information may be intercepted by a malicious party during transmission over the Internet, or
that the sellers may misuse their credit card information. With conventional credit card payment and
mobile payment, the funds are transferred directly when customers have authorized, while the third
party payment can decrease the risk by providing a chance for buyers to examine the product before
funds are really transferred, and sellers to confirm funds can be delivered before production being
shipped. The risk of virtual currency lies on the reputation and ability of risk management of the issuer.
Many third party payment providers offer fraud protection and risk management packages included with
their service or as an additional purchased feature. Generally smaller businesses do not have the
experience or resources to manage all risk internally; when they use the third party payment may benefit
from a larger, external institution handling risk management.
Online payment methods are also associated with costs. Such costs are referred to as transaction fees.
When cost is concerned, company's installation budget, sales profile and the nature of the business's
cash flow should be considered. If a small firm is just starting out, and operating on a limited budget, it
is better to choose a third party payment processor. This is because merchant accounts require high
upfront and regular charges. Companies with limited budgets may want to consider services that charge
transaction costs rather than monthly fees and installation costs. Businesses with large volumes of
transactions benefit from services with lower variable transaction fees. The time needed to access
revenue from sales depends on the particular service. Businesses with high cash flow needs should
obtain a service where money from the transaction is available quickly.
Finally, trading parties’ characteristics and production attributes may play a major role to affect people’s
decision about which payment method they would like to choose due to the concerns over risk,
convenience and cost. In general, traders’ characteristics include experience of online transactions,
reputation ranking, even age and education. For example, if the e-commerce firm has a high reputation,
customers may trust it easily, and it can issues virtual currency or uses conventional credit card payment,
and can collect its revenue quickly. Otherwise, it has to use third party payment or mobile payment.
Production attributes include production price and uncertainties associated with the production quality.
If the production is digital, such as, music, papers, and software or other online service, a firm may
select mobile payment method; by contraries, the production is physical and need be shipped materially,
third party payment may be a suitable selection. So firms should carefully examine the features of their
customers and their business, when they select an online payment method.
4 Conclusions
With the development of e-commerce, the importance of online payment systems increases. In this
research, we have analyzed the process and features of the major types of online payments in practice.
Online payment system can be categorized to thee type, conventional credit card payment, third party
payment and micropayment. With conventional credit card payment, the credit card information is
accepted and handled the card issuing bank; so it can improve the security of payment. the fund is
transferred instantaneously. However, owing to every issuing bank has its own payment gateway; it is
difficulty for e-commerce firms to maintain a lot of links with different gateway. Owing to its fund
delivered instantaneously, there is not chance for customers to examine the productions before fund
transferred. The third party payment may relieve these problems by collectively maintaining links with
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different gateways and holding the funds in trust for the trading partners. Micropayment can deal
arbitrarily small pieces and deliver funds instantaneously. It is suitable with those no-tangible, low price
goods. But virtual currency issuer should possess higher reputation; mobile payment may be the most
convenient, but till now it is not popular in practice, and it may be the future trend.
The key factors affecting online payment method decisions are convenience, security and cost. Trading
parties’ characteristics and production attributes may play a major role to affect the decision; firms
should carefully examine the features of their customers and their business profile, when they select an
online payment method.
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The author can be contacted from e-mail: [email protected]
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