Once E-commerce emerged in the retail landscape, it was less a question of “if’ and more a question of “when” merchants would adopt it. Many larger companies invested early and were able to get ahead of their competitors by setting up online merchant accounts with major financial institutions to process these new online payments. For small- and medium-sized businesses (SMBs), however, the barrier to entry was high — often too high. This also hurt financial institutions, by reducing the number of available transactions.
The digital fallout from the pandemic has made it even more critical that merchants get online fast. A survey by Electronic Transactions Association (ETA) and The Strawhecker Group found that 43% of SMBs viewed digital payments as more important to their business during the pandemic, yet fewer than half accepted digital wallets. Establishing E-commerce systems was still an expensive and logistical challenge for many. At least it was — until Payment Facilitators (PayFacs) changed the game.
Understanding the PayFac Model
A PayFac works by establishing one master merchant account, which can then be leveraged by multiple businesses for a small fee. In exchange for the user fees, PayFac underwrites these new merchants and assumes the risk of any payments made through its platform. This simplifies the onboarding process and enables smaller companies to roll out E-commerce solutions more quickly, while simultaneously expanding the number of transactions received by FIs.
As there is only one platform to integrate with FIs, it is also easier to build out and support additional tools which can then be accessed by PayFac customers, such as one-click payment options. With these features, independent merchants can provide comparative experiences to those of their larger competitors, while FIs need only to work with a handful of direct customers. PayFacs also often provide assistance with dispute management and reporting, which is useful for those with overburdened operations teams.
The Appeal and Opportunity of PayFacs
At the heart of it, PayFacs make it possible for SMBs to get faster, easier access to E-commerce without the need to establish complicated technical infrastructure. Some larger chains may want to own their E-commerce environment and control every element, which is when it may make sense to work directly with the FIs. For many merchants, this will simply create a technical and financial burden that detracts from their business mission, while also adding to the operational burden of the FI. PayFacs alleviate both issues.
Critically, it also adds a huge number of small merchants into the digital payments revenue stream, without taking on the usual operational burden of merchant acquisition. By partnering with the right PayFac, financial institutions can quickly and dramatically expand their own customer base without needing to integrate directly with each merchant.
There is also the benefit of customer familiarity. A PayPal study found that 25% of customers have abandoned their online cart when not presented with their preferred payment method, while 44% will trust a business more if it offers this preferred method and has a “good payments process.” By leveraging a PayFac that consumers are familiar with and may already have an account with, merchants can minimize friction and increase conversions — and FIs can receive more transactions.
Challenges to PayFacs/Sponsor Banks
With more merchant customers signing up to PayFacs and more financial institutions getting in on the action, there is increased responsibility on the part of the PayFacs and Sponsor Banks. As they serve their customers, there are a few challenges they face:
Front End Experience & Merchant Onboarding
As consumers spend more time online and merchants grow their digital offerings, both groups are coming to expect more from payments services. Front-end checkout experiences should be smooth and efficient, while the merchant’s onboarding experience should be similarly intuitive. This requires sponsor banks and PayFacs to commit more time and resources to develop their interface, rather than relying solely on function.
Risk Management
PayFacs are designed to accelerate the onboarding process, but faster approval systems could lead to more mistakes and increased risk. To minimize this, it is imperative to deploy automation where possible, to reduce the chance of human error without delaying the process. Of course, there is also the danger of taking this too far and removing all oversight from the approval journey; PayFacs should ensure they maintain some control with a human supervisor.
What to Expect from the Future of PayFacs
Now that merchants and FIs have both discovered the convenience of PayFacs, it’s unlikely that the market will ever go back. Instead, new competitors are expected to emerge and try to take a piece of the business for themselves; a report from Infinicept found that the PayFac market generated $2 billion in transaction revenue in 2018 and is forecast to reach $15 billion by 2025.
As the landscape becomes more competitive, it will be critical for companies to offer the most superior customer experience to retain business. The result will likely be even quicker onboarding, more intuitive user interfaces, and greater revenue processed through E-commerce.
