Types of Payment Methods You Should Know

A payment method is any non-cash instrument or system used to facilitate the transfer of money in a transaction. In the digital economy, the payment method landscape is complex, and has a huge impact on consumer trust, operational efficiency, and access to new markets. For businesses operating online, offering a variety of payment methods is a necessity, but it can also be important for brick-and-mortar stores.

A high number of accepted payment methods is proven to lower cart abandonment rates and increase conversion. For consumers, a selection of payment methods offers them flexibility, security, and access to personalized financing options, making the shopping experience seamless and convenient.

Traditional and Card-Based Payments

When you think of payment methods, a few obvious ones might come to mind, like credit cards. Sure enough, credit cards are a payment method! They’re one of the most important traditional methods that has helped define global finance for decades. But they’re not alone.

Credit and Debit Cards

Today, credit and debit cards account for about 35% of all transactions. Powered by networks like Visa, Mastercard, American Express, and Discover, credit and debit cards form the global standard for consumer transactions.

Credit cards work in four key steps:

• Authorization: Checking fund availability
• Capture: Reserving the funds
• Settlement: Transferring the funds
• Funding: Putting the money in the merchant’s account

Merchants typically pay interchange fees to the card-issuing bank and various processing fees to the payment gateway and processor to make it easier for consumers to use cards. However, these extra costs can make card acceptance a significant operational expense, especially for low-margin businesses.

Direct Bank Transfers

Used extensively in B2B transactions and for recurring bill payments, direct transfers involve moving funds straight from one bank account to another. This category includes Automated Clearing House (ACH) and international wire transfers.

Bank transfers offer high security and are generally subject to lower fees than card transactions. However, they typically suffer from slower settlement times and require precise input, raising the risk of manual error.

Cash on Delivery (COD)

Not quite as common anymore, COD is still relevant in areas with few banks or where consumers are hesitant to provide credit card details. Think, rural areas of the U.S. or parts of Latin America and the Middle East. Essentially, COD pays cash when something is delivered. It removes security concerns about online payments, but it’s slow, logistically difficult, and expensive, which is why it has largely been phased out.

Digital Wallets and E-Commerce Solutions

Smartphones have made digital payment methods more convenient than ever. Digital wallets and e-commerce payment solutions prioritize speed, security, and a frictionless checkout experience.

Digital Wallets

Digital wallets like PayPal, Apple Pay, Google Pay, and Amazon Pay are basically digital credit cards. They securely store a user’s credit card and banking credentials, and leverage tokenization to replace sensitive card details with a unique, non-sensitive token during a transaction. They eliminate the need to manually input card details online, and can make payments at the counter as simple as tapping their phone against a reader.

Buy Now, Pay Later (BNPL)

BNPL providers like Affirm, Klarna, and Afterpay have become increasingly popular as a way for consumers to break big purchases into multiple smaller ones, usually with interest-free installments. These providers pay the merchant upfront (minus a fee), while they take on the risk of collecting installment payments from the consumer. It’s basically a streamlined method of invoice factoring.

Businesses pay BNPL provider fees because they often translate to a boost in Average Order Value (AOV) and higher conversion rates, especially on higher-priced products.

Local and Closed-Loop Systems

Every global market has its own payment methods and comfort levels. Internationally-minded businesses have to recognize the dominance of local payment methods like Alipay and WeChat Pay in China, or Pix in Brazil.

Taking the time to learn localized digital payment options will ensure you’re catering to a complete customer base. Failing to do so will lead to local consumers not trusting your service.

Emerging and Decentralized Payments

The future of payment innovation is already upon us, and it’s being characterized by decentralization and instant, direct settlement.

Cryptocurrency and Blockchain

The blockchain is the decentralized ledger that empowers most cryptocurrencies and digital assets like Bitcoin, Ethereum, and stablecoins. Once purely an investment vehicle, the use of digital assets for consumer and B2B transactions is slowly growing. Transactions are borderless, offer high transparency, and can have lower international transaction fees compared to traditional banking. However, widespread adoption is hindered by volatility, regulatory uncertainty, and the technical complexity in holding and using the coins.

Account-to-Account (A2A) and Open Banking

Open Banking allows regulated third-party providers (with consumer consent) to securely access financial data and initiate payments directly. The A2A model facilitates instantaneous payment settlement directly between the consumer’s bank account and the merchant’s account, bypassing card networks and their associated fees.

A2A is growing in the European Union (EU) and the United Kingdom, but hasn’t quite picked up steam in the US yet.

Security and Merchant Strategy

Whatever payment methods you want to use for your business, it’s crucial that you securely handle payments and make the payment experience seamless for costumers.

Regulatory and Compliance Standards

Any business that handles card transactions must comply with the PCI DSS (Payment Card Industry Data Security Standard) to protect cardholder data. Merchants can also use tools like tokenization and 3D Secure (3DS) to elevate security standards within their business and uphold regulatory requirements.

Strategic Payment Acceptance

You don’t need to offer every payment method under the sun. In fact, given the cost, you certainly shouldn’t do that. Instead, you need to analyze your customer base to see what they prefer. Track which payment methods are most used and which have the highest failure rates to see where in your marketing funnel you can improve the experience. Likewise, you’ll need to understand the fee structures of each method and balance the costs and benefits.