The purpose of this article is to familiarize different merchant services industry players (merchants, resellers and payment service providers) with the concept of sub-merchant funding and associated features required from a payment gateway.
Introduction
The concept of sub-merchant funding becomes relevant when some company is functioning as a reseller (payment service provider, aggregator) of merchant services to other companies. Sub-merchants are, thus, merchants that processes transactions with assistance from a reseller (aggregator, PSP), who is playing the role of an intermediary.
In contrast to merchant funding, where the funds are transferred immediately to merchants, under sub-merchant funding the funds are transferred to sub-merchants from a certain payment service provider’s (or reseller’s) portfolio, while the aggregator gets its revenue portion.
The overall goal of the entire sub-merchant funding mechanism is to get the funds for transactions that a merchant processed to that merchant as quickly as possible.
There are two ways in which sub-merchant funding can be organized; each of these ways has its own advantages and disadvantages.
Sub-merchant Funding Models
Direct Sub-merchant Funding
Under the first model the processor transfers the funds directly to sub-merchants. Merchant services fees in this case are withheld by the processor and part of the fee amount is transferred to the PSP (see article on {residual revenue sharing}).
The advantages of this approach are:
- sub-merchants get their money faster, as no additional banking transfers are required to move the funds to the PSP and then to sub-merchants
- fewer bank accounts are involved, so reconciliation becomes easier for sub-merchants
The disadvantages of this approach are:
- PSP is fully reliant on the processor to do the funding accurately and to service its customers (sub-merchants) well. If quality of this service is not satisfactory for sub-merchants, the reputation of the PSP can tremendously suffer
- sub-merchants are directly exposed to the processor, so there is a chance that the processor company might try to seize them from the PSP
- the approach is efficient only in cases when all transaction types needed by a given merchant can be handled by the processor within sub-merchant funding process. For example, if a merchant processes ACH and Amex, but the processor can only handle Visa and MasterCard, and, consequently, the PSP is required to take care of Amex and ACH transactions, the entire approach loses its meaning
Sub-merchant Funding through the PSP
Under the second model the funds are transferred to the PSP, and the PSP transfers them to each of its sub-merchants taking care of fees and funding of its respective sub-merchants on its own.
The advantages of this approach are:
- Greater independence and more control of the process (funding schedules, merchant statements etc.) for the PSP
- PSP gets more privacy in portfolio management, and, consequently, greater control over pricing. As a result, it has more potential bargaining power with the processor, since the processor has a lot less visibility into pricing of the sub-merchants
The disadvantages of this approach are:
- PSP must have some type of software system to take care of sub-merchant funding and merchant statements
- In cases when the processor funds to the PSP net processed (with fees deducted) versus gross processed transactions, or when reserves (see respective article for details) are withheld, reconciliation process can become rather complicated
Conclusion
If you are a PSP having the necessary technology and expertise to handle sub-merchant funding, it is better to perform it on your own, as it gives you greater control of the process and, probably, guarantees a more profitable arrangement for you. On the other hand, if you do not have skills and/or staff to handle reconciliation, it might be better to go with processors that can offer sub-merchant funding on their platforms.
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