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. 162

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. 163

Customer 1. Customer orders and credit card Information Is sent to the shopping cart 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 7. Sends funds settlement request and acquiring account Information to the card Issuing bank 4. Sends request for payment authorization to the card Issuing bank Acquiring Bank 8. Funds are transferred Issuing Bank 5. Reviews the credit Information and checks the credit limit 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. 164

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, 165

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 166

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 167

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. References [1] Chen, J. J. and Adams, C. (2004), "Short-range Wireless Technologies With Mobile Payment Systems," Paper presented at the 6th International Conference on Electronic Commerce, Delft, The Netherlands, October 25-27 pp. 649-659. [2] Dandash, O., Wu, X., and Le, P. D. (2005), "Wireless Internet Payment System Using Smart Cards," Paper Presented at the International Conference on Information Technology: Coding and Computing, Las Vegas, NV,, April 4-6, 2005, pp. 16-21. [3] Haizheng Li,Han Zhang. (2004) How People Select Their Payment Methods in Online Auctions? An Exploration of ebay Transactions. Proceedings of the 37th Hawaii International Conference on System Sciences, [4] Herzberg, A. (2003), "Payments and Banking with Mobile Personal Devices," Communications of the ACM 46(5), pp. 53-58. [5] Hsieh, C. (2001), "E-commerce Payment Systems: Critical Issues and Management Strategies," Human Systems Management 20(2), pp. 131-138. [6] Meng, B. and Xiong, Q. (2004a), "Research on Electronic Payment Model," Paper Presented at the 8th International Conference on Computer Supported Cooperative Work in Design, Xiamen, China, May 26-28, pp.597-602. [7] Párhonyi, R., Nieuwenhuis, L. J. M., and Pras, A. (2005,) "Second Generation Micropayment Systems: Lessons Learned," Paper Presented at the 5 th IFIP Conference on e-commerce, e-business, and e-government, Poznan, Poland, October 26-28. [8] Peffers, K. and Ma, W. (2003), "An Agenda for Research About the Value of Payment Systems for Transactions in Electronic Commerce," JITTA :Journal of Information Technology Theory and Application 4(4), pp. 1-16. [9] Valentine, L. (2003), "The 'Fraudsters' Playground," ABA Banking Journal 95(8), pp. 39-42. [10] Wright, D. (2002), "Comparative Evaluation of Electronic Payment Systems," INFOR: Information Systems & Operational Research 40(1), pp. 71-86. The author can be contacted from e-mail: mbxie@jmu.edu.cn 168