PayFac vs. ISO: Which Should a Merchant Choose?

In the world of payments, selecting partners to help transact business is one of the most complex, but critical, processes any business can complete. Choosing the right partners can increase the success rate of payment processing, reduce the cost of getting payments moved around the world, and deliver customer experiences that build a loyal following; the opposite, of course, is also true. Selecting between a PayFac and an ISO determines both the simplicity and the cost of service, and is fundamental to any payment processing automation project.

What are PayFacs and ISOs?

PayFac is short for payment facilitator, and refers to an entity that acts as an intermediary between its clients and the broader payment ecosystem. Merchants working with a PayFac generally do not have to gain their own merchant account - a process that can be time-consuming and frustrating - but instead become ‘sub-merchants’ to the PayFacs main merchant account. PayFacs’ business model is to markup the cost of processing, in return for simplifying the process of getting the merchant live and selling; they also can afford to negotiate excellent underlying fees, which can mean their marked up fees are still quite competitive.

By contrast, an ISO, or independent sales organization, is a facilitator, helping merchants to identify and acquire the best merchant account and payment service provider for their business. Their job is to match merchants to service providers, and they are paid by the service providers when they bring good prospects to the table. 

What Does a PayFac Do?

A PayFac essentially manages the risk and relationship between its client merchants and the payment ecosystem. The PayFac

• Maintains merchant accounts, which can be used to transact business for its clients
• Operates a shared payment infrastructure, which its clients use to execute payments for their goods and services
• Offers interfaces and related services to help their merchant clients do business, such as APIs, embedded purchase pages, reporting, and so forth
• Manages the security of the system, as well as data at rest, ensuring that its merchant clients’ customers’ data is safely transmitted and stored
• Monitors and secures all transactions, with an eye to keeping fraud and chargebacks below the thresholds card networks use to apply punitive measures

What Does an ISO Do?

An ISO acts as a super-connector, helping merchants without extensive business relationships in the payments space to identify and contract with appropriate payment partners. The ISO

• Builds relationships with banks that offer merchant accounts, with payment service providers and gateways, and any other service provider a merchant may need to run their business
• Finds businesses with payment needs, analyzes their business, and proposes appropriate payment partners. Acting as an intermediary, the ISO shares terms of use, payment details, and so forth, on behalf of the service providers, so the merchant has a single point of contact for multiple partners
• Connects the partners and merchants together, facilitating the creation and closure of contractual relationships, bringing valuable business volume to their partners, and critical capabilities to their merchant clients

What are the Big Differences Between PayFacs and ISOs?

While they may appear similar on the surface - both, after all, accelerate the process of their merchant clients getting up and running in the payments space - they actually deliver markedly different outcomes, in completely different ways. Some of the contrasts include:

• Business model: PayFacs have an ongoing fee setup, in which they charge a small amount on every transaction merchant clients execute for the entirety of their business relationship. By contrast, the ISO is generally paid by the partners with whom the merchant clients sign, and do not receive a percentage of future transactions
• Risk management: because the merchant clients run their transactions through a PayFac’s merchant account, by necessity the PayFac must monitor their activity to ensure they don’t create unnecessary risk. For this reason, a PayFac can change the nature of its relationship with its merchant clients over time, including changing rates or even canceling the contract if the risk is too great for their broader business. By contract, an ISO simply signs the merchant client up with a partner - any future risk exposure is taken on by the merchant and partner.
• Revenue distribution: because an ISO is little more than a facilitator, it has no operational involvement in transactions once they start to flow, so the merchant client must work with whichever payment partners it has selected; this can result in complex business processes, as different partners may take different approaches to settling transactions and distributing funds. By contrast, the PayFac is at the heart of its merchant clients’ whole payment process, and will be in charge of all transaction settlement and revenue distribution, normally on a simple-to-understand and regular basis

Should You Choose a PayFac or an ISO?

Many new merchants opt for a PayFac, as often as not a full-service PSP like Stripe, in order to accelerate the process of getting their business up and running. The speed with which a system can be established and brought to market is extremely appealing, especially when considered against the longer-winded applications and underwriting needed to sign up for merchant accounts and related services by way of an ISO.

That said, the speed benefits of the PayFac wear off quickly, and can be replaced by concerns that the merchant now has a single point of failure, that its continued ability to transact deals is subject to the PayFac’s risk assessments, and that the all-inclusive fee structure does not allow for the sort of leverage and arbitrage that is necessary to optimize payment system economics.

Most merchants, in the long term, will find that they can increase their proportion of successful processed payments, while reducing their cost to process, by building a stable of different partners, offering distinct services. As such, if there is no immediate pressure to take a business live, most merchants will gain greater long-term benefit from interacting with an ISO to build out a partner ecosystem that best fits into their payment automation solution. The benefits include

• Tighter control over processing fees, allowing the merchant to, for instance, recognize lower fees on debit cards versus credit cards
• Improved geographical presence, allowing the merchant to avoid cross-border charges by transacting deals with payment providers in the same location as the customer
• Reduced business continuity risk, with no single provider having the power to take the merchant offline by shutting down their account
• Greater control over customer data, allowing the merchant to control its customers’ cardholder data, rather than ceding control to a PayFac