Anatomy of the Online Checkout (#30)

Also: key metrics to select the best PSPs, and the future of checkout

May 09, 2021

Welcome to the 30th issue of the Unit Economics. This issue covers the online checkout process, and highlights the choices that merchants face in designing it. The idea is to emphasize how the small considerations in choosing the payment service providers can have significant trickle-down effect on their sales. It also deliberates on the key trends in the checkout space. The focus, as usual, remains on checkout components related to payments.

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What is Checkout?

An online shopping experience flows from page visit to delivery. A checkout page is one of the last legs of this experience. It is where you fill in the shipping and billing details. At the time the customer lands on the checkout page, he/she has likely been through the store’s catalogue of products, considered the ones to purchase, selected a subset of them, and added them to the cart. It should seem then that the bulk of the purchase experience has been provided by this step.

This is true for our physical (in-store) shopping experiences. The checkout line can perhaps delay our purchase or make the overall experience a little underwhelming, but few actually abandon their purchases at the checkout. We value the time we had put in to scourge and select products, and most likely go ahead with the payment. Almost as if the checkout experience stands separate and lower from the process beforehand.

But online, the significance of the checkout is different. It becomes more pronounced. We select our products and move to the checkout quicker in an e-commerce store. We even stand on and compare checkout pages of multiple stores at the same time. Spoilt for choices and convenience, we perceive our overall shopping experience as more strongly tied to the checkout on the web than in-store.

This is a small but important realisation. With the pandemic, millions of businesses have shifted to e-commerce. Mastercard estimates a $900Bn or 30% YoY incremental spend online from Mar-20 to Feb-21. And these numbers translate to a six percentage-point increase in spend penetration for e-commerce, with its share of overall spend rising from 14% pre-pandemic to 20% after. In normal circumstances, this would have likely taken three to five years. You might wonder then that this shift is temporary. But it is mostly not. The same research finds that ~70-80% of the e-commerce shift is likely to remain permanent.

All this give way to a simple inference: millions of businesses that sell online and direct to consumer will have to design and make decisions on the checkout experience of their customers. And it is likely that the businesses, especially those that traditionally existed on the ground, do not fully grasp the relevance of the checkout process.

How important is the online checkout experience?

Checkout abandonment rate, i.e. proportion of shoppers that add items to their cart and initiate the checkout process but do not go ahead with their purchase, is ~68-75% for most e-commerce websites. This is more than 2/3rd of all possible sales. One way to look at this is that if a merchant can bring the number down from 70% to 60%, ceteris paribus, its sales will increase by 33%.
Moreover, fraudulent transactions online cost merchants roughly 2% of their overall revenue. But interestingly, for each $X in fraud, $2.5-2.7X is spent fighting the fraud, including on fraud investigation, legal prosecution, and software security. The true cost of fraud then is significantly higher for the merchants. In our context, the decision to partner with a processor or build an in-house mechanism for fraud detection that has an advanced rules engine can effectively mitigate a 3-7% loss in merchant sales. Zapier and Postmates are examples of companies that have seen similar uplift with Stripe. Moreover, the lift in long-term conversion in sales can be even higher if we account for the higher customer loyalty through improved experience.
Lastly, upselling or cross-selling at the checkout by studying the user preferences can increase the average order value sufficiently that, assuming the number of customers remain constant, should also improve the merchant’s top-line.

Note that checkout abandonment is different from cart abandonment, where shoppers add to their cart but for whatever reason do not go ahead with the purchase.

Higher checkout conversions, lower frauds, and bigger order values are all sales multipliers. But for a small business shifting towards e-commerce, however, this is not intuitive. And, in their support, the decisions that merchants face while designing the checkout can be complicated.

It makes sense then to deliberate on such decisions and to think of ways to make the process easier.

What constitutes a checkout process?

For the merchant, the underlying objective of the checkout process is to ensure that the shopping ends with successful payment. But to do that, the merchant must allow the customers the ability to make payment with the method of choice, and as securely & conveniently as possible.

On a 30,000 feet level, this process would involve two steps:

Collecting the shipping and billing information

The merchant can either build the information pages itself or integrate the services of an existing provider such as Bolt, Shopify, or Stripe. In both cases, a high degree of personalization and customization is possible. The merchant can add discount offers, rewards, upsell or cross-sell other products, gather personal information, highlight store policies, and tax support among others.

Image: Customizable checkout page offered by Stripe; Source: Stripe

Each small decision on the page is likely to impact the customer experience and the sales conversion at the checkout. The challenge for the merchant here lies in ensuring that the experience is frictionless, while collecting and sharing all the necessary information. However, the good part is that most of these factors are controllable and merchants can tinker around the features and their placement to minimize abandonment at this stage.

Image: Top Checkout Features (incl. payments); Source: Pymnts Checkout Conversion Index

Accepting the payment

Unfortunately, the same flexibility is not afforded while accepting payments. Businesses, small or large, usually outsource the payment processing to either:

Payment service providers (PSPs) that allow merchants to accept payments by handling the account opening and other payment provider partnerships, or to
Payment gateways that exist on top of the merchant account and are responsible for sending customer information to the banks and authorizing cards and alternative payment transactions.

Often, the PSPs have in-built payment gateways that they encourage merchants to use. And if you are wondering, the process is outsourced since facilitating payments requires one to deal with multiple participants (banks, intermediaries), acquire licenses, add payment methods, enter into multiple legal agreements, comply with country-based volume and processing rules, report transactions periodically, handle frauds and disputes, and then further ensure technical superiority to existing payment service providers. In short, it is a lot of hard work.

Instead, the merchants can simply plug and play. The cost of using API-based payment processing is commonly a function of fixed + volume-based transaction fees. This works out for both merchants and processors, whose incentives direct them towards maximizing volumes.

And at checkout, it is this choice of the PSP or payment gateway that is likely to have the greatest consequences on your sales conversions.

How can merchants then optimize their payments acceptance?

By asking the right questions.

Selecting the best payment service provider is not only about offloading the processing effort, but it is about selecting the provider that offers customers the best experience. Broadly, the merchant should assess and compare the following while making the decision:

Compliance with the highest security standards: based on the geography that you are accepting payments in and from, the processor must comply with all relevant security standards. For example, European payments require compliance with Strong Customer Authentication (SCA) standards, while all card payments require PCI-DSS compliance. These standards can differ regionally, especially with the lack of standard regulations on the newer payment methods such as wallets or pay later services.
Payment Flow: whether you sell to businesses or customers, sell on the web or mobile, operate a marketplace model, or operate an escrow model – the payment flow would greatly depend on your business model. Understanding your ideal payments flow will be crucial to comparing the quality of payment processing services. Moreover, the payment flow would clarify whether you want to accept recurring billing, direct the user to a secure page while processing or require integration of the processing on the website itself. All of these would help select from multiple PSPs.
Payment Methods Integration: with the rise in alternative payment methods, customers have increasingly differing preferences in payments. A processor that allows alternate payment method integrations such as BNPL, A2A, wallets, among others is likely to give a better experience to your customers. Importantly, the ability to process payments on all relevant local payment providers should be top-of-mind.
Uptime and Latency: the quality of the backend processing infrastructure is best understood through the uptime/success rate of transactions. For payments infrastructure providers, reliability can be gauged through the proportion of API requests that are successfully answered within the acceptable processing time. Stripe, for example, periodically publishes data on the speed and the success rate of API calls. Note that for payments that run in millions of volumes, even a drop of one-tenth of a point in success rate can affect tens of thousands of transactions. This can have the domino effect of shifting hundreds of thousands of lifetime purchases to the competitor.
Fraud and Dispute Handling: Next, as discussed earlier, the costs of chargebacks and of resolving disputes can be significant. A processor that has superior rules design to recognise fraudulent transactions and merchant-oriented dispute handling terms can save you over 3% in sales. Equally importantly, lower fraud can result in higher product ratings and brand reputation, which can trickle down to better customer acquisition. A clear-win here for the merchant, for example, can be a processor integration through Bolt (below) that promises zero fraud and covers all chargeback charges.
Image: Bolt’s Zero Fraud Guarantee Policy; Source: Bolt
Multi-Currency and Language Support: if you are selling your product or service to multiple countries, the ability to accept the localized currency and detail the fees for currency conversion would be a crucial barrier for you to convert many from checkout to sales. Moreover, providing invoicing and other payment details in multiple languages can push the case for higher conversion.
Fees and Service Agreements: Lastly, as you narrow down on the acceptable payment processors, you should look at the costs of processing payments. At this step, merchants can negotiate the fees based on their scale, understand the industry-specific restrictions, and ensure that there are no hidden fees in the agreement. However, you must keep in mind that saving 1-2% in fees will not be a big win if it comes at the costs of poorer uptime or fraud detection.

There are other considerations of onboarding time, ease of integration, and value-added services that merchants can make to filter payments processors. Despite, the conventional wisdom suggests that if there are multiple payments processors, one must always prioritize the reliability of the provider through the lens of revenue optimization.

Also note that the statistics for uptime, fraud prevention, and other acceptance metrics are not publicly available for most payment processors and so awareness of the key metrics for your business is important to form the right questions and to differentiate between the good and the great payment service providers.

Where is Online Checkout heading?

The Future of Checkout: Invisible Checkout

The holy grail of checkout is to move towards no checkout at all. Think of it. For any purchase, you should only have to select what you want to buy and express your desire to go ahead with the purchase. And poof – it should be done. This is where Amazon Go is moving towards for physical shopping. Then, why is it that we still fill in multiple shipping and billing details for our online purchases?

There are two issues to solve here. One, an auto-checkout requires that you opt-in to give your information to the payment provider and then be able to leverage the information to make a one-click checkout. Teams at Shopify, Fast, PayPal, and Bolt, among others, have already built this after the Amazon patent expired. Second, the process requires that no further authentication be needed for the payment, which is not acceptable in most geographies that push security through additional authentication factors. The best-case scenario, instead, today is to allow one-factor of authentication (say, OTP) that is auto-read on checkout.

Payment Options = Shelve Space

The proliferation of alternate payment methods such as UPI, wallets, pay later services and the increasing number of players under each bracket has meant that positioning of your payment method becomes important. In this case, higher visibility of your payment method requires you to appear at the best or close to the best position in the list of payment methods. And at big merchants such as Shopify or Amazon, you are likely to pay a premium to avail of this service. Similar to the shelve spaces in department store chains or the ad spaces on the web.

So with more payment options, and easier integration through processors, expect a bidding war for the top positions at mid-to-large volume checkouts.

Online Fraud on a High

With low consumer awareness of protecting confidential information, newer payment methods, and more sophisticated fraudsters, online fraud is expected to increase at ~15% CAGR over the next decade. As per Juniper, e-commerce fraud is expected to rise to >$20Bn worldwide for 2021 itself – an increase of 18% year-on-year.

This threat will continue to delay our push towards frictionless checkout. An upcoming alternative that seems promising is that of Biometric authentication, which can make checkout invisible and authentication secure. It may sound boring, but the fraud and authentication space should be of high interest for payments folks, especially with the new modes of digital payments going mainstream.

Final few words: small summary

Checkout, as the final frontier, will continue to challenge millions of businesses and payment service providers. While not core to the business, the online checkout carries high significance and requires knowledge that is largely hidden. And so, in designing their checkout process, the businesses must clearly understand their payment flow and select the payment providers that offer the best possible security, reliability, and convenience to the consumers with the focus on maximizing sales.

Away from the merchants, the checkout space, in itself, has turned highly dynamic with the new payment methods and more sophisticated processors. And as the industry moves ahead, we must work towards moving the checkout experience to the background, and consciously fight the threat of online payment fraud.

Unit Economics