Industry Update

  What's u
PayP


p With
al?


by Phil Britt

   PayPal, the electronic payment alternative for Internet purchases, could threaten some of Visa and MasterCard's market, according to Brendan Ford, analyst for Datamonitor, New York.
   "A lot of small merchants are looking at PayPal because they can't afford the fees that Visa and Mastercard charge," Ford said.
   Though there are several other "person-to-person" competitors, PayPal is the dominant player. The P2P field also includes Billpoint, which EBay owns all of after buying back the 35 percent it didn't own from Wells Fargo in late January; Citibank's c2it, which has distribution through AOL and Microsoft; the U.S. Postal Service, and Western Union's MoneyZap.
   Though the amount of business through PayPal still represents only a small portion of the U.S. payments market, the company's business is growing rapidly. Even though EBay has its own P2P service, PayPal is the leading payment method for the online auction site. One of every four EBay payments is by PayPal.
   PayPal wants "to become the global standard for online payments, offering our service to users in 37 countries including the United States. We have over 12 million registered users, including more than 2.2 million business accounts. Our account base is growing by an average of 20,000 accounts per day, with virtually no traditional sales or marketing," according to PayPal's Web site.
   PayPal did return calls to Transaction World but could not legally comment because it was in the SEC-mandated quiet period prior to and immediately after its initial public offering on Feb. 14. The IPO, delayed briefly by a lawsuit, rose 55 percent to more than $22 on its first day of trading, though the subsequent transaction between EBay and Wells Fargo sent the stock plunging to $12 below its initial offering price -- before recovering to $15 by the end of February, then moving up a couple of dollars more in March.
   More stock gyrations were expected as the company battled other lawsuits and competitors in the embryonic P2P market.
   PayPal enables users to send money instantly and securely to anyone, be it a merchant or an individual, with an e-mail address. A user can also send money requests to a friend or group of friends, who can then pay the user online.
   Customers use PayPal to pay IOUs, to collect money for events, and to buy and sell items at online auctions sites, like eBay. PayPal is currently available through e-mail, Palm organizers, and Internet-enabled mobile phones in the U.S.
   PayPal's growing popularity is due largely to its enhanced security and lower costs than Visa and Mastercard payment options, according to Ford.
   PayPal had in earlier statements proclaimed that its fraud detection software, nicknamed "Igor" after a Russian hacker the company once caught, makes its payments more secure than others on the Internet.
   The buyer makes PayPal payments with his credit card or via his checking account. In January, PayPal added the ability to make payments with a Discover card.
   "PayPal shares a common vision with Discover Financial Services -- to give our customers a safe, secure, and convenient payment method for online transactions," said Todd Pearson, PayPal Senior Vice President, Financial Services, at the time of the announcement. "By partnering with Discover Card, PayPal users get the added flexibility for online transactions with the convenience of a brand they know and trust."
   Whether the buyer uses a credit card or a deduction from his checking account to make PayPal payments, PayPal first makes a minimal payment to the buyer account. The payment generates a reference number on the buyer's monthly statement, which he uses as an additional identifier when making a purchase through PayPal. The buyer makes the payment directly to PayPal, which pays the seller.
   PayPal offers three types of accounts:

  • Personal accounts are for individual use only and may not receive credit card payments. These accounts are limited to less than $100 in transactions per month.
  • Premier accounts are for members who will have a high transaction volume and need to accept credit card payments, or would like to access special features.
  • Business accounts are for account holders doing at least $1,000 in transactions every month.

   The business accounts offer a pricing advantage to small merchants compared to payment cards, Ford said.
   Accepting online card payments through PayPal service can save merchants more than 100 basis points off the average discount rate charged by merchant acquirers, according to Ford. Banks typically charge online merchants 30 cents per transaction plus 3.2 percent of the transaction amount. PayPal charges 2.2 percent plus 30 cents per transaction, and also gives business accountholders a 1.5 percent discount on purchases made through the PayPal debit card. So the business accountholder's effective rate is only .7 percent, Ford points out.
   PayPal derives its income from this fee, from the float it holds payments for a few days before forwarding them, enabling the company to earn interest on the money and from cross-selling other products, Ford said.
   Mastercard and Visa are starting to take notice. In January, MasterCard allied with CertaPay to enable Mastercard holders to make P2P payments. The CertaPay platform is designed to leverage a financial institution's own security and brand strategies. CertaPay's P2P money transfer application enables consumers to send and receive money -- in real time, using only an e-mail address -- from their own financial institution's online banking or online account management services.
   MasterCard members that install the CertaPay platform can offer their customers the ability to use their MasterCard credit or debit account to pay another person through their participating financial institution. To transfer money by e-mail, the customer:

  • Logs on to his/her online account with their participating financial institution and click the e-mail payment feature.
  • Inserts the recipient's name, e-mail address and the amount of the transfer.
  • Identifies the MasterCard account or other account (checking, savings) from which to take the funds.
  • Writes a personal note to the recipient of the funds. The recipient instantly receives an e-mail notification with a hyperlink to accept the funds and then decides where to deposit the funds, whether it is a MasterCard account or bank account.

   If the recipient is a customer of a bank using the CertaPay system, the funds are received in real-time. The funds are transferred using existing payment clearing arrangements. If the recipient does not yet bank online at a CertaPay partner institution, he/she must register himself/herself as a new CertaPay user. The process is done quickly and securely online.
   Then the recipient receives a final confirmation of the deposit of funds. Though Visa has no announced plans for a similar partnership, the association can certainly be expected to watch the further development of PayPal and the Mastercard/CertaPay alliance with great interest.
   Meanwhile, PayPal is making advances with its own business plans. The company followed up the addition of Discover Card Financial Services with its PayPal Visa credit card, launched at the end of February.
   "Our credit card is more useful and it provides you with safety and success," the company said in its press release.
   The PayPal Visa offers:

  • No PayPal sending limits when using the card on PayPal, though the user is still limited to the card's available credit.
  • A $5 credit the first time the card is used.
  • Zero liability for online and offline transactions.

   Though PayPal is the industry leader now, it will have to continue to prove itself as new competitors enter the scene. In mid-April, Digital Insight Corp., Calabas, Calif., and CashEdge, Inc., San Francisco, Calif., teamed up to offer inter-institutional transfer and person-to-person payment technologies.

SideBar

   Online merchants are looking for alternative payment systems because they object to interchange fees, which are typically higher for online merchants than for many of their offline counterparts, according to Steve Mott, CEO of BetterBuy Design, Stamford, Conn., a virtual investment and consulting company that helps merchants and other clients work with new and emerging technologies.
   Mott pointed out his concerns over interchange at BAI's recent retail delivery conference.
   "Merchants are not very happy with the payment systems that have been provided by the financial services community to date," Mott said. "There are some real pressures for changing the status quo. The major issue that any merchant has is that they don't like interchange."
   Though there might be some more risk in online rather than offline purchases, online purchases also are much less costly to handle, yet this lower cost isn't reflected in lower interchange fees, Mott added.
   Merchants also object that debit cards, which should be less risky than credit cards because payments are deducted directly from a checking account rather than 30 days later, have higher interchange fees than credit cards.
   The card associations are promoting smart cards as one way to lower risks of online and offline card purchases, yet there's no definitive answer as to whether smart cards will result in lower interchange fees.
   If the traditional financial services companies don't try to address these merchant concerns, non-traditional payment vehicles like PayPal, Billpoint, etc., could replace many of the credit cards and checks used today, according to Mott.