PayPal Runs Up Against Competition
Ari Weinberg, 03.08.02, 2:30 PM ET
forbes.com
NEW YORK - PayPal has reached a fork in the road. At one end lies an Internet success story; at the other is a bottomless pit.
With February's initial public offering, Palo Alto, Calif.-based PayPal (nasdaq: PYPL - news - people) and its exponentially expanding users are putting pressure on competing online payment systems. But just as many online companies with "first mover advantage" and "viral marketing" found out, PayPal, with a market value of $1 billion, could be the test-market fall guy for major banks and credit cards cautiously waiting for the market to develop.
Consider that in 2001 PayPal facilitated more than $3.5 billion in payments, generating more than $100 million in revenue. For the fourth quarter of 2001, PayPal earned $3.2 million in operating income, excluding $22 million in charges.
PayPal is just more than two years old and sees huge potential to expand on its 13 million customers. The Tower Group estimates that there will be 250 million person-to-person payments this year, up from 100 million in 2001. This includes PayPal and competing services.
For users the system is simple. PayPal facilitates online payments by allowing members to send payment by e-mail. The money is drawn from bank accounts or credit cards. While cash transfers are free, the surprise comes on its main selling point: allowing any consumer to accept credit card payments. The consumer is hit with a 30-cent transaction cost, plus a charge of between 2.9% and 2.2% on the amount received. EBay (nasdaq: EBAY - news - people), through its eBay payment system, charges 35 cents, plus a charge of between 2.5% and 1.75%.
Given the extensive nature of offline payments and the legacy technology, PayPal and eBay have implemented their online systems to undercut existing merchant rates. They are considerably less than most small merchant offline rates, but a shock to non-merchant consumers and casual online auctioneers.
Consumer backlash, though, is growing. A class action suit was filed in February over customer service and frozen assets. And unless PayPal and eBay act, their systems may soon become legacies as well.
"Right now the PayPal model will work because consumers need the service," said Robert McKinley, chief executive of Cardweb.com, an industry watchdog. "But the backlash is building. There's a lot to be fleshed out."
It's just a matter of time before the third-party nature of the credit card system--on the Web, at least--is circumvented by the banks and credit institutions, which actually control money and short-term consumer loans.
In fact, it's already happening. C2it, a two-year-old online payment system offered by Citibank, has grown to 350,000 users from 200,000 in November. That was when the company slashed all fees associated with domestic payments--whether funded with cash or credit. C2it was actually rebuffed in an attempt to purchase PayPal outright.
C2it's expansion is currently slowed by transaction dollar amount limits that prevent it from cutting into the other payment systems' bread and butter--users who make a living off their online auctions. Still, "business accounts," or those that accept credit card payments, make up just 20% of PayPal's users.
According to a C2it spokeswoman, the company can afford to slash rates for credit charges, given that Citibank controls nearly 20% of the credit card market in the U.S. and that nearly 50% of C2it users also have a Citibank credit card. Currently, C2it only accepts MasterCard and Visa. For eBay, add Discover. PayPal brings in both American Express (nyse: AXP - news - people) and Discover. Credit card funding of PayPal and Ebay payments are generally charged as purchases, not as cash advances, which carry fees for the cardholder. For C2it, only funding from a Citibank credit card or Universal AT&T card is not charged as a cash advance. For other cards, it depends on the issuer.
While C2it is on the right path, and could be made stronger through its alliances with MSN and America Online, an even better model exists. And it starts with banks working together on standards for the technology of cash transfer and clearing.
A small technology company out of Toronto, called CertaPay, has signed on four out of Canada's five major banks, with Royal Bank of Canada currently the only holdout, to implement e-mail payments. CertaPay Chief Executive Mike Ginsberg says his company is also negotiating with major banks in France, England, Australia and Singapore. And in December, MasterCard (which issues a debit card for PayPal through processor First Data (nyse: FDC - news - people) and sponsor Bank One (nyse: ONE - news - people)) announced that it was working with CertaPay as well.
CertaPay's ethereal goal is to unify financial and credit institutions on one technology--the equivalent of transactional nirvana.
However, Ginsberg says that the number of banks in the U.S. currently makes such a standard's system difficult to implement. Canada's banks are going on the idea that what's good for the system is good for the individual. Charges will range from 15 cents to $1 (Canadian), but the decision regarding credit card payments is currently being debated. In the U.S., ATM company NCYE is working on a similar service.
Currently, PayPal dominates e-mail payments in the U.S. While most payments on PayPal are no-fee cash payments, the desire for credit card protection by online auction buyers shows that credit card fees will bring in the bulk of the profit.
Any move by either U.S. banks or credit card issuers to standardize their online payment technology will be able to price PayPal out of the market.
PayPal must make the proper alliances--perhaps with eBay or an offline processor like industry-leader First Data--or see its early and phenomenal success go the way of the dot-coms. |
