The e-mail that flooded Billpoint’s offices one day last October carried welcome news: The company’s top rival in the person-to-person Internet payments business, PayPal, had begun collecting fees from longtime users, and they were looking to defect.

It was a day of “great delight” in Billpoint’s San Jose, Calif., offices, said Janet S. Crane, chief executive officer of the company, which is 65%-owned by eBay, the Web auctioneer, and 35% by Wells Fargo & Co., Ms. Crane’s former employer.

Unfortunately for Billpoint, the “floods of e-mail” that Ms. Crane described amounted to a mere blip on PayPal’s radar screen in Palo Alto, Calif. Fewer than 1% of PayPal’s six million users jumped ship after the company began enforcing its new pricing policy, said Vincent Sollitto, vice president of corporate communications.

Therein lies the enormous challenge Billpoint faces in competing with a company that boasts one of the fastest-growing Internet communities around. Besides executing most transactions on eBay, the granddaddy of all Internet auction sites, PayPal also pulls users from auction services hosted by Yahoo, Amazon, and others, as well as from individually owned merchant sites.

Every day, PayPal, a private company formed in December 1998, adds 20,000 customers from the 26 countries in which it operates; every day, its customers send more than 150,000 payments, worth more than $7 million. PayPal got another big boost this month — a $90 million equity investment, mostly from European and Asian financial services companies, to help it expand internationally.

Billpoint’s frustrating efforts to catch up to a company just half a year its senior suggests there is some first-mover advantage in the person-to-person sphere. People may simply embrace the first online payment system they encounter, unlike account aggregation — in which people seem content to wait for their primary provider to offer the service rather than moving their accounts to one that already does.

But Ms. Crane argues that PayPal’s main advantage comes not from being first but from offering its services for free for several months. Now that PayPal has begun charging fees, Billpoint is prepared to showcase its grounding in solid business models, such as fees for services, exemplary customer service, and bank-backed risk management.

“The market is shifting,” Ms. Crane said. “People understand they have to pay for this service.”

But PayPal, a nimble and tenacious competitor, moves quickly. It has already dropped plans to open a Web bank, which was to have been called, but has begun generating revenue streams through recently introduced money market accounts.

Billpoint operates in a much smaller arena than PayPal, serving only customers of eBay, which has 22.5 million users. But most eBay participants who use online payment services rely on PayPal, so even on its own turf, Billpoint must contend with PayPal’s remarkable record in attracting and keeping customers.

Based on daily surveys it does of eBay auctions, PayPal estimates it is the preferred payment vehicle for 60% of all sellers. About 15% prefer Billpoint, according to PayPal, a figure that jibes with one Ms. Crane gave in a speech at the Bank Administration Institute’s Retail Delivery conference in December.

Billpoint has some modest expansion goals. It wants to help the eBay sellers who also run their own Web sites to accept payments. This year, it also wants to expand outside the United States, one country at a time, into the eight other countries where eBay operates.

Ms. Crane, a veteran of payments who previously headed Mondex USA, says Billpoint has always posted positive returns on a gross margin basis, though it has yet to turn a bottom-line profit. She noted that only 50 people run Billpoint, so “the nut to cover is not that huge. We can see the profits.”

Though Ms. Crane would not disclose transaction volumes, eBay said in its latest earnings report that Billpoint’s transactions had grown 145% in the fourth quarter.

Ms. Crane attributes the momentum to Billpoint’s real-world business model and distinguished backers. Wells Fargo invested last March, when it also became Billpoint’s payment processor.

As part of that agreement, Wells handles fraud and risk management, an arrangement that has “averted millions of dollars of fraud that Billpoint otherwise would have taken,” said Debra Rossi, Wells’ executive vice president of business Internet services.

Wells also supports Billpoint’s customer service, for which it enjoys an enviable reputation as a responsive and efficient provider. “If you’re managing risk, you’re automatically managing customer service,” Ms. Rossi said.

Ms. Crane maintains that Billpoint benefits from having its roots in a big-bank environment where risk management and customer service are standard operating procedures. The per-transaction fee of 2.5% to 3% that Billpoint charges eBay sellers is another example of the company’s pursuit of tried-and-true business models, she said.

She highlighted the distinction in Billpoint’s approach from PayPal’s early model, in which it charged no fees and paid $10 to new users and $10 to anyone who referred a customer. The strategy “made it very popular with users, but you can’t make money that way,” Ms. Crane said.

PayPal decided to begin charging customers after it noticed the high number of online auction sellers using its service, Mr. Sollitto said. In June, it imposed an average per-transaction fee of 1.9%, plus 30 cents for people who collected more than $100 a month through PayPal. Customers who use the system for personal transactions — such as payments to friends or relatives — continue to get the service free, he said.

One million of PayPal’s six million customers now have business accounts, and they do the vast majority of their transactions on the system. A few hundred thousand converted their accounts to business status in October when PayPal got serious about enforcing its new pricing policy, Mr. Sollitto said.

He took issue with Ms. Crane’s contention that Billpoint has always charged fees, saying that Billpoint was free upon its launching in April and remained so through June. He also said Billpoint began offering free services again, starting in October and going through December, to take advantage of PayPal’s tougher pricing policy.

But Ms. Crane said Billpoint has always charged transaction fees. In October, November, and December, she explained, it ran a promotion in which purchases made with Visa cards were free, though MasterCard transactions continued to incur fees.

The aggressive pricing strategies of the dueling companies indicate the cutthroat nature of a market expected by Tower Group to grow from 100 million transactions this year to more than four billion by 2005. PayPal and Billpoint get most of their business through online auctions, considered the “sweet spot” of p-to-p payments. Online auction transactions will continue to make up more than 95% of p-to-p payments through 2005, Tower says.

So far, PayPal appears to be the most aggressive competitor.

Both Billpoint and PayPal act as “master merchant processors,” handling credit card transactions on behalf of hundreds of thousands of small-dollar sellers. The service lets auction sellers take credit card payments affordably and without the hassle of having to open their own merchant processing accounts.

Beyond that, however, their strategies differ. Though the vast majority of Billpoint’s transactions occur through credit cards, only about half of PayPal’s do. The other half are made through stored-value accounts held at PayPal. With fewer card transactions — a method initially used by 90% of customers — PayPal pays out less in interchange fees.

The company weaned people from cards by offering incentives, including a money market rate of return, a $5 bonus, and $5 referral fees, to business customers who open stored-value accounts. The balances in these accounts are swept nightly, letting their holders earn 5% interest.

“These customers are very valuable to us,” Mr. Sollitto said.

As another bonus for stored-value account holders, PayPal announced in December a MasterCard cobranded debit card that lets users withdraw funds from automated teller machines or spend money wherever MasterCard is accepted.

The money market fund is “pretty innovative,” said Avivah Litan, research director at Stamford, Conn.-based GartnerGroup. “PayPal’s goal is to lower costs and increase revenues by moving people away from credit card accounts and into checking accounts,” she said. Offering ATM access to funds, a service that lets PayPal collect interchange fees, “is a second way to increase revenue and keep money in PayPal,” Ms. Litan said.

Mr. Sollitto, who last January was the 30th employee of a firm that now employs 570, said PayPal expects to turn a profit by yearend. There is no doubt the company is working diligently to retain its rank as the No. 1 provider of person-to-person payments.

“I don’t think PayPal has many viable competitors,” Ms. Litan said.

But Beth Robertson, a senior analyst at Tower Group, said an estimated 75% of online auctions still are settled by traditional methods, such as checks and money orders, creating significant opportunities for all providers. Billpoint’s record of exemplary customer service will work in its favor, especially since PayPal has begun charging fees for business accounts, she said.

Ms. Crane is also upbeat. Internet auction sellers, especially new ones, will differentiate between a processor that is an “unknown start-up” and one backed by Wells and eBay, she said. “That gives users a great deal of comfort.”

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