Facebook Fast-Tracks Its Payments Business
Competition between Amex, Discover, MasterCard, PayPal and Visa is fierce and intensifying. What would Facebook's angle be if it aspired to build a broader payments business?
Facebook Inc. is becoming a payments contender a lot faster than it has led observers to believe.
In its S-1 filing this month, the social network revealed it got 15% of its $3.7 billion in revenue last year from payments, and said the next step would be to receive money transmitter licenses to avoid regulatory backlash. But that step is already behind the Menlo Park, Calif., company in at least 15 states, according to an American Banker analysis.
The licenses enable Facebook to handle transactions and to potentially transform its digital currency, Facebook Credits, into something that would allow it to compete more directly with banks.
"It all starts with having a large number of users and a large number of merchants and connectivity between the two — and certainly Facebook has that," says Philip Philliou, a payments consultant. "When you think about … products such as prepaid, global money transfer [and] person-to-person money transfer, these are all achievable products for them."
The requirements for money transmitter licenses vary from state to state. According to states' online listings, those that have issued licenses to Facebook's payments unit include: Arkansas; Delaware; Georgia; Idaho; Iowa; Kansas; Kentucky; Missouri; Nebraska; New Hampshire; North Dakota; Oklahoma; South Dakota; Texas; and Washington.
But Facebook may have licenses in still other states; not all make this type of information clearly available online. A search covering the remaining states and some U.S. territories found no further licenses, however.
Money transmitter licenses are required for a variety of reasons. Some states, for example, require these licenses for payroll companies. Others require the licensee to sit in the middle of Western Union-like money transfers. But for any company that can meet the requirements, the licenses are as easy to obtain as a driver's license, experts say.
"The pain in the neck is when you do it in all 50 states," says Brian Riley, a research director in the bank cards practice at Towergroup. "Your accountant usually handles it, because it's like sending out payments to all 50 states."
Right now, Facebook's payments profits come from selling Facebook Credits, a digital currency used by companies that develop apps that run on Facebook's website. For example, Facebook credits, which cost 10 cents each, can be used to buy items within Zynga's massively popular Farmville game.
A Facebook representative would not speak on the record about the licenses, or the company's overall payments plans.
Facebook said in its S-1 filing that "to mitigate regulatory uncertainty, we have applied for certain money transmitter licenses and expect to apply for additional money transmitter licenses in the United States." It did not indicate that it had already received any licenses.
Though Facebook Credits are nowhere near as useful or flexible as the dollar, Facebook's decision to pursue licensing has industry watchers comparing it to another company that transformed digital money into a serious rival to bank services: eBay Inc.'s PayPal.
"When PayPal got started it was surrounded by two kinds of legal controversy: regulatory and patent-related," says James Van Dyke, the president and founder of Javelin Strategy and Research.
State-by-state licensing is "a barrier to entry, and why so many small payments outfits cannot simply bootstrap their way to success," he says. However, the licensing is also "an enabler of broader success for well-heeled organizations," he says.
But even for those companies that can get the proper licensing in every state, there are risks.
"The money transfer business is not as simple as it looks, because it's fraught with fraud," says Riley. "You can't just turn it on like a vending machine business."
And companies that cannot handle the risk "don't get off the hook" if there is a problem, says Riley. "The big question is: Are they inclined, as a company, to play in that arena?"
The company behind the mobile payments service FaceCash, Think Computer Corp., has learned this lesson the hard way. It shut down operations in California after the state's Department of Financial Institutions determined that Think Computer did not have the proper net worth to qualify for a license under California's Money Transmission Act.
If Facebook has been operating a similar business in California without the proper licensing, it may face the same fate as FaceCash, says Aaron Greenspan, Think Computer's founder.
"It doesn't mean anyone will prosecute them, but I think they [would] have a legal problem," he says.
It is possible the social network has already received an order from the state government saying they are exempt because of their size, Greenspan says. The net worth California requires of licensees varies by the size of the company and the nature of its business.
Still, what Facebook plans to do with the licenses is unclear.
It's possible that Facebook is applying for its licenses out of an abundance of caution, rather than to legitimize a business that already runs afoul of state laws, says Gwenn Bezard, research director at Aite Group
"It's possible that, as they become a publicly traded firm, they need to step up compliance in general," he says.
Another possibility is that Facebook's payments system, which is still relatively young, will eventually be adapted to allow person-to-person transfers.
"If Facebook moves into P-to-P transfers, money transfer licenses are in order," says Bezard. "It could be also that they are looking to compete more head-on with PayPal to support the development of e-commerce within their ecosystem, and that would require obtaining such licenses as well."