P2P Breakthrough, But Who Cares?

Person-to-person payments are poised for a technological breakthrough, now that one of the nation's largest ATM networks has gotten into the game. But that still doesn't mean person-to-person payments will become popular in the near future.

NYCE Corp., the funds-transfer network, is running a pilot, and in June plans to roll out a program that will allow customers of its 2,400 participating financial institutions—some 47 million people—to move money into other people's accounts instantly using the Internet.

But will they want to?

For most consumers, the answer is no. Even though the number of such transactions is projected to hit 100 million this year, Internet person-to-person payments represent a miniscule fraction of all consumer payments. Sure, they're cheaper than wire transfers and faster than sending a check. Yet payments experts believe that most Americans are likely to remain wary of them—or merely indifferent to them—for years to come.

"People aren't going to rapidly change the way they make payments in the next five years," says Beth Robertson, an analyst at TowerGroup, based in Needham, MA.

"Historically, the banking industry has not been very good at doing research to ask consumers whether they're interested" in new technology, says Richard Oliver, the Federal Reserve System's retail payments product manager. Person-to-person, he adds, "is an application waiting for someone to use it."

It also raises a host of questions and concerns about security, fraud, money laundering and other risks. The field is still so new that it's hard to fit into the regulatory framework, especially where it concerns non-bank technology companies.

Still, enough consumers have already demonstrated their interest in person-to-person payments to attract a handful of big banks. Citigroup, Bank One Corp., Wells Fargo & Co. and Canadian Imperial Bank of Commerce all offer the service either directly or through partnerships with Internet companies. Bank of America Corp. and FleetBoston Financial Corp. are readying similar programs for launch soon. Not surprisingly, money transfer giant Western Union also offers Internet person-to-person payments. And the bank-owned credit card associations, Visa and MasterCard, are working with their members to post such transactions to cardholders' accounts.

Despite the strengths of those brands, however, none of those companies markets the service under its own name. Citigroup calls its service c2it (as in "see to it"), Bank One named it eMoneyMail, and Western Union launched it last September as MoneyZap. Wells Fargo has a joint venture partner with online auctioneer eBay Inc. in person-to-person pioneer Billpoint. CIBC acts as the behind-the-scenes service provider for Yahoo! PayDirect, while Citi powers America Online's branded version.

The big financial institutions' brand strategy with person-to-person is surprising, considering the power of their own names. Indeed, many observers believe that brand power, on top of vast experience in the payments business, gives banks (and firms like Western Union) an edge over the new technology companies that created and now lead the Internet person-to-person payment business.

"The banks are going to win in this marketplace," says George Thomas, who runs the New York Clearing House's Electronic Payments Network.

If that's so, the question remains: What will they win?

At this point, the Internet person-to-person payment market is composed primarily of customers who participate in online auctions such as those run by eBay and Yahoo! Although banks and others tout electronic payments as an easy way for consumers to transfer funds among their own accounts with various institutions or send money instantly to family and friends, experts believe that technology-infatuated "early adopters" will comprise the bulk of the market for years to come.

TowerGroup's Robertson wrote that U.S. consumers initiated an estimated 500 billion payments in 2000, whether on the Internet or in the physical world through checks, money orders, credit cards and cash. Only 7% of those were person-to-person, and only a sliver of those took place on the Web. "Of the 33 billion total U.S. person-to-person payments in 2000, TowerGroup believes that just 42 million—or well below 1%—were Internet P2P transactions," Robertson wrote.

That total may be low now, but the services are still relatively new and not heavily marketed outside the online auction world. TowerGroup estimates that in 2001, there will be 100 million Internet person-to-person transactions, and that they'll grow to 4 billion annually by 2005, a compound annual growth rate of 149%.

Even then, however, more than 95% of the volume will remain online auction payments, Robertson says.

What initially brought banks into the arena was the swift entry and rapid initial growth of a handful of start-up technology companies. The largest of them: X.com, based in Palo Alto, CA, which has by far the largest share of the market. Thanks to a merger about a year ago, X.com owns PayPal, which claims to be the first Internet person-to-person payments company. (Both firms were started in late 1998. Competitor Billpoint, though formed a few months later, actually launched its service first.) The privately held X.com, backed by venture capital, boasts more than 5.5 million customer accounts and says it's adding more than 20,000 users a day.

But those numbers should be taken with a grain of salt. With PayPal, customers on both ends of a transaction—that is, both the sender and recipient—must open accounts. Robertson calls this a "viral marketing concept," and notes that the "firm's customer account numbers are not indicative of either the number of active users or the total payment transactions." Neither are they "a true indicator of market potential," according to her report.

Here's how it works: The sender funds a PayPal account with a credit card, direct debit from a bank account or even a paper check. When those funds are verified, the recipient gets a notice that payment is available, and must open an account to receive the payment. The whole process can take days, but once both the sender and recipient have PayPal accounts, processing takes much less time than, say, sending a check in the mail.

There's no fee to use PayPal; like a bank, X.com makes money on the money parked in customer accounts.

Also like a bank, the company's Web site states: "All accounts insured up to $100,000." Consumers might confuse that insurance with the FDIC tagline they see on their bank statements, but X.com isn't a bank. It insures customer accounts only against fraud (not against its own failure) through Citigroup's Travelers insurance unit.

Other companies that offer online person-to-person payments don't require the recipient to set up an account. Citi's new c2it service, for instance, funds the payment by charging the sender's credit card, then sends recipients e-mail stating that funds are available and asking how they'd like to receive their money, either by check or with a credit card payment.

That's not much of an improvement over simply mailing someone a check. But the technology is evolving rapidly. In the next few months, c2it will add the ability for customers to receive their funds as if they were in the form of a prepaid debit card, allowing them to spend the transferred money at online merchants' Web sites or even receive cash through an ATM. It will also begin to allow international payments.

The company also has a deal with AOL to provide a similar service to its online subscribers, called "AOL QuickCash by c2it."

"We believe that sending money over the Internet will become as natural for consumers as e-mail is today," says Antony Jenkins, a veteran Citibanker who is c2it's chief operating officer.

For Citi, the ultimate aim is to create a business that allows consumers to move money from any account they want to any other account they want. Jenkins calls its payments policy "person-to-anywhere."

According to Jenkins, the company has five ways to make money: transaction fees, foreign exchange (when international payments start), float, interchange fees and interest on credit balances. C2it transactions carry a $2 fee for the sender, who does not have to have a Citibank account to use the service. (The service is free for the first 90 days.) Senders are limited to $400 a day or $1,000 in any four consecutive days.

Jenkins and his team first targeted very active Web users for c2it. Now they are looking for ways to reach consumers who have specific electronic payment needs. They include people who want to buy things through online auctions or classified ads, to send gifts at holiday time, or to coordinate a payments from a group of friends (say for a colleague's wedding gift or a big ski trip).

"Our launch strategy has been to test value propositions and customer acquisition strategies," he says. "We want to make sure we connect with people who value what we can offer."

Wells Fargo took an even more cautious approach to person-to-person by entering into a joint venture with eBay in Billpoint. Its whole purpose is to allow online auction participants to pay for purchases over the Internet without waiting weeks for personal checks to be sent and cleared.

Although eBay bought Billpoint in 1999, it didn't do anything with the technology for a year. In the meantime, PayPal came on strong to eBay users and still eclipses Billpoint on that service's home turf.

In June of last year, however, Wells stepped in to help Billpoint launch a payment service called Electronic Check. It uses the automated clearing house (ACH) system to transfer funds. An escrow option is in the works.

Working with an online auction partner gave Wells both a natural market for the service and a good way to learn how person-to-person actually works. "It was perfect to go into eBay," says Debra Rossi, executive vice president of business Internet services at Wells Fargo. She's been involved in the payments business at Wells for nearly two decades.

Using the ACH means that Wells can apply the same risk management techniques to E-checks as it does to paper checks and debit card transactions. When customers register with Billpoint as sellers on eBay, Rossi says, Wells authenticates their identity as it would for anyone opening a bank account. With E-check, the bank then verifies that the buyer has enough money in his or her bank account—no matter what bank that account is with—and debits funds electronically.

"So far, our risk management has worked very well," says Rossi. "We've stopped transactions within a matter of seconds."

The next step for Wells is to move beyond the eBay customer base. The bank could offer similar services to its own customers—Wells already has one of the industry's largest and most active rosters of Web banking customers—or to other Internet merchants and portals as a payment option for their customers. "We think the next service will be 'person to anyone,'" Rossi says.

Still, using the ACH means a one-day delay in payment. The real future of online person-to-person may well be real-time debit using an electronic funds network such as NYCE. This winter, the Woodcliff Lake, NJ-based ATM network processed its first person-to-person transfer, moving $1,000 from a Citibank account to an account at People's Bank of Connecticut. The recipient had given his ATM card number (not his bank account number or routing code, as in a wire transfer) to the sender. The full amount was transferred immediately.

Starting in June, NYCE plans to begin rolling out its person-to-person payment service to all 2,400 financial institutions participating in its network. It could take as long as nine months before the system is fully in place.

The move is likely to spread person-to-person payment capability beyond the tech companies and big banks that jumped in first. "We're not competing," says Denise Lima, network product manager at NYCE. "We're helping our financial institutions compete against the PayPals."

Ultimately, NYCE's goal is to allow so-called PINless debit and credit payments—instant funds transfers that don't require someone to provide a traditional personal identification number to complete.

The risks? As with any financial service, fraud is a big one. So is the chance that a financial institution—or nonbank transfer agency or technology company—could become a conduit for money laundering.

But perhaps the biggest obstacle for electronic person-to-person payments may be customer acceptance. Smart cards have yet to catch on in the United States, and online currency barely made ripples as a fad. The number of paper checks written reached a record in 2000. And even direct deposit has failed to score the success its fans projected.

"The American consumer is very particular about this payment thing," says Oliver at the Atlanta Fed. "Somewhere deep in our psyche, we like the idea of money. That's going to be an issue—not a business issue, but an emotional issue."