SEATTLE — Bankers have spent years puzzling out how to compete against PayPal — the online person-to-person payment mechanism that dominates the eBay auction site and proliferates in other areas of e-commerce as well.
To Meg Whitman, the president and CEO of eBay Inc. and its PayPal subsidiary, the banking industry is not the opponent, but an important ally. In large part, that’s because she sees PayPal not so much as a P-to-P service, but as a provider of merchant accounts to small businesses. And PayPal is less of a threat to the banks here, she says, because its service has allowed these small operators to do something that banks have not been much help with: making electronic payments instead of paper ones.
“I think we have been almost entirely additive to the banking industry, because so many of our small businesses” didn’t have merchant bank accounts, Ms. Whitman said in an interview after her speech here Monday at the electronic payments association’s Payments 2004 conference. “So all that volume [of payments to small merchants on PayPal] is actually incremental, because it replaced checks and money orders.”
This cheery message may have sounded slightly dissonant to the 2,200 bankers and others who converged here Monday for Nacha’s annual conference, but to Ms. Whitman, the concept of banks being enemies to PayPal is ancient history. From where she sits, PayPal is a major processor of credit card payments and has pipes into the ACH systems of many of its users’ bank accounts, so where’s the threat?
Though PayPal was not the first to see the potential of authorizing money transfers through the Internet, it was one of the first — and very few — to develop a system that caught on with consumers.
And just as the banking industry found itself trailing behind the upstart Internet company in the P-to-P space, banks now may want to keep a close eye on PayPal’s moves in the small-merchant market that the company claims is the heart of its business today.
Matt Bannick, the senior vice president of payments and central manager of PayPal, elaborated during the interview on the ways that his service is misunderstood. “The thing some people miss about what we’ve done on eBay is we’ve moved transactions from paper to electronics,” he said. “Sometimes people say, ‘Oh, you’re taking away credit card transactions.’ In fact, what we’re doing is taking all these paper transactions, making them electronic transactions, of which half are credit card transactions that never would have occurred with credit cards before — they would have been paper.”
Some figures about eBay and PayPal: eBay’s 95 million registered users hail from 220 countries, and would, if amassed as a nation, be the 12th most populous one in the world. In the United States about 60% of eBay transactions are cleared using PayPal (less in the United Kingdom, though the percentage is rising fast).
Most of the remainder are paid by check, though a good number still involve buyers mailing cash to sellers. Some 50% of PayPal transactions are on credit cards, and the other half divided between ACH transactions and stored value accounts. Wells Fargo & Co. is both PayPal’s credit card gateway and ACH processor, and will write paper checks to PayPal customers when it needs to.
In the fourth quarter of 2003, $77 million a day was spent on eBay, and a video game sells once every eight seconds on the site. Among the online sellers that use PayPal, two-thirds of them do so through eBay, with the remaining third selling either wholly on sites other than eBay or on some blend of eBay and elsewhere. That figure has remained fairly consistent, Ms. Whitman said.
And that leads to two things that banks find threatening about PayPal: one, that it considers auctions only the tip of the iceberg, and, two, that the merchants it attracts are slowly getting bigger.
“Absolutely, [PayPal] is a ubiquitous payment method on the Web,” Ms. Whitman said. “The core may always be eBay, because it is the largest aggregation point for small business, but we are delighted to have businesses that sell part-time on eBay, part-time on the Web — we love for you to use PayPal in both places.” PayPal has a merchant services division that is wholly focused on devising products and services for small businesses that don’t sell their wares through eBay.
Perhaps one reason PayPal elicited such strong emotions from the banking community was that it originated not only outside of eBay, but also within an upstart online bank with a generic-sounding name, X.com, in the brash Silicon Valley culture that seemed so antithetical to the measured, reasoned, and risk-averse culture of the ACH gang.
Bankers simultaneously bristled at and tried to emulate the service that was viewed primarily as a person-to-person e-pay mechanism, a venue for the transfer of fortunes from one’s own DDA to that of one’s college-age offspring. Several banks established competing services that crashed and burned, including Bank One Corp.’s long-ago eMoneyMail and Citigroup Inc.’s more recently concluded c2it.
But Ms. Whitman blithely dismisses that business model as a PayPal raison d’etre. “The core business is not person-to-person,” she said. “I think a little bit of that exists, but the fact of the matter is that it’s mostly small businesses being able to accept payments from customers.”
Indeed, the core PayPal customer is still a small office or home business, one that would consider annual revenues of $10 million a glittering prize. “These are the little guys,” Ms. Whitman said. “This created functionality that did not exist for them, and that was the genius of what PayPal did. And the other thing is it took hold on eBay. Because eBay is the largest aggregation point for small businesses, and so that’s why I think it was as successful as it was.”
Another major achievement was PayPal’s fraud management and authentication techniques. Indeed, eMoneyMail’s architects made no secret of the fact that unexpected fraud rates hobbled their system.
By contrast, PayPal experienced a fraud loss rate in 2003 of 30 basis points, versus 110 basis points for the top 150 online merchants, Ms. Whitman told the Nacha crowd. “Part of eBay’s success has been in its ability to keep the bad guys out of the system,” she said in her presentation.
Later at the Nacha conference, some speakers registered their own opinions about PayPal. George F. Thomas, the president and chief operating officer of Electronic Payments Network, the private ACH operator and subsidiary of The Clearing House, used the service’s success to take the banking industry to task, at least in some payment transaction categories.
“It boggles my mind why the financial institutions let PayPal take that market when they have the perfect vehicle to do it — home banking,” he said.
And in a panel discussion, PayPal’s authentication system won high praise, albeit from a banker whose company is PayPal’s primary conduit to the U.S. banking system.
Nevertheless, it was clear that Sanjiv Sanghvi, an executive vice president at Wells Fargo, was not just trying to tout a client when he warned a Nacha audience of the potential dangers of the newish WEB and TEL categories of ACH payments, which do business in a relatively new space. EBay and PayPal have “done a wonderful job on authentication, but why would we have a system that was so open that it would allow anyone to initiate a transaction without the authentication of a PayPal?” he said.
“I don’t think we’ve done enough as an industry or as an organization … to make sure we actually have a mechanism to support Web payments,” Mr. Sanghvi said. “And if we don’t, I think we better just back off. Can you do it through fees, fines? Is that going to be enough? I don’t know.”
Mr. Bannick said it was a lucky fact of life for PayPal that it had found a way to “do” risk management well. “It’s one of those survival-of-the-fittest things,” he said. “If PayPal hadn’t figured it out, PayPal wouldn’t be around. There were a lot of folks who didn’t quite make it.”
Does Ms. Whitman perceive PayPal as a competitor to banks and their ACH and credit card services? No, she said. Are there competitors to PayPal? Maybe, she said, though market share numbers don’t exist, to the best of her knowledge. One way or another, the question didn’t seem tremendously relevant.
Here’s how she answered it: “I think there will be and have been competitors to PayPal for the person-to-person and small-business market,” she said. “And I don’t actually think that’s horrible, because the more people who understand how this works, sometimes you grow the whole pot. I think this is such a nascent business, that the chances are that more competitors will help educate and grow the overall pie. So if we maintain our share, we’re in good shape.”
