eBay Puts Its Mark on PayPal

  Online payments provider PayPal is quickly leveraging its ties to new parent eBay as it expands into business-to-business sales. But is eBay trying to dissuade customers from using credit cards?
  For all the success merchant acquirers have enjoyed in making plastic the currency of the Internet, accounting for about 95% of consumer payments, one achievement that has eluded them is making card acceptance affordable to Web-based micro merchants. That triumph belongs to PayPal Inc., the online payment mechanism that went from cult status to stardom practically overnight.
  PayPal's popularity is due in large part to its huge following within the eBay Inc. community, a nation of 61.7 million registered users who buy, sell and bid on everything from collectibles to everyday products to business equipment over the Internet. During the fourth quarter of 2002, eBay generated $4.6 billion in gross merchandise sales, a 68% increase from the same period a year earlier. Of that amount 51% was settled using an online payment mechanism which includes cards and PayPal, up from 44% during the third quarter.
  In December, Mountain View, Calif.-based PayPal had 23.3 million accounts on the books, up 82% from a year earlier. It adds around 27,000 new accounts daily. About $7 billion in payments went through its system in 2002. Of that amount more than $2.1 billion in payments were transacted during the fourth quarter, a 77% increase from the same period in 2001.
  About 60% of PayPal's revenues come from eBay transactions. In the fourth quarter, revenues from auctions accounted for 66% of PayPal's total payments volume.
  So great is the affinity among eBay users for PayPal that the San Jose, Calif.-based auction site spent $1.5 billion to acquire PayPal last October.
  Now that it owns PayPal, eBay will by June 30 jettison its Billpoint payment service, into which eBay had invested millions since 1999. Unlike PayPal, nearly all Billpoint transactions were settled using credit cards, which made it tough for eBay to offer low merchant payment processing rates without losing money.
  PayPal's ability to offer small Internet merchants attractive card pricing is based on its ability to recover through non-card sales the merchant fees it is assessed for credit card transactions. Although PayPal is technically a merchant in the eyes of the card companies, it serves as payments aggregator for micro merchants by settling card transactions on their behalf through its merchant acquirer, San Francisco-based Wells Fargo & Co.
  About 25% of all PayPal payments are direct debits initiated through the automated clearing house, which costs PayPal about 3 cents per transaction. Another 25% of transactions are credit transfers between PayPal accounts, which costs PayPal practically nothing. The remaining 50% of transactions are card-based, which costs PayPal an estimated 2% to 3% of the transaction total.
  But PayPal prices its transactions virtually the same, no matter what the actual method of payment. By diverting half its transaction volume onto lower-cost forms of payment, a percentage that is expected to grow significantly in the coming months, PayPal earns an average of 2.2% of the transaction total, according to Avivah Litan, vice president of financial services for Stamford, Conn.-based Gartner Inc.
  With such a healthy rate of return, PayPal can afford to charge merchant fees of 3% or less of the purchase total to settle a transaction. PayPal's rates are well below the 7% to 12% per transaction often quoted by acquirers to micro merchants. Acquirers charge high rates to cover the higher risk of chargebacks associated with online merchants.
  "PayPal has been good for the card industry in that they have been able to profitably offer card acceptance to micro merchants," says Litan. "But the way they make money is by getting consumers to pay using their bank account. Paying by credit card is a great way to get customers started, but they are quickly urged to move away from that practice."
  With eBay now overseeing PayPal's strategic direction, some observers believe that PayPal will aggressively push its ACH option to commercial buyers over cards as a way to maximize profits. Doing so will rob card issuers and Wells Fargo of lucrative charge volume on high-ticket items, such as computer equipment. Citing client confidentiality, Wells would not comment regarding its strategy with PayPal.
  "At this point, PayPal won't eat into card volume on business-to-business transactions, because it is positioned more as an alternative," says Elizabeth Robertson, a senior analyst for Needham, Mass.-based TowerGroup. "But eBay does have a heavy investment in PayPal, and that is a strong indicator it will eventually position PayPal to make a run at cards."
  Indeed, eBay dumped Billpoint in favor of PayPal because it was a money loser and because PayPal had demonstrated a capability to beat earnings projections. PayPal began turning a profit after going public in February 2002, less than three years after being formed. The company's fast run to profitability is a rare distinction for a dot-com with a management team of people in their twenties and early thirties.
  Besides being profitable, PayPal's attractiveness to eBay includes its staying power in a volatile marketplace by outlasting competing online payment mechanisms such as e-cash and electronic wallets.
  Pushing Volume
  "PayPal is going to get eBay good profits by helping to push more volume through the eBay network, rather than through an acquirer," says Shawn Milne, a research analyst for Soundview Technology Group, a San Francisco-based market-research firm.
  That is readily apparent in some of the changes PayPal has made to its Web site since being acquired by eBay last October. PayPal users are now urged to consider other payment options than cards, according to analysts. "There are reports from users that PayPal is pushing the use of bank accounts to make payment," says Litan. "To what extent that is making PayPal less flexible remains to be seen."
  A high success rate by PayPal on that initiative could prove to be costly for the card companies as eBay pushes into business-to-business sales. Already, eBay has struck deals with more than 20 major retailers and manufacturers to sell new products at fixed prices. The list of vendors includes Apple Computer Inc., International Business Machines Corp. and Hewlett Packard Co. Brand-name sellers can also pay $500 a month to be listed as an anchor store on the site. In return, the seller's logo appears on a search page as buyers browse the site. Fixed price sales represent about 30% of the volume on eBay. Of that amount, about 2% to 3% is sold through major manufacturers and retailers.
  "Fixed-priced selling is what it is about for eBay power sellers and mid-sized businesses, and to a lesser extent, the big guys," says Milne. "As long as PayPal and eBay can grow volume, there may not be a need to push more volume through PayPal's ACH option, because it might curtail growth (by angering customers who want to use cards) and that will suppress margins. But keep in mind that the mother ship is now driving the bus."
  "Power seller" is a designation bestowed by eBay on sellers who have achieved a 98% positive feedback rating, consistently high sales levels and demonstrated professionalism when adhering to eBay rules. The designation assures buyers of a smooth transaction.
  Further evidence that PayPal is starting to move into the business-to-business market showed up in a survey of the business community conducted last year by Linthicum, Md.-based First Annapolis Consulting Inc. The survey revealed that about 1% of respondents acknowledged paying for a purchase using PayPal. PayPal has about 3.7 million business accounts.
  "This is the first time PayPal showed up in the results," says C. Marc Abbey, a partner with First Annapolis. "The percentage is small, but it does show PayPal is bleeding into business payments."
  PayPal insists that cards remain the dominant form of payment among users in the United States and the United Kingdom. The company also says ACH transfers do not play well with large commercial buyers that desire the detailed transaction reporting they receive when paying with corporate and purchasing cards.
  "Corporate sales are not PayPal or eBay sweet spots," says Todd Pearson, PayPal senior vice president. "Large merchants get their payment services through acquirers. Our market is to service small companies selling online that need to accept cards but which are not large enough to warrant it."
  Analysts concur that large, high-volume merchants generating $1 million or more in annual sales can get a better discount rate through a merchant acquirer than PayPal.
  Small Businesses
  PayPal merchants are charged either 2.2% of the transaction total plus 30 cents or 2.9% plus 30 cents, depending on their account status. On a $100 sale, Internet retailers would pay $2.50 and $3.20, respectively. Under current Visa and MasterCard interchange rates for consumer online transactions, the interchange assessed on a $100 sale would be about $1.90.
  Most Internet retailers in good standing with PayPal (e.g., those with low chargeoff rates and that average $1,000 in monthly sales), pay the lower merchant fee. The average payment received by PayPal merchants is more than $55 and is increasing by more than $1 every three months. Buyers do not pay a transaction fee.
  To boost its standing with small businesses, PayPal last year launched on its Web site the Small Business Resources Center. The service provides tools, such as password management and instant payment notification, as well as tips on using PayPal to grow a small online business.
  PayPal also is promoting its Small Business Developer Network, which encourages software developers to create e-commerce applications for entrepreneurs and small businesses. In addition, the company now offers sellers the ability to print United Parcel Service shipping labels directly from their accounts.
  "Expanding PayPal as an e-commerce payment mechanism is an attractive portion of their business strategy and was a strong component of negotiations to acquire the company," says an eBay spokesperson. "We feel there is plenty of opportunity to grow PayPal outside and inside the eBay community."
  While PayPal will not specifically state its desired ratios of ACH to card payments, company executives are quick to stress they maintain a mutually beneficial relationship with Wells Fargo and the card companies.
  "We help drive volume for the card companies and we have a symbiotic relationship with them," says Matthew Bannick, senior vice president, global payments for PayPal. "We provide a service to micro merchants that they can't necessarily get elsewhere."
  To further illustrate the point, Bannick says PayPal accepts cards in 36 countries and recently began accepting euros and British pounds sterling for payment. PayPal also accepts Canadian dollars and the Japanese yen.
  International expansion will parallel eBay's push abroad, but it will be done prudently, says Bannick. EBay reported revenues of $107.4 million from transactions on its international sites during 2002's fourth quarter, up 173% from the same period a year earlier.
  "We need to localize our business for each country, and there is a learning curve to do that," he explains. "A lot of the issues surround language, local business customs and the country's banking structure. The model of penetration will vary for each country."
  Language Barriers
  Dialect is one of the biggest hurdles in overcoming the language barrier. Although the British and Australians speak English, they prefer the Queen's English to the American version. In currency notations, Europeans will separate the equivalent of dollars and cents with a comma, rather than a period. Germans are more inclined to pay through an electronic funds transfer than use a card. "It is a lot of little things that add up to making the customer comfortable using the service," says Bannick.
  Though Bannick declines to reveal what types of payment products PayPal is considering as it grows its international business, he says future partnerships with banks are a possibility. "We have thought about a private-label person-to-person payment product," he says. "There may be some banks that want to roll out a product like that and that is an area where we can help."
  Near-term growth, however, is focused on capturing a higher percentage of payments from eBay users. "That's really where the immediate growth opportunities lie," says TowerGroup's Robertson. "When you consider that eBay is expanding into business-to-business sales and internationally, having a track record there first makes it easier to apply its business model outside of eBay."
  The million-dollar question facing the card companies is whether PayPal wants significantly less than 50% of its transactions paid for with credit cards. With PayPal tight-lipped about its desired ratio, that is anyone's guess. Still, there are signs pointing to PayPal moving in that direction.
  While it is doubtful PayPal will completely turn its back on card acceptance, the company may soon establish itself as more of a rival than an ally to card payments.
  That's not an appetizing prospect for a credit card industry intent on carving out a larger slice of the electronic-commerce pie.