PayPal Explores a 'Virtual' Alternative

  PayPal is optimistic enough about the "virtual" debit cards it is testing for online purchases that it is increasing the number of eligible users.
  The payment division of online auction house eBay Inc. began testing a MasterCard-branded virtual debit card-in which no plastic is issued, just card information-among eBay and PayPal employees in July. Last fall, PayPal expanded participation eligibility to about 1 million PayPal account holders, and it plans to continue expanding eligibility in similar increments over time.
  The importance of the test extends beyond PayPal. The pilot's outcome could affect the future of virtual cards, which have had difficulty gaining traction. If PayPal is successful, more issuers may decide to venture into the virtual card market.
  PayPal has not set a timeline for a general rollout of the product, but some analysts say that the time is right for virtual payment cards like PayPal's that change numbers with each transaction for improved security.
  Unlike traditional debit cards, PayPal's virtual cards require no plastic. That is because the cards exist only in electronic form, using technology supplied by Dublin, Ireland-based software firm Orbiscom Inc., which also has an office in New York.
  PayPal users create password-protected online accounts that are funded from their deposit or card accounts. When they pay using the accounts, they do not have to provide direct bank-account or card-account information online. While PayPal was developed as an alternative to traditional credit and debit card payments for online transactions, the virtual MasterCard allows PayPal to expand acceptance of its product to merchants that do not accept payments from traditional PayPal accounts.
  To merchants, the online transactions are no different from any other signature-debit card transaction, including the interchange fees they ultimately pay. But for customers, the cards are an easy way to pay online retailers that accept MasterCard, but not PayPal, without having to enter extensive personal or financial account information.
  PayPal touts how virtual cards mirror the security and convenience PayPal transactions afford. "It really stemmed from feedback that we were getting from users who really liked the security PayPal brought them of not having to share information (for Internet purchases)," says Chris George, PayPal senior director for financial products. "They were interested in being able to use PayPal in more places. While we have a large merchant base, there are still places where PayPal's not accepted."
  "Millions" of merchants - some individual entrepreneurs - accept PayPal, according to a company spokesperson, who would not specify the exact number. MasterCard does not specify how many of the 25 million merchants worldwide who accept MasterCard are online.
  To use the card, PayPal account holders download software from PayPal to their computers. Whenever users visit online merchants that do not accept traditional PayPal payments, the software generates messages that ask them if they would like to use their PayPal virtual debit card.
  If a user chooses that option, he logs into his PayPal account with his password. PayPal provides a debit card number that is valid only for a single transaction. It also provides users validation codes for the transactions.
  The virtual card transactions draw funds from users' PayPal accounts, just as traditional signature-debit cards draw funds from consumers' checking accounts.
  If PayPal account funds are insufficient, users can transfer funds from their bank checking accounts into PayPal accounts or select a backup funding source, such as PayPal Buyer Credit or the PayPal Plus credit card (if they have one) before continuing.
  First Data Corp. processes the transactions, which flow through MasterCard's debit network.
  PayPal's virtual debit card system also alerts users if they are being asked to provide sensitive information on Web sites that have been placed on industrywide lists for potential fraudulent or suspicious activities, George says. He says PayPal primarily has marketed its virtual debit cards directly to the most active and loyal of the holders of 133 million PayPal accounts.
  The virtual debit test is not PayPal's first partnership with MasterCard. PayPal also offers the PayPal Plus MasterCard credit card, a cobranded credit card that can be used online or in person.
  Virtual payment cards, with one-time-use numbers, did not catch on when they were first introduced in the late 1990s.
  Theodore Iacobuzio, managing director of the executive research office at TowerGroup, the Needham, Mass.-based research and advisory firm owned by MasterCard Worldwide, theorizes that many credit card issuers were willing to accept higher online fraud losses in the early days of virtual cards partly to help get the ball rolling on Internet commerce, which was still far from a mainstream mode of shopping.
  George notes that the few consumers who shopped online back then were as concerned about the security of their card transactions as they are today. "And the implementation of one-time use card numbers in 1999 wasn't as good as what we've built," he adds.
  Card use at Internet and brick-and-mortar merchants is safer than it used to be. Visa USA estimates that only 2% of breached payment card data results in fraudulent card-account use and says card-fraud losses have decreased from 18 cents per $100 of credit card spending in 1992 to 6 cents per every $100 of credit card spending in 2006. Moreover, the U.S. Department of Justice says that the number of adult victims of identity theft and fraud has decreased, from 10.1 million Americans in 2003 to 8.9 million in 2006.
  But consumer perception has a stronger influence on payment behavior than does reality. Many consumers either believe identity fraud and fraudulent use of payment accounts is rising, or they fear the consequences of fraud more now that media reports and industry education campaigns have made them more aware of the possibility of being victimized by fraud.
  Of 2,000 adults surveyed last August on behalf of Mintel Compremedia, a London-based card-marketing research service that also has an office in Chicago, 68% of respondents said they were "very concerned" or "somewhat concerned" that their credit or debit card number would be stolen if they used it for purchases via the Internet.
  Such perceptions increase demand for payment options that consumers perceive as more secure, as long as those options are reasonably convenient. Still, analysts find the marriage of PayPal and MasterCard for a new virtual debit card offering an intriguing arrangement given PayPal's original intent to be an alternative to cards.
  "It's interesting that PayPal would have a smack at this and that it would be in partnership with a debit card network," Iacobuzio says.
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  With debit card use continuing to increase in general, consumers are aware of the greater hassles that could be caused by needing to retrieve checking-account funds stolen via debit cards versus credit card charges that can be reversed if they are proven fraudulent, Iacobuzio says. "It's the actual funds that are at stake," he says. "Consumers are well aware of the difference between putting their credit card out on the Web and their debit card on the Web."
  PayPal's virtual debit MasterCard helps it compete even more with standard card-payment accounts, Gwenn Bézard, research director at Boston-based Aite Group, said when the test was announced in July. "The product is making PayPal's accounts look increasingly more like regular checking accounts," he said.
  Tim Sloane, director of Mercator Advisory Group's debit card practice, notes that while consumer use of one-time, virtual payment card numbers did not catch on among consumers in the dot-com boom, the concept has been in use elsewhere. "The MasterCard virtual card has been around for quite awhile, used in areas including (corporate) purchasing cards," he says. "It's understood that the technology works. What PayPal needs to discover is whether it solves a problem for the consumer or not."
  Though impressive for a beta test, the up to 4 million potential virtual debit card users represent only 3% of PayPal's total account base and are only a drop in the bucket compared with the nation's more than 1 billion credit and debit cards issued overall.
  The market is watching to see whether PayPal will secure enough consumer interest to move its virtual MasterCard debit test to a general rollout. The test's success or failure could signal whether consumer perception of the risk of using general-purpose debit and credit cards online will give virtual debit a second chance in the online spotlight.
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