PayPal, with Visa, Must Not Repeat Mistakes of Its Discover Pact

To hear PayPal CEO Dan Schulman tell it, his company's agreement with Visa this week is a transformative and history-making deal.

But in at least one way, PayPal must make sure that history does not repeat itself.

On the surface, the pact with Visa bears some resemblance to PayPal's 2012 alliance with Discover, which was meant to bring PayPal to the point of sale of any Discover card-accepting merchant. But that rollout was slow and required PayPal customers to carry a dedicated PayPal payment card, which seemed a step backwards from what PayPal was trying to accomplish in the digital age.

In describing what makes the Visa agreement different than the Discover project, Schulman said during his company's July 21 earnings conference call that all entities involved – the consumer, Visa, PayPal and the issuers – will benefit. While he did not say it directly, Schulman may have been hinting that Discover simply did not have Visa's scale, or that it might have been too early four years ago to excite PayPal account holders to use PayPal in stores.

"We have been in discussion with issuers, and they are excited about the benefit of transaction volumes we can bring to them at the [point of sale]," Schulman said. "This agreement removes many concerns that issuers and others in the ecosystem have had about working with PayPal."

In particular, PayPal is well-known for keeping its own costs down by urging consumers to fund PayPal accounts with ACH transfers rather than the bank-issued credit and debit cards they may have initially used to enroll.

This was a sore point with Visa as recently as May, when Visa CEO Charles Scharf publicly roasted PayPal for its longstanding practice of favoring ACH.

But unlike PayPal's 2012 deal with Discover, this time PayPal won't have Visa working against its success, said Gil Luria, analyst with Los Angeles-based Wedbush Securities.

"Visa and Mastercard issuers and acquirers did everything they could to block that deal and prevent PayPal from successfully deploying with Discover," Luria said.

In addition, the deal with Discover came in the "pre-NFC" days in which few, if any, retailers had Near Field Communication technology for contactless payments at the POS. This made the plastic PayPal card more of a necessity than it is today.

"The Discover-PayPal agreement was a new and exciting concept, but it was too hard to make it work,"  Luria added.

PayPal also has new management steering it today. Then-president David Marcus and vice president of retail services Don Kingsborough have left the company, and PayPal is also independent of its longtime owner eBay Inc.

PayPal's initial attempt with Discover followed an earlier deal to develop a person-to-person Money Messenger service to compete against Visa and American Express, which were moving forward with similar services.

But with the Visa pact, it's likely PayPal will use it as a framework for similar alliances with Mastercard and American Express, Luria said.

Visa's Scharf insisted that PayPal could not treat the card networks as "frenemies," and had to drastically change its practices if it wanted to form any kind of alliance. In describing the recent deal, Schulman said that providing consumer choice and transaction data to Visa and its issuers, "turns us into their friends."

While Visa's history is filled with angst in terms of merchant relationships, PayPal has enjoyed a far better position as a merchant ally. The deal should not alter that perception since PayPal does not need to sign up retailers under different terms.

"If a terminal takes Visa contactless, it can take PayPal," Luria said. "All PayPal has to do is sign up issuers, and now that they have struck this deal, there is very little reason for issuers not to do that."

Because PayPal charges market rates for transactions, merchants will not see any change in that process for online or offline transactions, Luria said.

Merchant organizations did not respond to PaymentsSource inquiries about the Visa-PayPal alliance prior to deadline.

Ultimately, the partnership's success will depend on its ability to bring revenue to both companies. If the math does not work out, it could face a similar fate as the now-defunct partnership between Square and Starbucks that began in 2012.

Starbucks was able to slash its transaction costs by working with Square as a processor, but it was clear from the start that this deal was too-one sided, especially since Starbucks was not committing to Square hardware and was using the company only as a payment processor.

Indeed, late last year, Square reported the companies would not renew the agreement they had in place, as its commentary for its initial public offering revealed the Starbucks deal was costing Square money — Square reported transaction revenue at $123 million for 2014 and costs of $151 million.

PayPal has described the Visa deal as one that not only creates opportunity for both companies, but also mends PayPal's biggest pain points as an independent company.

"This opens a new chapter for PayPal, as we all work together to advance digital payments going forward," Schulman said. "We will see customer satisfaction go up, and consumer churn go down."