CASE STUDY

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PayPal Has Company
PayPalthe online payment processor now owned by eBaywas the frst truly
successful Internet-based e-commerce payment system. Its origins were quite
simple. On Noember !"# !$$$# Peter %heil sat with friends at a restaurant. &hen
the bill arried# %heil used his Palm Pilot to 'beam' his share to a friend sitting across
the table. %heil and fellow co-founder (a) *echin had built a system that would
allow them to send money to one another ia a Palm Pilot+s infrared lin,s. -rom this
idea sprang one of the frst 'peer-to-peer' payment systems. a system that allows
indiiduals to send money to one another ia e-mail.
PayPal emphasi/es ease of use for both senders and receiers of cash. 0ere+s a
brief synopsis of how it wor,s. -irst# you create a PayPal account at the PayPal
&eb site by flling out a one-page application form and proiding credit or debit
card or ban, account information. Only PayPal is priy to this information# not the
receiing party. %hen# when you use PayPal to pay for a purchase# money is drawn
from the credit card or ban, account and transmitted to the 1utomated 2learing
0ouse 31204 Networ,# a priately operated fnancial intermediary that trac,s and
transfers funds between fnancial institutions.
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%he party who is to receie the payment is notifed ia e-mail that money is
waiting. If the receiing party has a PayPal account# the funds are automatically
deposited into the account5 if the person does not hae a PayPal account# he or
she must set one up# and then the money is credited to his or her account. Once
the funds are in the PayPal account# the recipient can then transfer them
electronically to a chec,ing account# request a paper chec,# or use PayPal to
send the funds to someone else.
*echin and %heil originally conceied of PayPal as a method for 'beaming'
money to users of handheld P61s. &hen this idea did not pan out# they changed
their target to arranging payments between indiiduals who ,new one
another. 0oweer# they quic,ly reali/ed that it would also wor, for a company such
as eBay# proiding purchasers and sellers with a way to short-cut the time-
consuming and cumbersome process of mailing chec,s and money orders and
waiting for chec,s to clear before shipping items. (oreoer# for small merchants
selling items on the &eb# it is di7icult and e)pensie to obtain the capability to
accept credit cards. 2redit companies e)tend these merchant serices only to
bona fde businesses# usually requiring a physical place of business as a
requirement.
%oday# PayPal is the largest and most popular online payment serice#
growing from a handful of users when it launched in late !$$$ to oer !"8
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million in 9::;# of which about <: million can be characteri/ed as actie users. In
9::;# PayPal processed =<8 billion in payments. 1bout ;:> of this gross olume
3=?: billion4 is tied to eBay users# and =!8 billion comes from non-eBay
transactions. One reason PayPal has grown so fast is because it e)periences the
benefts of networ, economics or the 'iral e7ect'. the more people who
accept and use PayPal# the greater the beneft to the consumer.
If I send you a PayPal payment ia e-mail# then you are incentiised to open
a PayPal account to receie the funds. If PayPal is to continue growing# it will
hae to brea, out of the eBay mar,etspace and fnd new payment opportunities.
PayPal earns money in many di7erent ways. -irst# online sellers 3who may be
indiiduals or small businesses that do not want the di7iculties associated with
obtaining a merchant credit card account4 pay a transaction fee for the serice
3?: cents plus !.$>-9.$> of the proceeds of the transaction4. %his generally wor,s
out to ?.?> of the transaction on a =!:: transaction. 2redit card frms generally
charge about the same or :.?> more due to their higher customer acquisition
costs. PayPal# in other words# can be slightly less costly than credit cards for
merchants.
One adantage for merchants on eBay is that they are not required to hae
a merchant ban, account# which is required by credit card issuers. (erchant
ban,s clear credit card transactions and charge fees. 2onsumers are not charged
directly for the use of their PayPal account although they do pay ultimately
because retailers need to recoer the costs of the transaction by raising the prices
on goods sold using PayPal. @econd# PayPal earns reenue by collecting the
interest earned on consumer funds not yet transferred out of the PayPal system.
PayPal has charges for transferring funds to foreign ban,s# conerting currencies#
and new fnancial products such as a PayPal credit card.
Part of the strength of PayPal lies in its simplicity. it piggybac,s on e)isting credit card
and chec,ing payment systems. %his is also one of its wea,nesses# howeer. PayPal
reportedly su7ers relatiely high leels of fraud related to the credit card system on
which it relies. %o protect against fraud# PayPal requires special authori/ation for
payments oer =9::.
In 9::9# PayPal went public and issued shares in an initial public o7ering. One of
the main reasons PayPal grew so rapidly was because of its popularity on eBay. In an
e7ort not to lose this lucratie transaction business to PayPal# eBay spent oer =!::
million promoting its own similar system called Billpointbut to no aail. In October
9::9# eBay purchased PayPal for =!.8 billionabout =9: a share. 1t the time# analysts
felt the price was too high# but eBay has had the last laugh. %oday# PayPal is alued at
=;-=A billion# and# according to the company# has a !:> share of the B.@. consumer e-
commerce payments mar,et and a 8> share of the global mar,et. In 9::"# PayPal
generated =!.< billion in net reenues for eBay. 1lthough this only accounted for about
98> of eBay+s reenues# the growth rate of PayPal reenues 3<:>4 e)ceeded that of
the rest of eBay+s (ar,etplace segment 39<>4 by oer !8>.
-or a brief period# PayPal enCoyed its position as the only widely adopted online
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platform 3aside from the credit card companies4. But this is changing rapidly. %he largest
direct competitor is Doogle+s 2hec,out system# an online digital wallet. Doogle 2hec,out
stores a user+s fnancial information# including credit card information# and then
presents this information to merchants when the user chec,s out. %he customer
does not hae to fll out forms or reeal credit information to online merchants. 2hec,out
does not support peer-to-peer payments# at least not yet. Doogle has been careful not to
directly challenge PayPal in the P9P mar,et# if only because eBay 3the owner of PayPal4
is the largest single adertiser on Doogle# and Doogle directs a signifcant tra7ic olume
to eBay. %hey need one another. Doogle will also use 2hec,out to support its adertising
networ,. 1ds for online stores that accept 2hec,out are highlighted with an icon#
increasing the chances that users will clic, on those sites. Once users clic, on an ad#
they are more li,ely to purchase. (erchants who accept 2hec,out on their sites receie
more tra7ic simply for o7ering the conenience of the serice# and Doogle has frequent
promotions where it eliminates all processing fees for periods of time# saing
merchants the 9> plus 9: cents it charges for transactions.
1n een more direct challenge is coming from unli,ely sources. cell phone carriers
such as 1%% and Eeri/on# especially in P9P payments. PayPal and Doogle 2hec,out are
both built upon the e)isting credit card system. &hat if you could eliminate the credit
card intermediariesF In Gune 9::;# Eeri/on announced a deal with mobile payment
company Obopay# Inc. to allow subscribers to transfer money and ma,e purchases
through their cell phones. Bsers can send money to anyone with a cell phone on any
wireless networ,. Now let+s see. there+s a billion P2s in the world# but around < billion cell
phones. 1round 98: million people in the B.@. hae mobile phones. 2urrently# Eeri/on
customers will hae to load their Obopay accounts at the Obopay &eb site with a credit
card. But in the future# Obopay hopes to integrate its serice with Eeri/on+s own
monthly billing serice# thereby eliminating credit card companies altogether from
the payment loop# reducing transaction costs merchants and customers# and
ma,ing it easier to use the serice 3there+s no sign needed as long as you hae a
Eeri/on cell phone account4.
PayPal also faces other challenges. PayPal+s brand is closely associated w
smaller merchants# P9P money transfer# and low-cost auctions. 1s a result# sot
larger frms might not want the PayPal brand image associated with their
brands.
PayPal+s business ma,es it a natural target for fraud# both by merchants
that not delier goods or serices paid for by its customers# and from outside
forces wl send fraudulent e-mails to its customers# attempting to steal the
customers+ passwor credit card numbers# or other personal information.
PayPal has been forced institute a number of costly measures to combat fraud in
the attempt to enhance customers+ confdence in its serices. PayPal+s protections
for consumers are wea,e than what credit card companies are required to o7er.
-or instance# you can deny credit card charge and hae a =8: ma)imum liability
if your credit card informatiol is stolen and used in commerce. &ith PayPal# you
may or may not receie you. money bac,# depending on whether PayPal can
receie its money bac,# and a host :. other conditions. PayPal has deeloped a
consumer protection program# but it alsc settled in 9::" with 9A state attorneys
general inoling concerns about certain business practices. 2hief among these
practices was encouraging users to allow PayPal to directly debit consumer ban,
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accounts# because PayPal can aoid paying credit corn-# panics a 9> funds transfer
fee# ma,ing the direct deduction option more proftable for PayPal. If you hae gien
PayPal both your credit card information and ban, account+ information# the default
payment method used by PayPal is your ban, account. Once funds are withdrawn
from your ban, account# they cannot be recoered# unli,e credit card
transactions. 0ence# the ris, to consumers is substantially greater. 2redit card
companies can retriee funds from misbehaing merchants more quic,ly by
simply reerse-crediting their merchant ban, accounts# which generates a
hefty penalty payment for them as well.
To cope with emerging new competitors# including the cell phone carriers with
deep poc,ets# PayPal is pursuing a number of other growth initiaties. PayPal
signed up both Napster and 1pple+s i%unes (usic @tore as merchants in its frst
foray into the micropayments mar,et. %he e)perience proed so successful that
PayPal is now inestigating similar deals for other micropayments mar,ets# such as
downloadable games# electronic greeting cards# and other online content. PayPal
introduced a new micropayments pricing plan designed to increase and
encourage the purchase of low-priced digital goods. PayPal is also pursuing an
oerseas e)pansion strategy. It has added locali/ed &eb sites in 2hina# 1ustralia#
Italy# and @pain to a list that already included 2anada# 1ustria# Belgium# -rance#
Dermany# the Netherlands# @wit/erland# and the Bnited Hingdom. In 9::;#
businesses or consumers with e-mail could use PayPal to send online payments in
!$: countries# and receie payments in "8 of those countries. Payments can be
made or accepted in any one of !; di7erent currencies. PayPal is attempting to
e)pand beyond eBay sales by setting up preferred merchant relationships with
other large Internet retailers such as Iahoo and 1ma/on# with mi)ed success.
Amazon has its own credit card and preferred methods of payment# but Iahoo
uses PayPal as a recommended payment method. In 9::"# PayPal also introduced
its mobile te)t message payment system# which allows cell phone users to pay for
goods and serices by te)ting PayPal payments to merchants.
6espite the challenges# howeer# the future for PayPal appears bright. In fact#
some analysts beliee that PayPal may someday become an een bigger
phenomenon than its acquirer# eBay.
Case Study Questions
1. What is the value proposition that PayPal offers consumers? How about merchants?
2. What are some of the risks of using PayPal when compared to credit cards and debit cards?
3. What strategies would you recommend that PayPal pursue in order to maintain its growth over the net
five years?
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!. Why are cell phone networks a threat to PayPal"s future growth?
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SOURCES: #$eri%on &nnounces 'eal with (obile Payment )irm *bopay+# Wall Street Journal, June 2,+ 2,,-. e/ay 0nc. )orm 1,12 for the fiscal year
'ecember 31+ 2,,3+ fi l ed wi th the 4ecuri ti es and 5change 6ommission+ )ebruary 27+ 2,,-. #PayPal Plans (obile Payment 4ervice+# by $auhini $ara+
Wall Street Journal, (arch 23+ 2,,-. #8oogle 4teps (ore /oldly 0nto PayPal"s 9erritory+# by (iguel Helft+ New York Times, 'ecember 2,+ 2,,3. #How to
(ake PayPal :our )riend+# by ;on <ieber+ Wall Street Journal, *ctober -+ 2,,3.
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2008 E-commerce business, technology, society Kenneth C. Laudon and Carol Guercio ra!er "earson "rentice #all.