PayPal’s Big Bet

PayPal-1-16-17.pngThis story delves into the following:

  • PayPal is pursuing an ambitious plan to become a major factor in the payments industry.
  • PayPal has worked out deals with Facebook, Visa, MasterCard and others to expand its presence.
  • PayPal, which owns peer-to-peer payments app Venmo, has an advantage over the banking industry in that payments and related activities are most of what it does.

It seems ironic that a company that helped pioneer the online payments business might now be described as an old line payments company. Founded 18 years ago in Silicon Valley, and later acquired by eBay, PayPal Holdings was instrumental in the popular auction site’s growth into a multibillion dollar company with operations in 30 countries. But 1998 is ancient history in the world of e-commerce, and today PayPal is trying to recalibrate its strategy to account for the fast growth of mobile payments.

PayPal is now an independent public company. Although it was spun off in July 2015, eBay is still its largest customer and accounts for a significant percentage of its revenues. San Jose, California-based PayPal’s largest business is processing credit or debit card payments on behalf of merchants for a fee. And while many of these merchants sell through eBay, the company has been successful at gaining acceptance at a large and growing number of national e-commerce sites that traditionally have accepted payments through Visa, MasterCard, American Express and Discover. In the third quarter of last year, PayPal had 192 million active customer accounts, an 11 percent increase over the same period in 2015, and it processed 1.5 billion transactions for the quarter, up 24 percent in a year-over-year comparison. That volume contributed to an 18 percent growth in both revenue, to $2.6 billion, and net income, to $425 million, for the quarter.

Now separated from eBay, PayPal is pursuing an ambitious plan to become a major factor in the payments industry. In a June 2016 report on payment service providers, Thad Peterson, a senior analyst with the research firm Aite Group, wrote that PayPal has the experience, resources, platforms and technology to some day rival established payment networks like the major card companies. In an interview, Peterson says he believes that PayPal wants to become a “fifth acceptance brand” next to Visa, MasterCard, American Express and Discover. “I think they want to take their place alongside the networks as one of the key acceptance brands on the planet,” he says.

To accomplish that objective, PayPal faces the challenge of increasing its penetration of in-store transactions-where it does not have a major presence-while also establishing the same brand awareness with consumers that the major card networks already enjoy. “Why would I use [PayPal] as opposed to my credit card, or my card on my cell phone?” says Lee Kyriacou, a managing director at the consulting firm Novantas. “They’re working hard at making that case, but it’s a difficult slog for them.”

For banks, it’s worth paying attention to what PayPal is up to because the banking industry has an immense interest in the future of the mobile payments business, and PayPal wants to be a major player in that space. Understanding PayPal’s mobile strategy offers a window into where the fast-growing sector is heading. Peterson is concerned that banks in their innate conservatism are not responding as quickly as they should be to the rate of change that is occurring in the marketplace. “Banks have traditionally always been followers, not leaders,” he says. “This is a space that’s moving very quickly. Even if you’re a fast follower, you have to be moving at a pace that I don’t think a lot of banks are very comfortable with.”

PayPal’s greatest strength today is its strong position in the online sector, where it is a major processor of payment transactions for e-commerce merchants, many of whom sell through eBay. “We have almost 200 million merchants and consumers together that we connect,” says Chief Financial Officer John Rainey. “It’s hard to completely separate the two because they’re so interrelated. Providing something to merchants could be fantastic, but if there are no consumers to adopt that, it’s of no value to them. Conversely, you could have a great digital wallet, but if it’s not accepted by the merchants, it’s of no value to that consumer.”

An important part of the company’s strategy is to provide a technology platform that gives merchants and consumers as much payment flexibility as possible. For merchants, this means they can complete a sale regardless of whether a transaction occurs at the point of sale in a store, online or on a mobile device. A phrase that PayPal often uses to describe this approach is technology agnosticism. For consumers, flexibility means they can use whatever payment options they choose, whether its PayPal Credit, a balance in their PayPal account, a debit or credit card or link to their checking account; and whatever device they choose, whether it’s a PayPal digital wallet or that of another company.

Although in-store and online payments still account for the vast majority of the overall payments market today, the future would seem to belong to mobile, which is growing at a much faster rate. Forrester Research forecasts that mobile payments in the United States will expand to $237.4 billion in 2021 from approximately $94 billion in 2016, for a compound annual growth rate of 20.3 percent. As of early December, mobile-impacted retail sales (completing a purchase in-store via a mobile device or purchasing products online with a mobile device) were expected to account for 31 percent of the revenue from U.S. retail sales in 2016, and to reach 37 percent by 2021. Mobile is also PayPal’s fastest growing business and now accounts for approximately 30 percent of its payments transactions, according to the company.

On the consumer side, much of the action has been centered on the development of digital wallets, which contain an individual’s credit and debit card information. They turn the smartphone into a payment device in an in-store environment. Technology companies like Apple and Samsung, as well as Visa, MasterCard and several large banks, have all jumped into the market with competing wallets, and as yet, no market leader has emerged. Bob Roth, a managing director at the consulting firm Cornerstone Advisors, expects there to be some fallout. “Consumers aren’t going to use seven of them,” he says. “It doesn’t make sense.” Digital wallets also require the installation of terminals that use near-field technology, which allows consumers to simply place their phones in close proximity of terminals when checking out. But merchants have been slow to invest in the new technology, which has restrained their use.

“Digital payments, while they can potentially allow for a more frictionless transaction, so you can [check out] faster, are really not a strong enough value proposition yet,” says Jonathan Magder, a senior manager at the consulting firm Accenture, who follows the payments industry. From Magder’s perspective, cash is still king and plastic is hanging on. “I think people are actually quite happy with the way they pay-maybe not happy, but at least content in the sense that if it ain’t broke, don’t fix it,” he says. “They need a really compelling reason to switch.”

When PayPal was still part of eBay, it was often viewed as a competitor by other e-commerce websites. “Historically we have been walled off as a payment option on [other] e-commerce sites, and when we separated [from eBay] we made a strategic pivot to be an open digital payments platform,” says Rainey. PayPal’s platform gives merchants the ability to accept any kind of digital payment and capture 100 percent share of checkout-or, to put it differently, not lose a sale because it didn’t offer a payment option that the consumer wanted to use. This strategy has been boosted by the August 2013 acquisition of Braintree, which enables merchants to accept online and mobile payments and provides consumers with a “One-Touch” checkout option that reduces cart abandonment where shoppers fail to complete a transaction.

On the consumer side, PayPal has tried to adopt a more customer-centric philosophy since splitting with eBay. For example, long-time PayPal users knew they would first have to use any money in their personal account to fund a purchase before they could use a credit card. This saved the company money on interchange fees but limited consumer choice. The Consumer Financial Protection Bureau also fined the company $25 million in 2015 over accusations that PayPal charged consumers for credit products, sometimes without the customers’ knowledge or control, which the agency considered to be an abusive practice. Now customers are able to select which payment option they want to use when paying for a purchase with PayPal.

“Our aspiration is to be an everyday part of our consumers’ lives,” says Rainey. “To do that we need to be successful offline [in order to] increase the ubiquity of PayPal. We don’t want consumers to think of PayPal as something that is used to check out at a few select merchants, eBay historically being one of them. We want to be ubiquitous, to where they can use us to pay their friends, pay their families, check out online, power successful apps like Uber and Airbnb, but also check out offline at everyday merchants where they shop.”

Venmo, PayPal’s app that enables individuals to send money to one another, has gained a tremendous following with millennials. “One thing I know having two kids that age is that Venmo has become a verb, like Google,” says Peterson. “It is their form of transaction.”

The service is not profitable to the company, although Rainey says there are offsetting benefits. “It’s a fantastic customer acquisition tool for us,” he says. “Right now, for the most part, it’s a peer-to-peer application, but we’re going to expand the same capabilities we have with PayPal to Venmo, so ultimately you’ll be able to pay at all the same merchants that one can pay with PayPal today. It’s a huge opportunity for us, and it has a great following.” Another P2P product, Xoom, allows individuals to send remittances to 56 countries outside the United States.

An important aspect of PayPal’s desired ubiquity is the ability to offer consumers as many payment options as possible. Last fall, it worked out a deal that expands PayPal’s availability as a payment option on Facebook and improves the checkout experience. And the company is not necessarily betting on any single wallet to gain supremacy in the market, including its own. PayPal worked out deals last year with Visa and MasterCard that helped bring to an end to years of acrimony between it and the card associations. Among the details, PayPal agreed to stop encouraging users to link their accounts directly to their bank accounts rather than their credit or debit cards, which charge higher fees. PayPal also gets access to the networks’ digital wallets, which should help it expand its offline presence. For example, PayPal users will be able to make payments at 5 million locations that use MasterCard’s digital wallet. PayPal’s concept of ubiquity means that it wants to get into the network’s wallets, even though Venmo is a similar-and potentially competing-app, because that provides the consumer with more choices.

PayPal is also trying to expand further into the offline payments market where its presence is much smaller than in the online sector, in an effort to expand its overall customer base. Pushing mobile will help the company expand its in-store presence as consumer adoption of digital wallets gradually increases. There is, in fact, a growing convergence between in-store and online commerce, where for example, a consumer could order a product online and then pick it up in a nearby store. “The world of online and offline is converging and we believe that the cross-section of those two is the mobile device, so our strategy is underpinned by mobile and where that is going,” says Rainey.

Gaining broader acceptance in offline payments is important to PayPal in part because the company expects digital wallet use to grow slowly but steadily, says Rainey. And for a payments company that might want to see its name in lights next to Visa, MasterCard, American Express and Discover, PayPal has to increase its presence in the in-store world. “If you want to grow, the physical world is a great place to do that,” says Peterson, who estimates that e-commerce still accounts for just 7 percent of total retail commerce. “Even in five to 10 years, the physical world is still going to be largely dominant in terms of where the transactions are occurring,” says Peterson. “If you want to be an acceptance brand, you clearly have to be accepted there.”

PayPal has an advantage over the banking industry in that payments and related activities are most of what it does, while for the vast majority of banks, payments is more of a sideline-or better yet, a utility. While the facilitation of payments is something that banks do, most banks still define themselves as lenders. But it can be argued that PayPal has a much stronger relationship with its customers on both sides of the e-commerce transaction, built around the payments experience, than the average bank has with its borrowers. And that’s a lesson the industry can learn by watching how PayPal builds out its payments strategy.

“The old saying is, if you want to build sidewalks on campus, look where the paths are worn in the grass,” says Rainey. “That’s what we’re doing with mobile. We’re not necessarily trying to change customer behavior in the way that they pay at checkout, but we’re using their mobile device to improve their overall experiences.”


Jack Milligan


Jack Milligan is editor-at-large of Bank Director magazine, a position to which he brings over 40 years of experience in financial journalism organizations. Mr. Milligan directs Bank Director’s editorial coverage and leads its director training efforts. He has a master’s degree in Journalism from The Ohio State University.

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