<http://www.economist.com/finance/PrinterFriendly.cfm?Story_ID=2693526> The Economist Online payments Paying through the mouse May 20th 2004 | SAN JOSE, CALIFORNIA

From The Economist print edition

PayPal is turning into a huge online-payments business ONE of the most powerful forces in e-commerce is the "network effect": the more people who flock to a particular website, the greater its appeal. The latest beneficiary of this phenomenon is PayPal, which now handles online payments at an annualised rate of more than $17 billion. PayPal is not a bank, but for online buyers and sellers it performs much the same function. It already has 45m account-holders worldwide, one-quarter of the number of the mighty Citigroup. Next time, online The company began in Silicon Valley in 1998. Its e-mail system for payments became so widespread on internet auction sites that the biggest firm in this business, eBay, set up a rival, Billpoint, in the hope of snaffling for itself some of the value of transactions. But Billpoint never matched PayPal's popularity, so in 2002 eBay bought PayPal for $1.5 billion in shares. PayPal's ambition is to become the global standard for internet payments and it is expanding overseas in eBay's footsteps. In the first quarter of 2004, the value of items sold on eBay was $8 billion, 51% more than a year earlier. Meg Whitman, eBay's chairman, told analysts recently that the company reckons one in three online shoppers in America now has a PayPal account. Although PayPal's customers mostly buy via eBay, usage elsewhere is also growing-estimated at well over $1 billion-worth of transactions in the first quarter of the year. Besides purchasing from other dotcoms, you can pay your taxes in York County, South Carolina or send a donation to the Pat Brody Shelter for Cats in Lunenburg, Massachusetts. PayPal also does gift vouchers. The payment mechanism is simple enough. Newcomers to PayPal provide details of a credit card or bank account. These are verified with a nominal transaction. Thereafter, a buyer can e-mail a payment directly to a seller. This is immediately debited from the buyer's credit card or bank account, and a credit is made to the seller's PayPal account. Money in a PayPal account can be withdrawn by cheque or transferred to a bank account. Individuals and small traders can receive credit-card payments without obtaining a merchant account. PayPal's cut comes from charging recipients between 2.2% and 3.4%, depending on the country, and levying fees for currency conversions. In the first quarter of 2004, PayPal's revenues were $155m, 69% more than a year before. PayPal has helped slash the time internet users spend completing transactions and has greatly increased confidence in trading online, says Matthew Bannick, the company's general manager of global payments. It can take several weeks for cheques to arrive in the post and for payments to clear, but online payments are made instantly, which means goods can be shipped straight away. "It has improved the velocity of trade," adds Mr Bannick. Another benefit, he says, is that buyers do not have to impart banking or credit-card information to merchants. Security remains the prime concern of internet shoppers. An NOP survey that PayPal commissioned in Britain, where the company opened its first overseas site last year, found that more than one-third of internet users are reluctant to spend more than #50 ($90) online. To overcome their concerns, payment protection is now offered in America (up to $500) and in Britain (up to #250) on goods sold by eligible traders (those who have built up good reputations within eBay's ranking system). This now covers more than 60% of all listings on eBay's American site. PayPal wants to expand internationally, to continental Europe and Asia. Although it has not said so, the likeliest next local site is Germany; China, eBay's fastest-growing market, looks like a good long-term possibility. Such growth will bring new challenges. People in different countries favour different ways of making payments offline: the French like cheques, for instance; in Germany, bank transfers are common. This might translate into different online habits. Countries also regulate financial services differently. PayPal has no plans, though, to become a bank, even though it performs some similar functions. Customers in America can earn interest on their PayPal balances by allowing PayPal to place the funds in a pooled savings account or by enrolling into PayPal's money market fund. It has been licensed as a money-transmitter in American states and in Britain. Regulation as a bank would require more costly and complicated compliance. Nevertheless, the company has faced regulatory challenges, not least because it could be used for the illicit transfer of funds. Soon after it acquired PayPal, eBay ended its services to online gambling merchants because of complaints from federal prosecutors that this violated America's Patriot Act, which Congress passed after the September 11th terrorist attacks to harden money-laundering rules. Last year, eBay paid $10m to settle the charges. Because most of its payments are small, big sums stand out. This should help PayPal comply with the authorities. Now it is interested in handling even smaller amounts. Late last year it introduced lower processing fees for micro-payments, to make it more feasible for online merchants to accept tiny payments for digital-music downloads. The success of portable music players, such as Apple's iPod, suggest that this too will be big online business. -- ----------------- R. A. Hettinga <mailto: rah@ibuc.com> The Internet Bearer Underwriting Corporation <http://www.ibuc.com/> 44 Farquhar Street, Boston, MA 02131 USA "... however it may deserve respect for its usefulness and antiquity, [predicting the end of the world] has not been found agreeable to experience." -- Edward Gibbon, 'Decline and Fall of the Roman Empire'