Paying through the mouse

R. A. Hettinga rah at
Thu May 20 12:20:22 PDT 2004


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

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

 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

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account can be withdrawn by cheque or transferred to a bank account.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

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

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

R. A. Hettinga <mailto: rah at>
The Internet Bearer Underwriting Corporation <>
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'

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