PayPal Merchant Services

Case Discussion Question 1

Right from its genesis in December 1998, PayPal was ideally suited to tap into the inherent market potential
of the so-called “ person-to-person “ electronic network transactions, which had established widespread
presence in the digitally connected world.  Deeper analysis of the strategy behind PayPal reveals four major
reasons behind the success of PayPal as a first mover in the digital transactions world :

1. Ease  of  Operation:  PayPal was tailor-made for fast and efficient online transactions maintaining
the required speed and reliability of data on either side of transactions. Registered users could
transfer payments to another PayPal account holder through PayPal’s online form giving a major
boost to online product sales. Payments were deducted from the source fund ( like credit card ,bank
or PayPal account) while recipients were notified through e-mails of the receipt of money in their
PayPal accounts. Recipients could also transfer funds to suitable funding source or leave proceeds in
PayPal accounts.

2. Acceptance by Sellers : PayPal was well-accepted by the seller community at large, primarily
because it offered them a quicker and more convenient payment method. Most sellers being
individuals or small businesses were unable to accept credit card payments directly from consumers
and this gap was well-filled by the middle layer of transaction that PayPal offered. Many sellers did
not have proper commercial credit history and hence did not qualify for a credit card “merchant
account” but not anymore with the emergence of PayPal with which the sellers did not have to wait
to receive checks or money orders by surface mails before shipping goods.

3. Acceptance by Buyers :  PayPal services also addressed the primary concern of most auction buyers-
the buyers could now fund PayPal accounts suing credit cards or bank account balances, without
divulging credit card numbers to unknown sellers. Sharing personal financial information was  a
serious concern that led many consumers to avoid buying online but that was no more the case . This
enhanced the overall trust factor in online transactions and was a major boost for PayPal.

4. Value creation for Two Side Transactions : PayPal transactions had intrinsic advantages over
standard credit card payments, which primarily helped  limit fraud related losses for merchants.
Firstly, PayPal served both sides of every transaction, enabling it to verify that buyers and sellers had
reputable histories. By contrast, different banks represented buyers and sellers for most credit card
transactions. This obviously made it harder for the sellers’ banks to confirm that buyers were
legitimate. More importantly, the “dual factor” authentication- requiring both  a user name and a
password – substantially reduced PayPal’s vulnerability to fraud related losses or stolen account
information. PayPal’s low dispute rate was testimony to this fact. In fact, if we consider the case of
online merchants in the value chain, after factoring in fixed fees paid per transaction and per month,
online merchants would usually pay their acquirer 3% to 5% for a credit card merchant account
versus only 2.5% for PayPal. A small online merchant would even pay about 4% to 7% for a
merchant account versus about 3.1% for PayPal. Such value additions weighed very favourably for
PayPal.

EXECUTION OF COST AND REVENUE MODELS

At a very critical point in 2005, PayPal started identifying customers as Business and Personal
Accounts. This helped them to identify customers who would be more likely to pay for the service.
Business customers were only 20% of the entire subscription but contributed to 90% of the total
transaction volumes. PayPal charged a nominal fees and was dependent on large sales volumes. It
identified 4 major streams to generate revenue. Moreover, PayPal was able to control its costs by
answering the two main cost drivers.  They had a dedicated 1000 member team to detect/ deal
frauds and “chargeback facility to lower the incurred transaction losses. After acquisition by eBay,
 PayPal was also able to improve its  previously cumbersome customer service especially for personal
users.

Case Discussion Question 2

By 2005, Google had established itself as the major Search engine and emerged as a worthy
competitor for e-commerce transactions based on Web search. However, on deeper analysis,
Google’s emergence can be considered only as a moderate threat to PayPal primarily based on the
Target groups and Synergies existent within boundaries of each company.

1. Target Groups : While Google had the upper hand in gaining customer base of 70% of all e-
commerce transactions which originate through Web search, this would mainly entail new
clientele/merchant groups. The original or existing customer base of merchants with PayPal
would remain mainly untouched as these customers already have a steady and well-defined
relationship with PayPal, apart from reliable dealings and IT infrastructure in place. Also Google
did not target groups who did not have access to credit cards .Paypal had 3 modes of payments
(credit cards , direct account transfer and paypal account balance) . Google Accounts on the other
hand was using only stored credit card information.

2. Synergies : eBay has been a large Google advertiser and PayPal has been good partners using
Google as a platform for online visibility. Such a scenario leaves a scope for a synergistic solution
also to be worked out within eBay and Google wherein an appropriate Revenue-sharing model
can be worked out for Google to provide visibility for an ad and revenues to be generated
through product purchase through either Google Base or PayPal be appropriately routed
between Google and eBay. As such, holistically, Google is a moderate but not insurmountable
threat.

Strategy for Google

For Google to create a mark in the world of e-commerce transactions, the following key strategies would be
crucial:

1. Core Competency of Web Search

Google’s core competency of extensive Web search gives it the advantage of scale- for instance, Google Base
hosted 45 million listings for a wide variety of items like jobs, apartments, products and information content.
In contrast, eBay’s US market place typically offered about 15 million products at any point of time. This
visibility can be a critical leveraging factor for Google to gain a foothold in the e-commerce world in terms of
visibility and sheer range of products for online sale.

Moreover, with Google’s trial payment system, users searched for items on Base, then could purchase them
easily using Google accounts that already stored their credit card information, thus giving the customers a
significant choice of which card to use online. In fact, the possibility of linking Google Base to Web search
would open up whole new world of keyword-linked text ads and would encourage a wider variety of
products and information to be transacted online.

2. Efficient Revenue sharing Models

Google would have to work out an efficient revenue generation and sharing model so as to maximise
synergies between merchants and Google accounts, keeping Base as the Web search driver . Google could
offer merchants a bundle that includes both paid search and transaction processing, with the merchant only
paying when a sale is actually completed. As such, “ Pay for Purchase” could be a viable model for the
viewpoint of merchants whereas from the viewpoint of Google Accounts, “ Pay per Click” has been the most
preferred method. Now herein lies the iterative feedback loops that Google can generate to actually track
how many of the online clicks actually turn into sales. These would pave the way for more effective paid
search campaigns and give Google valuable behavioural and commercial insights into the merchants as well
as the products offered by them. Leveraging Base as the tool, this can open up new avenues for Google to
utilise online transactions like Retail inventory management , cyclical demand variations or particular
product demands by certain demographies. These nuances can very well be captured by Google ‘s large Web
search Base and utilised for maximum Value creation. But using ‘Pay for Purchase’ which merchants might
prefer would go against what has caused Google to be successful so far. The best option for Google would be
to stick to ‘Pay per click’ and to charge an extra fee for all clicks which led to sales using Google Accounts.

Strategy for PayPal

In order to thwart the challenges posed by the emergence of Google, PayPal should consider the following
strategies:

1. Incentive schemes across Value Chain

PayPal should lay special focus on instilling loyalty and tapping into customer segments by
expanding/strengthening its range of services. Lower processing fees and zero payment charges can
favour it to the small and medium-sized merchants whereas APIs can enable integration of online
transactions into more aspects of the value chain like back-office systems, order management etc.
These should be phase-wise rolled out amongst large, organised online retailers as well. Loyalty
reward programs and bulk discounts on new product ranges can also be crucial. New online services
like Website Payments Pro increases the applicability of PayPal services beyond credit transactions
and in fact, makes it easier for merchants to select the appropriate payment product.
In fact, with an average charge of 2.2% to 2.9% for PayPal and offerings of Credit card accounts, bank
accounts as well as Balances in PayPal, as compared to only Credit card transactions for Google Base,
PayPal holds a distinct advantage in sheer range of applicability. Also the main revenue for PayPal is
coming from non credit-cards transaction as there are fees as well as non-payment charges
associated with credit cards. Using just credit cards it is not possible to generate enough profit. So if
PayPal offers slight discount to merchants it would not be possible for Google to match that without
suffering losses.

2. Strategic Alliances

It would be critical for PayPal to forge strategic alliances with competitive paid search engine
providers like Yahoo! and MSN. This would impart PayPal the much needed muscle in terms of
product range, reach and utilisation of Web-search based revenue models to optimise on revenues as
well as expand market share and visibility. A case in point is the partnership with Paymentech which
not only opened up new clientele base for PayPal but also enhanced the range of its processing
platform.

3. Expand Reach and Variety

In an ever-changing digitized world, new ways and diverse product ranges have to be the order of
the day to maintain competitive position.  eBay’s acquisitions of Skype as the VoIP platform as well
as the acquisition of VeriSign gateway business are steps in the right direction to strengthen market
reach and visibility of PayPal. Exposure to new information and customised products like financial
/technology services or latest products with complex attributes may hold potential of attracting new
customer base. PayPal should largely look at maintaining long term relations with Merchants and
offer incentives to match or exceed Google’s causing reluctance to shift towards using Base and
Google Payment