PayPal Has Company
PayPal—the online payment processor now owned by eBay—was the first truly successful Internet-based e-commerce payment system. Its origins were quite simple. On November 16, 1999, Peter Theil sat with friends at a restaurant. When the bill arrived, Theil used his Palm Pilot to "beam" his share to a friend sitting across the table. Theil and fellow co-founder Max Levchin had built a system that would allow them to send money to one another via a Palm Pilot's infrared links. From this idea sprang one of the first "peer-to-peer" payment systems: a system that allows individuals to send money to one another via e-mail.
When this idea did not pan out, they changed their target to arranging payments between individuals who knew one another. However, they quickly realized that it would also work for a company such as eBay, providing purchasers and sellers with a way to short-cut the time-consuming and cumbersome process of mailing checks and money orders and waiting for checks to clear before shipping items. Moreover, for small merchants selling items on the Web, it is difficult and expensive to obtain the capability to accept credit cards. Credit companies extend these merchant services only to bona fide businesses, usually requiring a physical place of business as a requirement.
Today, PayPal is the largest and most popular online payment service, growing from a handful of users when it launched in late 1999 to over 165 million in 2007, of which about 40 million can be characterized as active users. In 2007, PayPal processed $45 billion in payments. About 70% of this gross volume ($30 billion) is tied to eBay users, and $15 billion comes from non-eBay transactions. One reason PayPal has grown so fast is because it experiences the benefits of network economics or the "viral effect": the more people who accept and use PayPal, the greater the benefit to the consumer.
If I send you a PayPal payment via e-mail, then you are incentivised to open a PayPal account to receive the funds. If PayPal is to continue growing, it will have to break out of the eBay marketspace and find new payment opportunities.
PayPal earns money in many different ways. First, online sellers (who may be individuals or small businesses that do not want the difficulties associated with obtaining a merchant credit card account) pay a transaction fee for the service (30 cents plus 1.9%-2.9% of the proceeds of the transaction). This generally works out to 3.3% of the transaction on a $100 transaction. Credit card firms generally charge about the same or 0.3% more due to their higher customer acquisition costs. PayPal, in other words, can be slightly less costly than credit cards for merchants.
One advantage for merchants on eBay is that they are not required to have a merchant bank account, which is required by credit card issuers. Merchant banks clear credit card transactions and charge fees. Consumers are not charged directly for the use of their PayPal account although they do pay ultimately because retailers need to recover the costs of the transaction by raising the prices on goods sold using PayPal. Second, PayPal earns revenue by collecting the interest earned on consumer funds not yet transferred out of the PayPal system. PayPal has charges for transferring funds to foreign banks, converting currencies, and new financial products such as a PayPal credit card.
Part of the strength of PayPal lies in its simplicity: it piggybacks on existing credit card and checking payment systems. This is also one of its weaknesses, however. PayPal reportedly suffers relatively high...