I love PayPal- they are smart, they are innovative. PayPal has made it easy for the customer to pay merchants without sharing sensitive financial information. For online merchants, they have an easy to set up, all-in-one payment processing solution that is competitively priced. They have made it easy and safe to do cross-border transactions. They have made P2P payments a breeze- the Bump application is really cool. I thought opening up their platform to outside developers was a brilliant move. For a company that is a little more than a decade old, they have made great strides and are probably the only real competition to Visa/MC/Amex. And with more than 75 million accounts, they are by far the leader in the alternative payments space. Oh wait, did I say “alternative“?
What makes a payment provider have to bear the stigma (or advantage) of being labeled as an alternative? Just 25 or so years ago, anything other than cash or check would have been considered an alternative payment, so things have really changed in a relatively short period of time.
When I shop online as a customer, I have the option of paying using my Visa/MC/Amex and in some cases PayPal. And if I am okay sharing my card info with the merchant, there is really not much incentive for me to use PayPal. I use my American Express Starwoods Credit Card wherever I can so I get reward points that can be converted into free hotel stays or flights. And that is where lies PayPal’s problem. I was told that the average PayPal customer transacts only once per year using the PayPal platform. PayPal needs to incent its customers to use PayPal more often.
For PayPal to truly become mainstream and not being labeled as an alternative payments provider, it needs to give me more reasons to use PayPal as the payment method.
Before we look into some of the possible solutions, let us look at how PayPal makes money.
PayPal charges $0.30 plus 1.9%-2.9% of the transaction fee to the merchant (the fee structure is very competitive with what Visa/MC/Amex charge as interchange)
However, PayPal is uniquely positioned in terms of methods it can use to fund its transactions.
- PayPal balance – as these funds are flowing within the PayPal platform, there is not a cost of funds as there is with other methods of payment. This method of funding a transaction is the most desirable to PayPal, as it can charge its standard transaction fee, but incur almost no cost of funds.
- ACH (Automated Clearing House) – these transactions are funded by a direct transfer from a bank account and generally carry a flat fee of about $0.25. So the same $100 transaction costs PayPal a quarter, but they’re able to pocket most of the $3.20 transaction fee. Absent a PayPal account with funds available, ACH is next on the list of preferred payment methods.
- Debit card – debit cards utilize the payment networks of the leading card brands, and therefore carry higher fees. Fees for funding a debit card transaction are about $1.50 – $2.00 for a $100 transaction. PayPal still sees some revenue from this transaction, but the margins are rapidly evaporating. Because the transaction must utilize third-party debit networks (Visa or MasterCard), the cost to PayPal is greater and therefore the margins are lower.
- Credit cards – credit cards are the most expensive funding option for PayPal (as they are for all merchants). Fees can range from 2.2% to 2.5% for card transactions, so PayPal benefits least from this method of payment.
By now, you would have already guessed what PayPal ought to do.
PayPal needs to incent the customers that fund through PayPal balance or ACH to use the platform by offering some kind of rewards/loyalty program. This way, it is rewarding its most profitable customers.
By offering rewards for ACH funded accounts only, PayPal is urging more customers to fund their transactions through their bank accounts, thus generating more profit for PayPal. Agreed, they will reduce their profit per transaction by about 1% (the cost of funding the rewards program). But they will increase their overall profitability by building loyalty and providing customers reasons to increase their transaction activity using the PayPal platform.
What else do you think PayPal can do to become a mainstream payments provider?