Quick Thoughts – The Online Challenge Faced by PayPal Because of EMV Tokenization
Financially, the argument for splitting eBay and PayPal is stronger today than in the past because eBay now accounts for less than 30% of PayPal transactions (versus over 70% a decade ago) and because PayPal is so relatively large (accounting for near half of eBay revenues versus 20% a decade ago – see Chart).
Chart: Proportion of PayPal Transactions from eBay (blue line) and Proportion of eBay Revenues from PayPal (red line)
Strategically, however, PayPal is vulnerable and this is a challenging time for it to dilute one of its key competitive strengths: advantaged access to eBay customers. The reason is that eBay customers, like online shoppers generally, will enjoy a wave of new payment options as tokenization reduces the friction and security risk of using payments cards directly rather than through an intermediary such as PayPal. Visa Checkout and MasterCard MasterPass, for example, are emerging online acceptance brands that will obtain widespread adoption among online merchants, particularly as Apple Pay facilitates in-app purchases (accounting for ~30% of e-commerce), because they have lower acceptance costs than PayPal. In 2013, for example, PayPal’s “take rate” was 3.7% of transaction volume (versus our estimate of 2.5-3.0% for the average cost of payment cards to that merchant mix – see Table).
Table: PayPal Revenues in 2013
Source: Company Reports
PayPal can compensate for competitive pressures on the take rate by lowering transaction expense, but this depends on encouraging customers to enroll for alternative funding options to Visa- and MasterCard-branded credit cards. The firm does promote ACH-based funding options but these do not offer customers the rewards of network-branded cards and probably account for a steady, rather than growing, proportion of transaction volume of less than 25%.
Transaction expense is also held down by customers who have balances in their PayPal accounts from eBay transactions since PayPal incurs no transaction expense when payments are funded from these prepaid balances; the risk is that these “on eBay” volumes decline more sharply as eBay and PayPal operate more independently and as eBay merchants take advantage of acceptance brands, such as Visa Checkout, that offer the consumer convenience of PayPal at lower merchant cost. PayPal will doubtless look to manage this risk through tight contractual arrangements with eBay as part of the spin-off.