Paypal offers cashback for balance/bank 'sources'....

Background: Understanding PayPal's Source Mix

If you follow PayPal closely from a financial perspective, you realize that the key to model in PayPal is the 'source mix'.  To take a step back, there are essentially three ways to fund a PayPal transaction from the consumer's perspective:

1. Credit card - This usually costs PayPal as much or more than their rate they charge merchants.  PayPal is highly motivated to REDUCE credit card usage.  In fact if credit card was 95%+ of the source, Paypal's margin would be devastated.
2. PayPal balance - You are essentially moving money between PayPal's servers so there is little to no cost here.
3. Bank account - Usually called ACH, this is a bank to bank transfer of $ and in most scenarios is very inexpensive to process (.25-.50)

One analyst I follow, Scott Devitt @Stifel, has really started to get concerned this year about this fact.  Here's a snippet from a recent report:

eBay continues to have profit pool risk, most notably within its PayPal business given the fact that its generates all of its profit from balance transfers and bank account transfers. As well, PayPal defaults users to its highest margin options, negatively impacting the consumer experience, and allowing for competitors to eventually innovate away PayPal's profit pool. Finally, even with success, PayPal's aggregation with the core commerce business will continue to limit its ability to be appropriately valued by the market.

His thesis is that the source mix is PayPal's strategic advantage, but also it's strategic weakness.  What if there were a competing system that passed the true rates to merchants for these items?  Such a system would have a sub 2% effective payment take rate.  In theory it would be able to do this because the model would be built around something else.  3-4 yrs ago this seemed unlikely, but today you have Google Checkout, BillMeLater and there is some chatter that other large players are set to enter the field.

Devitt goes on to say:

PayPal makes all of its operating profit from PayPal balance funded transfers and bank account transfers. PayPal's credit card business is mostly a pass-through operation. Given this profit pool characteristic, PayPal defaults all user fund flows first through PayPal balance transfer and then through bank account transfer. If a consumer wants to pay with a credit card, it requires four extra steps and deteriorates the user experience. PayPal does this because it has to
as a mechanism for maintaining the companies profits. Amazon and Google do not have the same challenges as payments are not a profit center for either company. In fact, we believe it is possible that Amazon could use ACH (bank
transfers) as a mechanism for lowering their own processing costs and consumer product costs (through processing cost saving share). We have not seen material changes in this area yet given Google's slow start with Checkout and
Amazon's still nascent payments offering but as they say in technology circles, "much less changes than one may expect in a year's time, much more over 5 years."

To my knowledge, eBay doesn't release the PayPal funding mix - but I did find it in their 06 analyst presentation and at that point it was 53% credit card, 17% balance and 30% bank.

The three metrics they do release: (these are Q108 numbers):

• Global PayPal take rate: 3.88%
• Transaction losses: .24%
• Transaction expenses: 1.18%

Thus PayPal essentially has a 3.88-.24-1.18=2.46% profit rate which gives it a 63% margin (much lower margin business than eBay core, but definitely better than Skype).

Bottom line: the entire key to the PayPal business model is the source mix.

PayPal uses consumer promo to drive mix?

A reader pointed out that when they login to their 'buyer' PayPal account, they are seeing this promotion: (BTW I love the image!

As you can see, PayPal is now offering 1.5% money back to consumers that use the 'balance' or 'bank' source methods.  There are a couple of interesting aspects of this program:

• It's fascinating that PayPal is passing some of the savings to buyers vs. sellers.  Many payment systems drive consumer behavior via the merchant vs. direct to the consumer. The year of the buyer continues I guess.
• Note that this doesn't appear to be any kind of test.  eBay tests usually have all kinds of time/amount/max/day of week/phase of the moon qualifiers that water them down and make the complex.  This is simply 1.5% back, no limit, all of 2008.
• I haven't done the math yet, but this seems to be a better cash back rate than you would get from most credit card promos (miles/cash back/upromise/etc.)

Margin implications?

Because of the vastly more profitable attributes of bank/balance funding source, if this promo moves the needle on those sources just a little, it will be a very accretive promotion. However if for whatever reason it doesn't move the needle, it will effectively eat into the PayPal margin by 1.5% times some adoption rate (you have to sign up for the program).

PayPal's Motivation?

Only PayPal insiders know the real driver behind this promotion, but here's the ones I see being on the table:

1. Maybe they did a test of this and it was wildly profitable and they chose to expand it.
2. I know the execs at eBay read Devitt's reports. Maybe they were persuaded by his 'profit pool risk' analysis and decided it was time to get a little defensive on this vs. waiting for a competitor to strike.  Remember the adage the best offense is a strong defense?
3. Maybe PayPal is seeing the mix swing in a negative direction and this is a move to try and swing it the other way?

eBay Strategies readers - what do you think about this promotion?

Seeking Alpha disclosure: I am long Google.

Comments

[o.c.d.collectibles]

I have had no problem with using paypal in the past. In the recent past, however, with the threat of having my income "held" for 21 days (and the threat of that happening is increasingly more likely with the way feedback has been geared towards buyer extortion) has been a real troubling thought for me, as a seller. I don't shop very often online, I'm a thrift store shopper, and sigle parent survivor with an adult disabled son, so buying new stuff online is not my preference at all. I don't buy into those "cashback" schemes and all the other garbage that tries to entice folks to spend their dwindling income on the latest products.

When I shop for new items, I go directly to the place I need to go to online. Such as Best Buy or Overstock, maybe Sears, for a large appliance. Otherwise, I can go directly to Wallmart, I don't need any coupons or bonuses. I save my money by not spending it on non-necessities!LOL!

It used to be that you could pay bills with paypal. What ever happened to that? I LOVED that feature, and wouldn't mind getting money back for paying my bills!

[Bryan Morrison]

As an eBay seller, I have a strong preference to being paid by e-check. It seems that eBay and Paypal exhibit a strong aversion to this particular method. In fact, they go out of their way to hide even the existence of the $5.00 maximum fee for e-check, which is not, by the way, the same as Instant Payment from Bank Account. The e-check takes several days to clear and is the only way Premier and Business accounts at PayPal can receive funds at the $5 limited fee. Ebay forces sellers to link to a premier or business account by reducing the buyer protection coverage to $200 instead of $2000 if you sell using a Personal Paypal account. Personal accounts receive many kinds of payments with no fee at all but cannot accept PayPal credit card payments. Further, if you post an auction using a Personal Paypal account and someone tries to pay via payPal using a credit card, eBay requires you to accept the payment and upgrade to a premier/business account.

Further evidence that eBay and PayPal don't want users to know about the $5 fee limit on e-checks is found when a non-member attempts to go to the PayPal site and read about the fees. Guess what? if you are not a logged-in member, the published fee structure says nothing about it! It never mentions any $5 maximum fee on e-checks. They have a different web page with the word "outside" in the web address for those who click on "fees" who are not logged in. Even after you become a member and are logged in, the $5 limit on e-checks is obscured. It resides as a footnote only on a secondary page which comes up only if you actually click on the fee itself "2.9% + $0.30" that is listed in the matrix where Premier or Business Account intersects with the list of transactions including e-checks.

I have had auctions removed from eBay with no notice (tonight, in fact) and right after a customer had made a "Buy-it-Now" of a $1045 item. The reason given: I had asked buyers to use e-check and explained PayPal's fee on e-check was much lower. Basically, I quoted the paypal published fees.

They determined in their infinite wisdom that that was "circumventing eBay fees". They wrote an email to my brand new customer telling her that the auction had been cancelled by eBay and not to pay, but giving no reason. She had already paid. She freaked out, of course. I immediately refunded her paypal payment. I have been a Platinum-level ($25,000 per month) Power Seller during my four years on eBay and have 100% positive feedback...never one complaint! I've paid thousands upon thousands in eBay and Paypal fees. I'm steamed!

Now I read this guy's post here and he's telling us that paypal makes much more money on the bank transfers than on the credit cards. I suspect he's right, but doesn't have the whole picture. The gravy is in the "Instant Bank Transfer" (not the same as e-check and not subject to the $5 fee limit) and "PayPal Balance" transactions. These methods cost PayPal virtually nothing and they charge premier/business members the full 2.9% + $0.30 on them. They do well on e-checks, too, if they are for small amounts. But when we're talking about selling gold and platinum coins or expensive electronic test equipment, which is what I do on eBay, the difference can be hundreds of dollars. This will explain why eBay and PayPal don't want users to even know about e-check.

I suspect that the $5 limit is not PayPal's choosing, but rather part of some Federal banking law. I also suspect, from the way they bend over backward to hide it's low fee and discourage its use, that the e-check is only offered because they were required to offer it by law or legal charter.

Otherwise, I would think they would just drop it from the roster of available methods. eBay is vehement about it. If you so much as offer a $5 discount off your shipping/handling fee for payers who use e-check...Boom! Your auction is toast! If you add a surcharge to your auction for non-e-check use or if you state that you only accept paypal e-check payments...Poof! You'll be permanently ousted from eBay!

Arrrrrrggggggghhhhhhh!

[http://astore.amazon.com/greatsimplesh-20]

i have used paypal to buy things on ebay. I have never had a promblem at all. i have had an account for over a year.

[rikki]

pps. Thanks for the link for the 1.5%! Our PP lifetime cashback just hit the 10k threshhold and I look forward to having this option for our non cc payments!

[rikki]

It is a strategy that I've been considering for our b/m for what I think are similar reasons and I think it has many strategic advantages in both short and long term.

The credit card system of fees in the US is 'broken' in the smart business sense and there are some pretty strong forces at work that should wring some significant fees & structure changes over the next few years.

Electronic payments of any kind only cost pennies or a very small percentage of funds to actually accomplish. Right now due to the way credit card payments have evolved and monopoly factors, the pricing charged is way out of line on a reasonable cost/profit basis. The businesses that rely heavily on those payments are actively seeking options and heavily motivated for new methods of processing payments. Paypal is one of these businesses.

The credit card companies have trained their users well - even if the card is a debit and the money is coming out of a bank account - due to the 1% cash back option - use of a card as a 'debit' with its lower associated processing fees for the business has all but disappeared from the 'in person' retail environment. Our b/m fees due to 'reward' cards are much higher than the base cc rates - and sure - the buyer is getting cash back, but the credit card companies are getting a bigger cut of our sales.

ALL online purchases are done as 'credit' and involve insanely high fees for a very inexpensive electronic funds payment. This is creating a pretty strong force for business dependent on credit card payment processing (just about ALL businesses at this point) to develop the currently inefficient direct ACH system into a speedier and more widely available payment method.

In addition - paypals pricing to its business customers is fairly risky as it is based on an average of a mix of different costing payment options. Paypal's pricing/profit is very vulnerable to changes outside of their control.. not the most stable environment to practice in.

And last - it makes sense both financially and marketing wise for paypal to offer this 1.5 and become the default payment method of buyers due to this cashback strategy. Most reward cards are lower than this % - or will be as the cc margin gets driven downwards. Paypal actually has the size to effect some changes in the non-credit card payments processing system and this drive should contribute to that ability.

Also - I don't think it is so fascinating that Paypal is 'passing' this onto buyers vs sellers. The buyers are the ones chosing the funding source and the only possible rational beneficiary of this program. Sellers already receive a HUGE paypal benefit in that they are already protected from the astonishingly high processing costs of certain credit cards - AE, reward cards, business cards and intl transactions.

1.5 is easily covered by the decrease in paypal costs for ACH/balance funding vs cc funding.

What is not to like? Paypal comes out looking like the 'good guy'for giving 1.5%, promotes their payment method, lowers their costs and encourages use of a funding method that will likely increase in use in the future anyway. Direct payments time is coming. CC 'payments' as we know them are becoming slowly (very slowly) obsolete.

ps. For those who think that a credit card protects you, please just shop smarter and stop making the cc companies richer. In the end you will pay the cc processing companies far more than you could ever lose as a buyer. Please remember that 1.7-5% of every credit card purchase is 'wasted' on making some 3rd party flush with cash.

[Walter]

With regard to what the analyst, Devitt, had to say: "In fact, we believe it is possible that Amazon could use ACH (bank transfers) as a mechanism for lowering their own processing costs and consumer product costs (through processing cost saving share)."

Apparently Amazon reads his reports too. I made 2 purchases from Amazon over the last 2 days, and both times at checkout I was offered the option of paying by checking account transfer and enticed with an entry into a $500 monthly prize pool for doing so. Amazon has had ACH for a while now, but they seem to be pushing it a bit more actively.

[Walter]

I'm the reader who sent screengrab to Scot, and he brilliantly took the info about the promotion and developed it into a much broader post about PayPal's business model and reliance on bank transfers for profitability. Well done Scot.

Shortly after I saw the promo ad box in my paypal account I got an email from them too.

It says:

"We are pleased to offer you 1.5% cash back when you pay with PayPal using your bank account or balance. It's a special offer for our most valued customers. Just check out with PayPal - your bank account or balance is selected automatically."

It's that middle sentence about most valued customers that's the clue that it may be a bit of a test, and I just happened to be included. (I find it funny that I am lumped in with "Top Buyers". Maybe I buy 5-10 things on eBay per year. Rarely is it of any substantial value.)

You do actually have to sign up to qualify. I saw nothing onerous in the terms. You can see them, and attempt to sign up for the promotion, here:

https://www.paypal-promo.com/topbuyer/TB_1-5_landing.html?media=1523460Mark

Interesting that it's actually a separate domain as well.

I actually went right to that URL while logged out of paypal and signed up a separate account's email address that hadn't yet gotten an invitation. I've yet to receive a confirmation email from paypal as of this posting. (Strangely enough, I just checked and I never got one for the account that I signed up tht did get the invitation either. Who knows?)

I know one thing - I'm going to be getting more echecks and more buyers will be PO'd when I sent them by canned email about shipping delays using that source of funds.

It's going to be a long summer.

[BMX]

Thanks for bringing this to light. No one ever talks about it, but I've known this for a long long time.

I am amazed how many people trust paypal with their money and how paypal continually tricks users into using their bank accounts on the site. It infuriates me how a big company like this can trick its novice users. It is truly a disgrace.

Regardless of what paypal tells you:

ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!
ITS NOT SAFE TO PAY BY ECHECK or PAYPAL Balance!!!!

(did I get my point across??)

Take a note at their notice when you try to switch your funding option...

Your PayPal account balance is set as the primary funding source when it's available. You are 100% protected against unauthorized payments sent through your PayPal account.

AM I REALLY? Look at the play on words. 'Unauthorized payments' means you didn't pay for it... but confuses buyers to think that the are 100% protected through the transaction.. they are not!!!! Do most buyers know they have no chargeback rights with a paypal funded payment? Ebay should be ashamed they've been pulling this scam for years. If I was rich I'd file a class action law suit to stop this trickery.

If you pay with an e-check, paypal balance, you have basically no protection from a savvy scammer.

I had someone send me an empty envelope and I lost 1500 because paypal said it was 'signed for with delivery confirmation' and I paid with my paypal balance (I was a newbie at the time). They did credit me $150 per transaction due to 'buyer protection'. gee thanks.

Always pay with a credit card!!!!!!!!!!!! NO MATTER WHAT!!

This will definately hurt the buyer experience I believe and this is really the core problem at ebay. Not the 1% they are going after. Its all the scamming and fraud which while I believe is not as prevalent is still widespread on the site. That IS the core problem with ebay.

But we all know ebay is after that cash money and they don't care about you or the buyers.

Ebay is like a gold digging girlfriend who says they love you to your face but cheats on you behind your back and cleans out your bank account!

[Abbi Vakil]

I just logged in to my primary receiving account and my sending account & didn't see this promotion. Perhaps they've pulled it while they figure out the details? Or maybe it only applies to eBay purchases, where they can afford to give back some points seeing as how they get you coming and going...

[dimes]

Using a bank account on paypal is the least safe payment method because of the lack of consumer law protecting those payments, and the volume of fraud that occurs on eBay enhances the risk that a transaction could easily go south.

Using a bank account as a funding source simply transfers the payment risk from paypal to the buyer.

Yes, paypal has protection policies of $200/$2000 in place on eBay, but payments made elsewhere with paypal are subject to extremely limited protection that amounts to little more than relying on paypal's "best efforts" at recouping payment should something go wrong.

The protection on eBay is dependent on a laundry list of requirements, chief among them that the SELLER meet time and performance qualifications. Many transactions qualify only for $200 in coverage.

Credit card payments are not subject to the limitations of paypal's coverage programs, but payments made using bank/paypal account balances must rely on them.

Frankly, 1.5% (or 2%, as someone on a paypal board reported receiving) is at most $2 on a $100 transaction. Big deal.

Finally, as eBay mentions in its SEC filings, many consumers (myself among them) do not want paypal to have access to my bank account number. The risk that a security breach would reveal it to thieves is not one I am willing to accept.

[dimes]

Using a bank account on paypal is the least safe payment method because of the lack of consumer law protecting those payments, and the volume of fraud that occurs on eBay enhances the risk that a transaction could easily go south.

Using a bank account as a funding source simply transfers the payment risk from paypal to the buyer.

Yes, paypal has protection policies of $200/$2000 in place on eBay, but payments made elsewhere with paypal are subject to extremely limited protection that amounts to little more than relying on paypal's "best efforts" at recouping payment should something go wrong.

The protection on eBay is dependent on a laundry list of requirements, chief among them that the SELLER meet time and performance qualifications. Many transactions qualify only for $200 in coverage.

Credit card payments are not subject to the limitations of paypal's coverage programs, but payments made using bank/paypal account balances must rely on them.

Frankly, 1.5% (or 2%, as someone on a paypal board reported receiving) is at most $2 on a $100 transaction. Big deal.

Finally, as eBay mentions in its SEC filings, many consumers (myself among them) do not want paypal to have access to my bank account number. The risk that a security breach would reveal it to thieves is not one I am willing to accept.

[Michael]

Sellers do get a huge break when a buyer uses an echeck (which I assume is from bank transfer) to pay for a large ticket item. It looks like at about $220 sale price and above, we are only charged a flat $5.00.

Our average sale price is well above this $220 sweet spot so if paypal can encourage more buyers to use whatever method creates echeck payments, our savings as a seller will be very substantial.

Example: On a $2000 sale, normal paypal fees for us are $64.30, if the seller pays by echeck, $5.00.

[brilliant]

Its a brilliant move on many levels.

#1 You got the possibility of Paypal only appearing on eBay.com Q3/Q4 of 2008. (It would be best time of the year for a Paypal only change). A 1.5% cashback promotion will make every journalist that writes about Paypal only article "balance" it with the 1.5% promotion. Its a perfect counter by Paypal for the foreseeable negative press about the change.

#2 This promotion is also an excellent branding move. I guarantee all hot deal news sites will post something about this and will continue to post about the Paypal 1.5% cashback. Paypal brand will be associated with bargain shopping, which can only benefit the eBay brand.