FSW.biz article

Review: paypal

by Dr. Ralph F. Wilson, E-Commerce Consultant
Web Marketing Today, Issue 101, July 9, 2001

PayPal, Inc.
Palo Alto, California 94303
www.paypal.com

The lowest-cost, broad-featured system I've found for receiving payments on the Web is PayPal - and it doesn't require a merchant account or payment gateway. What's more, many international merchants can use it with relative ease to sell products in US dollars. With its integrated shopping cart feature, it is finally mature enough for small online merchants to use to launch low cost e-commerce sites.

PayPal began in 1999 as a tool for transferring money for payment in eBay auctions and is currently the most popular online payment system of its kind. PayPal estimates that it is the payment vehicle for 28% of the auctions that close on eBay, with its closest competitor used for only a small fraction of that.

Essentially, the system allows a PayPal member to e-mail money to anyone, though to retrieve the money the recipient must set up a free PayPal account for himself or herself. To date, PayPal boasts more than 8 million members, which account for a considerable fraction of those who make purchases via the Internet.

Fees

One of the most attractive features of PayPal is its low cost. Though personal account members can receive payments up to $100 per month at no charge, businesses pay fees to receive money. Instead of paying high set-up fees and substantial monthly service fees (as is common for merchant credit card accounts with payment gateways), PayPal only charges a percentage of the transaction plus a 30¢ transaction fee. But rates are going up. PayPal has announced that effective July 18, 2001, it will be charging two-tiers of fees.

In the chart above PayPal's closest competitor, eBay's BillPoint, appears to offer lower fees, but since BillPoint assesses a 0.5% fee to get money out of the account, eBay's effective rates are 3% standard and 2.25% merchant. Fees seem to be rather volatile right now - they've gone up and down in the recent past -- as these companies vie for members and seek to ensure a sound economic basis for their businesses. In the auction arena, BillPoint and PayPal are quite similar, but PayPal is a more mature product that offers tools, such as a shopping cart, that non-auction merchants need.

How PayPal Makes Money

PayPal makes most of its money on fees paid by its business members. According to PayPal Vice President of Corporate Communications Vince Sollitto, less than 10% of PayPal's income comes from the "float" - interest on money that accrues between the time it is deposited in the account and transferred out of the account. For PayPal this period is a minimum of about 3 to 5 days. The time period protects PayPal from fraud, but it also gives them time to earn interest on the money.

Recently PayPal began offering an optional Money Market Account that, as of this writing, pays 2.89%. (For comparison Vanguard Prime Money Market Fund currently pays 3.95% and charges a 0.33% expense ratio - a substantially higher return.) PayPal Money Market Account seems to be paying similarly to some bank money market accounts, netting them about 1%+ on funds deposited. US residents can opt for an automatic daily sweep that will transfer any funds from your PayPal account into your local bank account via ACH (Automated Clearing House) system for a 0.35% fee on the money transferred. (US residents can make the transfer to their local banks manually at no charge.)

One reason for PayPal's rapid growth was the viral marketing element of offering a bounty of $5 on new PayPal members. However, the newest fine print indicates that for you to qualify for the bounty only when your new member deposits at least $250 into his or her PayPal account in a single transaction. It's nice for PayPal if it happens, but many people pay with a credit card directly, rather than out of money sitting in their PayPal account. Don't expect to earn much on bounties.

I see PayPal's fees quite competitive and reasonable, and they'll probably stay that way since the competition is nipping at their heels.

Security

How well are merchants and customers protected through PayPal? Quite well, it appears to me.

First, the order form that pops up to take the customer's credit card uses PayPal's SSL (secure sockets layer) secure server. With PayPal the merchant doesn't need a secure server, only a standard website. PayPal provides the secure order form.

PayPal members, both sellers and buyers, are also covered by PayPal's contract with Travelers Insurance for up to $100,000 for unauthorized withdrawals from the PayPal account. Be aware, however, that US buyers who make purchases using money in their PayPal account rather than paying via PayPal directly by credit card don't have the same legal protections that they would if they make the purchase with a credit card. (See "PayPal no friend to online buyers," by Bob Sullivan, ZDNet News 7/20/00, www.zdnet.com/zdnn/stories/news/0,4586,2605840,00.html). Buyers who encounter problems with a purchase can, however, submit a Buyer Complaint Form that will prompt an investigation by PayPal that could result in the suspension of the merchant's PayPal account unless the merchant cooperates. PayPal doesn't have much tolerance for bad sellers or buyers.

In this policed environment, merchants are fairly well protected against credit card fraud. PayPal allows merchants to specify exactly what kinds of payments they will and will not accept: non-confirmed addresses, unverified users, international users, unconfirmed bank accounts, Web Accept and instant purchase payments, and payments using the "Send Money" capability on the PayPal website. This allows merchants to determine their own levels of risk. Elsewhere, you won't find such features outside of the fairly pricey fraud detection systems offered as options by payment gateways.

PayPal offers merchants protection against chargebacks so long as they follow certain guidelines that include: shipping only to a "confirmed address" in the US and obtaining proof of shipment for tangible goods. This chargeback protection doesn't extend to buyers outside the US, nor is it offered for downloadable software, information, or entertainment, but it is a good start - better than any merchant account or bank will give you! I'm told PayPal is working on confirming addresses of members outside the US to extend their offer to international merchants and customers in the future.

Another way that PayPal protects both sellers and buyers is by displaying information on how many PayPal transactions the seller or buyer has participated in. The idea is that a buyer who has made a lot of purchases via PayPal probably isn't a crook (at least they haven't been reported to PayPal for fraudulent activity). That can be quite helpful in preventing fraud. Merchants may not want their competitors to know how many sales they're making - and can opt-out of this feature - but the trust it builds with customers seems worth the loss of business privacy.

As I talk with small business people, the only criticism I've heard of PayPal is that some have had their accounts suspended arbitrarily. That didn't leave a very good impression. I asked Vince Sollitto about this. He told me that last summer and fall cyberthieves, especially in Russia, learned how to use PayPal to get money from stolen credit cards. They would steal credit card numbers, then use PayPal to send funds from these PayPal accounts funded by these credit cards to another PayPal account where they would withdraw money from the system. The effect on the fledgling payment transfer industry was disastrous; many of PayPal's competitors went out of business as a result. Sollitto said that, in the thick of combating this, any PayPal account that had received payments from a stolen credit card was frozen. Now it's pretty well sorted out, he says. As a result of their anti-fraud measures, the fraud rate within PayPal is only 0.45% compared to about 2.6% of all credit card based transactions on the Internet.

Site Promotion

Though it may not be a big factor, PayPal offers to help merchants promote their website in two ways. US residents can list their website under PayPal Shops for no cost, and that may bring some traffic. In addition, when a payment is made through your PayPal order form (such as for an auction purchase), the order form encourages the buyer to visit you at your website URL, also.

Receiving Your Money
The important question merchants should be asking is how they can get PayPal Money into their own checking accounts.

That's pretty easy for US residents and the residents of seven other countries that can make transfers from their PayPal accounts to their local bank checking accounts. For US resident's there is no charge for this ACH transfer, though there is a small charge for residents the other countries. People in 43 countries (www.paypal.com/cgi-bin/webscr?cmd=p/gen/approved_countries-outside) can currently be PayPal members. But in only seven countries outside the US can members transfer money from their PayPal account to a local checking account: Australia, Canada, France, Germany, Netherlands, New Zealand, and the UK. As noted above, it takes 3 to 5 working days to get money out of PayPal, so it isn't instantaneous.

Outside these seven countries and the US, merchants have no easy way to get their money out of the PayPal system. I asked Vince Sollitto why PayPal couldn't mail a check in US funds to merchants in these countries. PayPal is in the business of electronic - not paper transmission of funds - he told me. He spoke about the high costs of issuing checks. I'm not convinced.

But to PayPal's credit, they're doing something that really hasn't been done before - developing a low-cost system to transfer US funds to banks in other countries. Costs to wire funds from one country to another can run $10 to $15 or more, but PayPal's fees are only $1.50 for merchants in these seven countries to get money into a checking account. PayPal has been working at this project country by country, working first with countries that have the highest PayPal volume. The seven countries they've developed so far account for nearly half of PayPal's international volume.

Here's one way for a merchant outside the eight favored countries to get their PayPal account converted to cash. Just make sure it doesn't break any banking laws in your country. A merchant in Sweden (who can't make local bank deposits from a PayPal account) can e-mail $200 via PayPal to a friend in the UK who then deposits it in a local bank and snail-mail the Swede a check. But it will be a happy day for all when funds transfers to all countries will be possible.

Shopping Cart System
The feature that makes PayPal especially useful to non-auction merchants is PayPal's WebAccept (for single item purchases) and Shopping Cart (for multiple item purchases).

The PayPal shopping cart differs from most of the basic cart programs that I've seen:

For PayPal this is wonderful since they don't have to maintain huge product databases for merchants who do little or no business. Instead, all the information PayPal needs is transferred to it from the merchant's website when a customer clicks on the "add to cart" button.

For the merchant, however, there are three downsides to this approach: (1) Petty hackers can easily change the price they pay for products by copying the webpage, changing the price amount, and making a purchase from the altered webpage. (2) Webpages sizes begin to bulk up if they include the "add to cart" buttons for very many products. (3) Merchants must do a lot of repetitive typing to create new products.

In my experience, however, I haven't seen many people changing prices on webpages. The advantage of this system is that a savvy merchant could hook up a product database to the mailmerge program in Microsoft Word and produce HTML code rather quickly for all the products in the database, then paste them onto the appropriate webpages.

These are the fields available in the PayPal Shopping Cart for the typical product: item_name, item_number, amount, shipping, shipping 2 (additional shipping cost for more items of the same product), handling, image_url (for a 150x50 merchant logo that personalizes the cart and order pages), return (URL for redirection after the completed transaction), cancel_return (URL for redirection if the order is cancelled), and no_note (whether a box should be provided for customer comments).

One of the strong elements of the PayPal cart is the ability to sell subscriptions that include recurring billing. That feature alone will make some e-merchants drool since it is seldom found in off-the-shelf e-commerce systems.

Another nice feature is Instant Payment Notification. When you switch on this option, PayPal automatically notifies a URL on your webserver of the details of each sale. PayPal provides some sample Perl and ASP/VBScript code to implement the feature on your website. With this you can develop a database on your own website that captures customer and order details. A programmer could then integrate this into the merchant's order management system and accounting system.

Ordering System Problems

But PayPal's shopping cart and ordering system still has some rough edges that may snag merchants.
There's no provision for variations of a single product, such as size and color. In the PayPal Shopping Cart system, each variation needs its own separate order button - kind of clumsy if you're selling T-shirts. Yes, a database-driven site could get around this, but the average merchant is pretty well stuck. You could indicate size or color in a drop-down HTML menu corresponding to different product numbers (SKUs), but this is difficult except for the HTML-savvy.

The shipping provision is also very weak. You specify for each item:

• Base shipping. The cost to ship a single item.
• Shipping2. The cost to ship each additional item.
• Handling. Any additional handling cost.
  

This may work fine if your shipping costs are the same no matter where you ship. But most shipping costs vary according to weight and distance. The shopping cart system contains no field for weight and no way to compute shipping to various zones like most shopping cart systems. An HTML-savvy merchant might set up a work-around to have the customer indicate location and a corresponding shipping price in a drop-down menu above the "Add to Cart" button.

Nor does the PayPal cart have any provision whatsoever for sales or VAT tax. This is probably because it was developed in the tax-blind auction environment. But merchants can't ignore paying sales taxes when sales are made to residents of their states. Using the PayPal cart they'll have to include sales tax in the purchase price.

Accounting Integration

One strength of using PayPal is its growing integration with common small business accounting software. You can download your transaction history into Quicken, QuickBooks, or a comma-delimited file which can be used by spreadsheets, accounting ,or order management programs. QuickBooks 2001 now offers you the option to invite payment of invoices via PayPal. I was able to install my existing PayPal account into QuickBooks within a couple of minutes. I've also set up my PayPal Money Market account as a bank account in QuickBooks, so it can be used both to pay vendors and receive payment on invoices within QuickBooks. Last week I used PayPal to pay one of my best affiliates who lives in Australia. As my affiliate program (www.wilsonweb.com/affiliate/) grows, I can use PayPal's Mass Pay feature to make quick payments to multiple affiliates and track those payments in QuickBooks.

Readiness for E-Commerce

Overall, I'm very impressed with PayPal as a maturing tool for online merchants. PayPal members can receive payments from 43 countries, which include nearly all those with large e-commerce traffic (but leaves out a number of customers in Eastern Europe, South America, and Asia, including some countries with notorious fraud problems). I think small merchants have the most to gain with PayPal - the ability to accept credit cards and e-checks without high monthly or set-up fees, all from a standard website. Many established merchants, including yours truly, will begin to offer it as a payment alternative. The shopping cart's problems with options, shipping, and taxes will need to be improved for it to become a primary solution for mainstream e-merchants. But if you're starting your e-business on a shoestring, I can't think of a better solution than PayPal.

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