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Anxious Competition

 All this growth hasn’t gone unnoticed by the giants of the credit card industry, which have been scrambling to catch up. Bank One, one of the nation’s five largest bank holding companies and parent of credit card company First USA, launched eMoneyMail in March 2000. Within six months, however, the online payment service shut down after experiencing a fraud rate reported to be as high as 25 percent. Bank One spokesperson Tom Kelly confirmed an unacceptably high fraud rate but said, “I don’t think we have a lot of interest in talking about it.”

In the fall of 2000, Citibank, the nation’s largest bank and credit card issuer, introduced c2it (pronounced “see-to-it”), a P2P system being marketed via multimillion-dollar deals with Microsoft and America Online. It only managed to sign up 100,000 customers in its first year, despite offering a $10 sign-up bonus, but officials aren’t letting up. “This business is strategically important to Citi,” says Antony Jenkins, chief operating officer of c2it. “At the end of the day, processing transactions is what banks do.”

Then there’s eBay itself, which acquired PayPal rival Billpoint and began running it as a joint venture with San Francisco banking conglomerate Wells Fargo in March 2000. All these competitors combined have managed to eke out only a tiny market share against surging PayPal. “PayPal had a bit of a head start,” says Kevin Pursglove, eBay’s senior director of communications, “and they are very aggressive.” He adds, however, that “the market is still young,” and that eBay thinks Billpoint will soon begin to achieve something like PayPal’s critical mass.

Traditional credit card issuers seem to be spooked by PayPal, and not just for fear of losing out on online transactions. To understand why, one must understand a basic fact about PayPal’s business model. Let’s say that Julia has just won an eBay auction for an antique lamp, agreeing to pay $276 plus $24 in shipping costs. The seller, whom she only knows through the eBay handle LampMan and his e-mail address,, advertises that he accepts PayPal. Already a PayPal member, Julia goes to to send the $300 total payment to that e-mail address. At that point, she has two options. She can instruct PayPal to charge her Visa or MasterCard, or she can have the amount debited directly from her checking account.

Although PayPal claims to be indifferent to the outcome, Julia’s choice makes a big difference financially. If she opts for the credit card, PayPal becomes the merchant of record on the transaction and must pay Julia’s credit card company a two percent “interchange fee.” After collecting the same two percent from LampMan, PayPal essentially breaks even. But if Julia chooses her checking account, PayPal doesn’t have to pay the fee, and it still collects the two percent from LampMan. PayPal, therefore, has the financial incentive to shift as much business as possible to checking accounts. However, if PayPal moves too aggressively to phase out use of credit cards, it risks antagonizing Visa and MasterCard, which currently offer the company their lowest fees, under the assumption that PayPal is significantly increasing the industry’s overall volume.

Thiel and Levchin are careful about such questions. “Yes, we make a bigger margin [on checking-account transactions],” Thiel says. “But we don’t envision displacing Visa and MasterCard. We are enabling consumers to make their own choices. We can’t force them.”

PayPal’s attempts to get customers to abandon traditional banks and credit cards belie this statement. One such enticement: the PayPal money market fund, managed by Barclay’s Global Investors. Under this option, buyers and merchants can earn money on the funds they keep in their PayPal accounts, which makes transactions even simpler and more profitable for the company. More recently, PayPal introduced debit cards, so that customers can use their PayPal accounts for offline transactions as well. If PayPal’s more than 10 million members start using the new debit card instead of credit or debit cards issued by MasterCard and Visa, these giants may begin to see their market share erode.

So Thiel’s claims about having no designs on credit card companies aside, these moves, along with PayPal’s recent launch of an online bill payment service, have exacerbated fears that the company has set its sights beyond online transactions. Such suspicions are rampant even among the company’s own backers. PayPal’s seed money has come not only from traditional venture firms like Goldman Sachs and J. P. Morgan Chase but also from banks like ING, Providian and Germany’s Deutsche Bank, which are hedging their bets against PayPal’s expansion.  “Unless they’re partnering with PayPal, banks aren’t keen to see it succeed,” says ING’s Hegstad. “What bank would want to give up ownership of its customers?”

Citibank, with its c2it service, is especially anxious to counter PayPal before growth gets out of hand. “This is a huge opportunity,” says Citibank’s Jenkins. “Technology always changes the way financial services get delivered. Credit-scoring software and database marketing led [30 years ago] to the credit card industry itself. In the future, we think that everyone who now has a credit card will also have a P2P account.” But in the wake of debacles like Bank One’s eMoneyMail, Citibank is proceeding cautiously. “We wanted to understand the fraud component before we mass-market the product,” adds Jenkins.

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