December 26, 2000, 9:55 AM

CyberSource, software merchant turned payment services vendor, knows from fraud

Bill McKiernan’s customers were downloading thousands of copies of software from his new Web business, just as he’d imagined they would. Yet McKiernan was downloading a nightmare beyond imagining: hundreds of bogus credit card transactions. “The business was going to fail,” recalls the founder and CEO of Software.net, now known as CyberSource. “We were despondent.”

When McKiernan launched his pioneering Internet venture in 1995, selling software over the Web seemed like no-lose proposition. Rather than taking software orders and shipping the boxes, McKiernan figured he could field online orders and ship the software over the telephone line. But on a gloomy Monday just four months later, McKiernan came to grips with the realization that merchants are 100% liable for a fraudulent transaction when the buyer’s card is not present.

Huddled over the printer in their tiny two-office suite above a barbershop in Menlo Park, Calif., McKiernan and his colleagues grimly sorted through reams of credit card orders that had poured in over the weekend. “We could see just by looking that more than half of our orders were fraudulent,” he says. “Some of them were obvious. People were downloading our software with fake names and addresses that the address verification system missed.”

Yet even while pondering the potential chargebacks, McKiernan began to see a new-and even bigger-opportunity. “I realized if we could pick out the bogus orders by sight, we could teach a computer to do it.” Within a month, the company had its first fraud screening system up and running.

Flexibility learned firsthand

In 1997, the company was split into two businesses, each with market caps currently surpassing $1 billion: Beyond.com, at 45,000 titles, became the world’s largest online software store, while CyberSource focused on providing Web merchants with a suite of back-office e-commerce services that range from its flagship fraud screening system to payment processing. The evolution from Web merchant to purveyor of Internet services was a logical outgrowth of the Software.net experience, says William Donahoo, vice president of marketing at CyberSource. “As a merchant, we lived and died by our own system. We understood the problems firsthand.”

More importantly, retailing in the digital frontier consistently forced the company to come up with solutions. When the Federal Trade Commission threatened to shut down Software.net over potential software export violations-buyers in restricted countries were downloading antivirus software-the company created an export control service to satisfy government regulations. The software polices who’s entitled to order which products and from where, then routes shoppers wanting to purchase restricted items to customer service. Another transaction service, this one designed to manage product distribution, grew out the needs of Microsoft, a major supplier to Software.net. The software giant wanted CyberSource to implement its distribution policies on Microsoft’s Web site. An order from Germany, for example, would be routed to its in-country software distributor. “We cut our teeth on digital goods,” says Donahoo. “By doing that, we were able to solve many of the problems faced by online merchants.”

Apple pays a visit

The strategic turning point came in early 1997, when several suppliers, including Apple, Adobe and Symantec, asked Software.net for help in building a “buy” button for their Web sites. That led McKiernan and his team to explore creating a separate division to provide Internet services. They first planned to sell software outright, but McKiernan thought the company could better leverage the power of the Internet by selling transaction services online. At the time, the concept of an application service provider was still new to the online industry. “We looked closely at selling our server software, but we were hesitant to get into that business,” says McKiernan. “Software like Fraud Screen would be hard to sell as a stand-alone. It’s continually being tweaked and updated.” Fortunately, McKiernan’s initial customers liked the idea of buying the services per transaction.

Others were quick to follow. In less than 12 months the company had signed up nearly 40 customers for its online transaction services. McKiernan then convinced his board to split Software.net into Beyond.com and CyberSource, now based in San Jose, Calif. McKiernan, who still serves as chairman of both companies, brought in Mark Breier, head of marketing at Amazon.com to run the renamed software retailer, and turned his attention to CyberSource.

His efforts at CyberSource have paid off. By the end of 1998, the company had 300 customers, and transactions had grown exponentially-from 800,000 in 1997 to 8.6 million a year later. The company entered strategic partnerships with Visa International and GE Equity, which provided additional funding.

But the good times have not rolled at Beyond.com. The e-retailer has struggled to set itself apart in a crowded market and suffered a heavily publicized outage last fall. In January, with revenue below expectations, the company revealed plans to cut its staff by 20% and focus on the business-to-business market. Breier resigned.

Suite success

CyberSource is a different story, having consistently expanded both services and revenue. Today, the company offers merchants a wide range of back-office services, including payment processing, fraud screening, tax calculation, delivery address verification, distribution control and fulfillment messaging. Like Fraud Screen, each transaction is a unit of service, with discounts for volume and the number of services used. The customer roster has swollen to more than 800 and includes big-name brands like Amazon.com, Buy.com, Casio, Intuit, Compaq, Nike and Microsoft.

The biggest challenge, says Donahoo, is keeping up with the boom in Internet retailing. During the first nine months of 1999, CyberSource, booked $7.9 million in revenue, a 343% increase over the same period in 1998. Net losses were $17.8 million compared to $6.6 million last year. Transactions over the period climbed to 25.5 million compared to 4.5 million in 1998. Its IPO last June raised $44 million.

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