September 30, 2002, 12:00 AM

What eBay Gets from Its New Best Friend

(Page 2 of 4)

At the lower rate, PayPal’s merchant fees become more attractive than credit cards to small Internet merchants who lack the volume to negotiate lower rates with credit card processors. The average payment received by PayPal merchants is $55 and is increasing by more than $1 every three months, according to PayPal. At that level, a seller with preferred status will pay $1.51, or 2.74%, for the transaction. Buyers do not pay a fee.

Seeking a jump

Given the modest amount PayPal earns per transaction, it appears eBay will need to realize a tremendous amount of gains in volume and operating efficiency to justify the $1.5 billion paid for PayPal. EBay expects to generate additional revenue through expansion of PayPal’s Web Accept product for small Internet merchants selling goods and services outside of online auctions. Because many small merchants have trouble achieving credit card status but still need a fast, electronic payment mechanism, the company expects Web Accept to be popular. “Web Accept allows small merchants to accept PayPal at their site, which lets them create a more convenient payment experience for consumers,” says David O. Sacks, chief operating officer for PayPal. To sell its services, PayPal will still rely on word of mouth and merchants’ experiences on eBay.

PayPal also will be targeting small Internet retailers and manufacturers selling excess merchandise direct to consumers. These sellers typically discover PayPal through eBay. Once they become comfortable with selling online, they often leave the auction community, establish their own web sites and offer PayPal as a payment option.

Further, some analysts believe that as PayPal becomes a more mainstream online payment mechanism, the company may be able to sign deals with high volume Internet merchants, such as Amazon.com and Buy.com. “PayPal’s niche is with online merchants generating less than $1 million a year in revenue, which is a market with plenty of growth opportunity,” says analyst Devitt. “But if its pricing structure is competitive with card acceptance fees for the largest merchants, there is no reason they can’t sign deals with Amazons of the world.”

Although eBay will say only that it intends to expand PayPal volume on its site and outside the auction community, such a presumption is not far fetched. And in fact, eBay can use PayPal as an entre to sell auction services to retailers, PayPal says. “Our non-auction volume is growing twice as fast as volume through auction sites,” Sacks says. “Some of these merchants sell through e-mail marketing and even offline marketing channels. We provide eBay with an opportunity to present its e-commerce platform to small businesses using PayPal, but which don’t use eBay.”

Many of PayPal’s business accounts offer fixed-price goods and services. During the second quarter of 2002, PayPal’s payment volume from non-auction transactions represented 41% of total payment volume, up from 39% during the first quarter of 2002. PayPal processes 300,000 transactions a day. “There is no question eBay wants to be in other areas of e-commerce besides the auction community,” Sacks says. “PayPal is an online payment processor that facilitates acceptance of credit cards for small businesses, which might otherwise find card fees too high.”

To help further boost non-auction revenues, PayPal recently launched on its web site the Small Business Resources Center. The service provides tools, such as instant payment notification, which lets sellers know when a payment has been posted to their account, and tips on using PayPal to grow a small online business.

PayPal is also promoting its Small Business Developer Network, which encourages software developers to create e-commerce applications for entrepreneurs and small businesses. As of June, 138 PayPal-compatible applications have been developed. Solutions include payments applications for web sites featuring digital content and e-commerce solutions for the Microsoft VisualStudio.Net and ASP.Net platforms. In addition, the company now offers sellers the ability to print United Parcel Service shipping labels directly from their accounts.

“Expanding PayPal as an e-commerce payment mechanism is an attractive portion of their business strategy and was a strong component of negotiations to acquire the company,” says an eBay spokesman. “We feel there is plenty of opportunity to grow PayPal outside and inside the eBay community.”

While eBay is reaching out to non-auction sites with PayPal, experts also expect eBay to place greater emphasis on PayPal payments within eBay. Although about 60% of PayPal’s revenues, which analysts project will total $222 million this year, come from eBay transactions, only 40% of payments made by eBay’s 46 million users originate from online sources, including PayPal. EBay says it hopes to increase that percentage.

Analysts expect eBay to initially try to convert customers who send payment through the mail. Next will be credit card users and finally users of other online payments mechanism, such as Citicorp’s c2it and Yahoo’s PayDirect.

PayPal has already begun marketing in these segments by adding features. One is Auction Finder, which allows winning bidders to pay for multiple purchases through eBay at one time and directly from PayPal’s home page. Another feature is Winning Bidder Notification, which encourages buyers to use PayPal for a successful bid.

Converting to PayPal

Converting users of other payment services to PayPal may require the use of incentives, such as additional credits for opening an account, according to e-commerce experts. “PayPal has certainly been aggressive in growing its business outside eBay, but I think that emphasis will take a back seat as eBay focuses PayPal on its core business,” predicts TowerGroup’s Robertson. “Certainly not everyone is going want to use PayPal and eBay will recognize that because they are not in business to lose sales. But as eBay grows its volume, PayPal is likely to grow in accordance. And as an eBay-owned PayPal increases its market share, the opportunities for competing online payments services to grow on eBay will be limited.”

Anxious investors are certain to want to see rapid growth by both companies to ease concerns that it may take eBay years to realize a satisfactory return on investment. At $1.5 billion, eBay will pay a hefty premium for PayPal, which it reportedly attempted to acquire in 1999 for about $800 million. When PayPal refused to sell, eBay bought Billpoint.

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