Wednesday, November 21, 2007

Credit Cards Lose Ground to PayPal

Internet-based payment services are growing in popularity, as PayPal and others capitalize on fear of identity theft and payment fraud

Burt Reynolds is an unlikely choice for the role of Santa's helper. That didn't stop computer-maker Dell (DELL) from casting the actor in a series of commercials aimed at the social networking set. In the videos, launched on Nov. 16, Reynolds encourages viewers to buy Dell products online as holiday gifts for friends and family.

The star of Smokey and the Bandit and Cannonball Run isn't the only surprising casting choice. Playing the part of payment collector is eBay's (EBAY) PayPal. Dell typically lets customers purchase computers with their Visa or MasterCard (MA) credit cards. But with this new service, all payments must go through a PayPal account. "People are moving to using different payment options, and looking at this one in particular opened up a lot of opportunities," says David Clifton, a spokesman for Dell's consumer group.

Easier Way to Pay

PayPal's payment service is likely to show up on a lot of unusual sites this holiday season. On Nov. 20, PayPal released tools that let online shoppers use its service nearly everywhere online, even in cases where the merchant doesn't accept PayPal. Online shoppers can download a toolbar that lets them use a temporary Mastercard number when making a transaction. Payments are then withdrawn from the user's PayPal-linked credit card or bank account. The payment is processed through PayPal and the merchant never sees the original account details. The system is designed to guard against identity theft and credit-card fraud. "PayPal is the safest way to pay online because we don't share your financial information," says Chris George, senior director of financial products at eBay.

Dell's decision to include PayPal as an option underscores the growing popularity of Internet-based payment services. In a matter of a decade, PayPal and other non-credit-card electronic-payments processors have grabbed more than 30% of the U.S. online payments market, though PayPal is the leader, making up roughly 24% of the market. The service processed $12.2 billion in the most recent quarter, a 34% increase in volume from a year earlier. Much volume comes from people buying and selling on eBay, which acquired PayPal for $1.5 billion in 2002. But the off-eBay business is growing fast. Nearly 45% of the payments processed in the third quarter were for non-eBay purchases.

As the holiday shopping season unfolds, vendors want to make it as easy as possible for consumers to buy online, especially as stock and real estate market turmoil raises concerns of a not-so-merry Christmas for retailers. U.S. consumers are expected to spend more than $31 billion online this holiday season, according to a Nov. 15 report by research firm eMarketer. That would translate to a growth rate of 18.5%, smaller than the 25.5% growth rate merchants saw last year.

PayPal isn't the only online payment service set to benefit from increased reliance on alternative payment methods. Google Checkout (, 1/25/07), PayPal's nearest U.S. competitor aside from Visa and MasterCard, launched in late 2005. Since then it has grabbed roughly 12% of the U.S. online payments market, says Richard Feinberg, director of the Center for Customer-Driven Quality at Purdue University and a professor of retail management.

Potential Abroad

Fear of identity theft and payment fraud is driving the adoption of PayPal and Google Checkout in the U.S., says Feinberg. Incidences of identity theft have increased more than 50% from 2003, according to a March, 2007, report from Gartner (IT). More than 15 million Americans had their financial information stolen between 2005 and 2006, according to the study. "Consumers are afraid to give out their credit-card information," says Feinberg. "So PayPal and Google Checkout and other smaller services offer an extra level of protection."

PayPal and Google Checkout (GOOG) also have offered financial incentives to use their services. PayPal, which has several banklike services not offered by competitors, offers a money-market fund for customers that has traditionally offered more than 5% returns, a significantly higher rate than those offered by many banks. Google has offered breaks on payment processing fees for small businesses that are also search-advertising customers.

There may be even more opportunity for alternative payment systems abroad. As broadband adoption expands in Latin America and Asia, more customers are doing business online. But they're not doing that business with credit cards. Credit-card adoption worldwide, excluding the U.S. market, is only at about 38%, says Manuel Montero, a former American Express (AXP) executive who now heads online payment service SaftPay. In part that's due to differing attitudes toward debt and the difficulty of obtaining credit in other countries, particularly in emerging markets. "The fact of the matter is the credit card is not that popular outside of the United States," says Montero. "In most places in Latin America and Europe, people buy through bank transfers and through debit cards."

Of course, the credit-card companies see the potential abroad, too. But even if online payment services never gain the popularity of Visa or MasterCard, even a sliver of the $30-billion-plus U.S. holiday market is plenty to go around. Says Feinberg, "We are talking a lot of money here."