Why PayPal et al don’t matter

Many of us get excited about new and different toys in the payments world.

From Jack Dorsey’s twittering Square to PayPal’s billions of payments, we think the world is changing dramatically. SMS texting payments in Africa and credit exchanges on Facebook add weight to our arguments for change in the core of bank processing.

We then use these illustrations of small change to make allegations about big change. We speculate that everyone will be using twitter for payments via PayPal’s core system within the next few years, for example.

I do it myself because it’s nice to see a bit of concern in a banker’s eye; a slightly less confident swagger in a global transaction processor; a jitter of confidence in a commercial banker’s pricing.

But it’s all just a bit of noise when you look at the reality of these systems. It’s just cream on the cake.

In fact, I would say that all of the online P2P consumer developments in payments are nothing more than a wart on the backside of the flea attached to the hairs on the backside of the cat, which purrs in the lap of the banker who operates just a small piece of the parts of the whole, that comprise today’s global payments industry.

Oh yes, and that backside’s wart includes PayPal.

Shock, horror, heresy but yes, it is nothing special.

PayPal, Facebook Credits, Square ... even prepaid cards and mobile payments, it’s all just a little bit of froth or cream on the layers of the cake of the core banking industry, and its heart of payments processing.

Let me illustrate it best by picking on PayPal (sorry mates).

Today, PayPal deals with around $80 billion worth of transactions per annum – they broke $20 billion in transactions processed for the first time in Q4 2009, processing $21.4 billion in transactions for a revenue of $795.6 million.

That sounds significant, doesn’t it?

For them, it is as PayPal is a major growth machine that has eaten its parent, eBay, by becoming the de facto standard for online payments.  PayPal's revenues hit a billion per year in 2005 - now they do that per quarter.

The thing is that it is major for them but, in the scheme of the overall payments world, it’s not major at all.

First, their revenues are peanuts.

Assuming PayPal generates around $3 billion per annum in revenues this year, it’s still a long way off the largest banks that make $3 billion in pure profit in a typical year.

Second, PayPal sits on top of the core banking infrastructure. It hasn’t created anything new. It’s just added a layer of cream to the cake of payments. It sits on top of Visa and MasterCard which, in turn, sit on top of bank accounts.

So nothing has changed.

This is why PayPal is cream on the cake, but not a core ingredient.

The core ingredients are the infrastructures of clearing houses and banks, of counterparty systems and SWIFT messaging, of Real-Time Gross Settlement and Card Processing systems. PayPal is just a little bit of cream on those layers of cake.

For this reason, although I love PayPal as a model of providing payments for new internet and mobile services, from a payments context it is nothing serious.

As for Facebook Credits or other add-on services like Twitpay, which all use PayPal as their underlying service, these are just froth on the cream.

Third, even if you take them seriously, what are they actually doing? They’re providing a bit of payment functionality on top of the card and bank account functionality.

Actually no, they’re not even providing that. What they’re actually providing is a bit of account aggregation of payments for a small fee.

In other words, because banks and payments processors aren’t interested in sub-$10 payments processing, someone had to do it and that someone was PayPal.

So PayPal scooped up all of these P2P small payments online, and that’s their core business.

It’s not high value payments processing. It’s peanuts processing.

OK, so PayPal does the odd airline ticket for $1,000 but, for every airline ticket, they process $1,000’s of more dollars for buying cables, DVDs, mobile phone covers and similar goods at $10 or less.

Bring on Facebook credits and Twitpay and they’re processing $100s of more dollars for sharing a note, reading a page or downloading a song for $0.99 or less.

In other words, they are just payments aggregation services.

Like a telephone billing service, PayPal and its gang of payments aggregators offer small payments processing on a massively scalable platform. By doing this, it enables them to generate enough to warrant a worthwhile bank payment per month.

But they are not payments processing, just aggregating payments like a telephone service.

A telephone service provider processes 100s of transactions a month to generate a single worthwhile monthly payment through the banking system.

PayPal, Facebook and Twitpay are doing the same thing for online services.

This is why they are actually irrelevant, in terms of core payments processing.

Core payments processing represents $4 trillion of debit and credit card payments per annum, significantly more than PayPal’s $72 billion for the year.

Core payments represents the almost $4 trillion in foreign exchange transactions performed every day.

That's over a quadrillion dollars worth of transactions per year.

A quadrillion dollars per annum makes PayPal look like a bit of detritus on the landscape of global payments volumes.

This is not to say that PayPal are detritus. They are important, but they are not all consumingly the be-all and end-all of innovation or even change because, when it comes to payments, nothing much has changed.  In fact, banks are starting to eat back into their business by launching secure online payments systems like iDeal and Rightcliq by Visa.

And this is easy, when you have an industry that processes gazillions of dollars per year using standards, structures and systems which have globally stood the test of time.

These standards, structures and systems allow the billions of transactions in global capital markets and corporate supply chain and person-to-person payments to operate.

These are the core ingredients of the cake.

So yes, add to this a little bit of cream on the cake, PayPal; or add to this a little froth on the cream, Facebook and Twitpay.

But don’t mistake the froth and cream as core.

It’s not.

Comments

[Trevor LaFleche]

Well said Chris. The Insight is being able to see the froth and cream from the foundations.

No one has replaced the bank account or core payments system with all the internet innovation. What would be true innovation is to disassociate the "bank account" and the "Bank" choose your service provider. This would be similar to my personal email account/domain. Imagine your inbox as your bank account. Folders as different allocations of money (Savings, etc) and I could chose a provider to service this for me. (Google, Amazon, HSBC, etc). As an identifier for payments use a banking DNS system to direct the payments to my account (and enable me to change service provider from time to time). The Danes already have a banking DNS of sorts and Vocalink envisions the potential for a similar service.

Unless this disassociation happens there will always be the necessity to build layers on top of the core. More virtual account, more parallel payment systems, aggregation, and other activities which simply make it more complex for consumers.

Could the banking industry really reform itself to something as useful and flexible as the internet? Somehow I have my doubts.

[Brett King]

Chris, agree and disagree here.

Let's use the analogy of the Electricity market. The Reserve Bank is the generator, the banks the wires, who owns the meter? The bank has a monopoly on the wires, but they are losing the customer. Aggregation and innovation of the gateways to banking services results in lost opportunities for customer engagement.

Sure banks will still be processing the payments, but the bank won't own you as a customer anymore. They have no unique differentiation.

Banks just aren't pervasive enough individually, and simply aren't coordinated enough collectively, to represent the single viable solution in this space. Octopus in Hong Kong for example showed this, as has M-Pesa in Kenya.

Using the utility analogy again - the retailing of 'finance' (the meter) is no longer restricted to banks. I agree that banks own the 'core', but I'm sure there are heaps of organization ready to chip away at the froth and cream where margin lies. If banks get left with just the core - they don't have much retail margin left...

[Pragmatist]

Hi Chris, thanks for a thought provoking piece from the bankers' point of view.

Of course I disagree. The front-end 'payment aggregators' like PayPal etc are critically important. They are eating into retail banks' share of the 'last mile', in telephony jargon: the link between the industrial strength payment systems you describe so well, and the retailers, shoppers and remittance payers/payees. These new entrants are simply creating more user-friendly services that the banks can't or won't provide. What you describe is a world where the banks are the back office service providers for the next wave of financial services, at least for the time being... ;-)

Best
SDJ

[Jonmatonis]

Hi Chris,

Having worked for VISA and then for VeriSign on payments and banking, I have to agree with you. I have been thinking those same thoughts but never put in on paper. Well done, someone has to say it.

It seems as though the world has stood still with respect to payments (maybe even slightly backwards). PayPal was originally created to be a killer of government money -- instead they have morphed into a mere pass-thru mechanism. e-gold had 1/3 Paypal's volume at their peak and they were snuffed out by the US government, because they were guilty of maintaining customer's financial privacy.

The true 'innovation' that will matter is how to advance from a paper $100 bill to a digital $100 bill without losing the anonymity and privacy features of the paper cash. It hasn't been done yet, because governments don't want that innovation. In the meantime, we should reject all digital monies until, at a bare minimum, it can maintain the privacy of a simple paper $100 bill.

--Jon Matonis
http://themonetaryfuture.blogspot.com

[Dion Lisle]

It is nice to see someone with both the knowledge and the nerve to acknowledge the truth. Well done. As a bank employee, but clearly not a banker - I agree.

The amount of money moved by banks on a daily basis is nothing short of stunning. I know my institution moves trillions.

Now on to the more important matter, driving innovation in payments so they are more secure, more convenient and better for merchants. I look forward to tapping my phone at a train station to enter the subway and then buy a soda at a vending machine with only my phone, like they already do in Japan.

As the mover of trillions of dollars (Euros, Pound, Yen, etc.) I hope Banks will take the lead in this next exciting phase of the digitization of money.

[Michael Rolph]

An interesting read and some good follow on comments. For me what is highlighted by the blog is the processing banks market myopia. As this suggests unless you define the business you are in both now and for the future you will leave yourself open to new entrants and by not consciously investing in new methods of spend and capture tools they (the banks) have created the gap that these new players now fill.

So bank's cannot feel too hard done by that they are starting to loose the 'last mile' after all they have let it happen. No one can predict the future but that does not mean you don’t invest in it.

[Jeremy Kidd]

I disagree with the core foundation of your post Chris, and I have a sneaking suspicion you do too. In fact, I’d be willing to bet you’ve already written the counter-point article in which you disagree with yourself out loud. I expect you’re just tweaking it now to address some of the comments on this polarizing article.
My problem with your post is the underlying principle that what matters most is being big, and being on the back-end of everything. The processing engines that are at the bottom of all of these payments from the froth layer are indeed important - critical even. The problem is that the more and more the payment processing core becomes merely the underlying foundation, the more and more the banks become like a public utility (I like that analogy) and the thinner their margins will get. The banks still have nice fat revenues AND income from the transactions business, but unless they get innovating in the froth, they’ll be left with the fat revenues maybe but only a wafer-thin income. Not good.
I work for an agriculture firm who’s history is commodities processing – we used to be nicknamed “tons-r-us”. In the last decade or two, our leadership has turned us from a processing firm with razor-like margins into a true partner with our customers and suppliers and our goal is now meeting their needs and adding value, not just turning grain into flour. Our income has been growing ever since. What you seem to be arguing, Chris, is that the banks are OK resting on their position as the “billions-r-us” financial commodity processors because PayPal and the like are just small. The fact is, PayPal and the like are meeting customers’ needs and adding value for them. Unless the banks get in that space, they’ll move more and more to the back end and eventually lose their ability to charge more than a commodity price for their services.
Looking forward to part 2 of this thread…

[Chris Skinner]

Gawd Jeremy, am I so bleedin' predictable ...

http://thefinanser.co.uk/fsclub/2010/03/why-paypal-et-al-really-matter.html

[Jeremy Light]

Banks have for centuries financed the "last mile" of payments by making cash available into the economy, without acting as an intermediary - but at vast expense with very little revenue. Innovators in the "last mile" are driving cash displacement and driving cash handling savings for the banks, which in time, could be huge. And as electronic payment volumes skyrocket, margins will become wafer thin... so the oft-cited risk of disintermediation of the banks may be no risk at all.