After a great deal of speculation, Visa and PayPal (or is it PayPal and Visa?) have announced a partnership where the two companies will “collaborate to accelerate the adoption of digital payments.” The announcement, which was actually more detailed than most partnership announcements, speaks of putting the two companies “on a new path” for the benefit of consumers and merchants.
It’s always interesting to look at the motivation behind these sorts of partnerships, drill down into the benefits to each party, and explore the potential ramifications. Let’s walk through the deal points, see what they said, and then offer an interpretation.
Deal Point #1 – Funding Source Steering
Enhanced Consumer Choice and Improved Experience for Visa Cardholders: PayPal will make it easier for new and existing customers to choose to pay with their Visa cards and ensure a more seamless experience: Visa cards will be presented as a clear and equal payment option during enrollment and subsequent payments, with an easy ability for consumers to set as their preferred payment method; Visa digital card images will be incorporated into payment flows; PayPal will not encourage Visa cardholders to link to a bank account via ACH; PayPal will also support and work with issuers to identify consumers who choose to migrate existing ACH payment flows to their Visa cards.
Elimination of ACH steering primarily benefits Visa
Visa benefits from increased purchase volume that will come primarily from Visa cardholders that prefer to use their Visa cards but were too inconvenienced to change the funding source on a transaction-by-transaction basis. Visa purchase volume goes up; ACH purchase volume goes down. PayPal users, who are also Visa cardholders, will enjoy a cleaner user experience with less purchase friction. In spite of its stated strategic importance, Visa will have less urgency to establish Visa Checkout as an alternative to PayPal. This aspect of the partnership also scores points with Visa issuers for having converted non-revenue producing PayPal ACH transactions into revenue producing PayPal debit card transactions.
For PayPal, the company loses the economic advantage of ACH funded transactions for Visa debit card-carrying users in the U.S., but this is offset somewhat by a reduction in ACH NSF reversals. Placing Visa on equal footing with other payment methods will also likely impact the extension of PayPal Credit in the U.S., which is a net win for Visa’s issuing partners. And, while minor in nature, a partnership with Visa also mitigates the competitive threat from Visa Checkout.
Deal Point #2 – Tokenization at POS
PayPal will Join the Visa Digital Enablement Program (VDEP) to Expand Point of Sale Acceptance: PayPal will join VDEP, a commercial framework for Visa partners to access Visa’s token services and other digital capabilities in the United States. This will enhance transaction security and expand acceptance for PayPal’s digital wallet to all physical retail locations where Visa contactless transactions are enabled. Consistent with VDEP, issuers will be able to choose whether to participate and retailers can expect to pay fees that are consistent with other contactless transactions they accept today.
Participation in the Visa tokenization program primarily benefits PayPal
By joining the Visa Digital Enablement Program, PayPal gains access to Visa tokens that can be used at the point of sale anywhere Visa contactless transactions are enabled, presumably through the PayPal app running on Android (with open access to the NFC radio.) Maybe we call this “PayPal Pay”. PayPal would have no economic angle on these transactions, as they would be processed through the merchant’s existing acquirer. The merchant would, in fact, have no relationship with PayPal. This is similar to Apple Pay and Android Pay, where neither company has a contractual relationship with the merchant and earns no revenue from merchants.
PayPal’s motivation here is likely to be increased utility of the PayPal app in the everyday life of the PayPal user, which is a stated corporate goal. Beyond the stated use at the POS, tokenized Visa payment credentials would also likely be used on all Visa-branded funding transactions for PayPal and Venmo. There is a real possibility that, long term, 3D Secure V2.0 (now being finalized by EMVco) might be used to shift some of the fraud liability away from PayPal and its merchants and to Visa issuers.
For Visa, it benefits indirectly by the further propagation of tokenization out into the industry and the accompanying reduction in the data breach footprint. This is also a big selling point for all the Visa issuers.
Deal Point #3 – Instant Withdrawal of Money
Instant Withdrawal of Money: Consumers will be able to instantly withdraw and move money from their PayPal and Venmo accounts to their bank account via their Visa debit cards leveraging Visa Direct – providing an experience that offers speed, security and convenience.
PayPal’s use of Visa Direct is a balanced benefit to both Visa and PayPal
For Visa, further adoption of so-called OCT transactions provides the firm with a leg up on the next generation Faster Payment system from The Clearing House coming to the U.S. in 2017. PayPal’s usage is an endorsement of the OCT technology in the U.S. and may spur others to adopt as well. More importantly, it may provide Visa issuers in the U.S. with an incentive to move to the optional “Fast Funds” model that many have ignored to date. Fast Funds is the model used to immediately post funds received to the recipient’s bank account. PayPal’s support for Visa Direct goes hand-in-hand with elimination of funding source steering for Visa cardholders. For these PayPal users, ACH will no longer be used to fund accounts OR to withdraw funds.
To the extent that Visa issuers participate in Fast Funds, withdrawals from PayPal and Venmo accounts via Visa Direct provide faster settlement to bank accounts and directly benefits PayPal’s customers. This comes at a cost however, as PayPal will now be paying card transaction fees instead of the ACH fees on withdrawals from a PayPal or Venmo account. Presumably, there will be a reduction in exception handling for PayPal as Visa Direct is able to verify the account exists and is open prior to the funds being pushed to the cardholder’s bank account.
Deal Point #4 – Enhanced Data Quality
Enhanced Data Quality: PayPal will ensure that data provided to issuers and their cardholders for Visa-funded transactions will be consistent with the information that is received with traditional Visa card transactions. This will ensure a better consumer experience, reduce cardholder confusion, ensure proper application of rewards, and reduce costly and time-consuming disputes.
Enhanced data quality primarily benefits Visa with no significant downside for PayPal
Visa has long held a stated grievance against PayPal for providing “incomplete” transaction data. Of course, PayPal provides the transaction data that is required by card company rules, but not a lot more. The card networks have changed their requirements over time – they now require PayPal to provide merchant tax IDs for example – but the grievance remains.
In my opinion, this is a bit of a red herring issue as the only real data concern was likely just the incomplete mapping of PayPal sponsored merchants across all of the ISO merchant category codes (MCCs). This incomplete mapping is the result of PayPal asking small merchants to self-map against a predefined subset of MCCs rather than making them work their way through hundreds and hundreds of potential category codes. Instead of knowing that a specific merchant is a “specialty retailer,” Visa will now know that the merchant is actually a “jewelry store.”
Providing enhanced data quality to Visa does not really cost PayPal anything more on a transaction-by-transaction basis, but perhaps they have to invest some money into getting the MCC self-assignment mapping right. Not the biggest deal, but it speaks to how important payment data is today for the increasingly analytics-driven card companies. Providing Visa with this data does not detract from PayPal’s ability to use the same data.
There is a possibility that there is more to this deal point than meets the eye, but it’s hard to know at this point. There are lots of other data elements PayPal could share with Visa, but that would be beyond what is structurally provided to the network on a card transaction.
Deal Point #5 – Economic Incentives
Economic Incentives: The agreement affords PayPal certain economic incentives, including Visa incentives for increased volume, and greater long-term Visa fee certainty.
Economic incentives, of course, primarily benefit PayPal
If successful in implementing the various partnership components, PayPal will financially benefit from “Visa Incentives” meaning that some of the economic downside from other points in the partnership will be mitigated by these incentives. “Greater long-term Visa fee certainty” probably speaks to fixed (if not reduced) network assessments over the length of a long-term contract – and perhaps a promise that Visa will not dream up new fees that are specifically targeted at PayPal. Perhaps this deal point also includes some offsetting compensation for card-not-present transaction interchange on Visa transactions, but we have no way of knowing.
While this might appear as a pure cost to Visa, it indirectly benefits Visa as well, as the volume incentives provide PayPal with clear motivation to minimize their tendency (post-Durbin) to steer qualified Visa debit transactions over PINless debit rails from STAR and NYCE instead of over Visa’s signature network rails. This PINless debit steering technique is used by PayPal to reduce the cost of network assessments on select debit card funding transactions in the U.S. It also will occasionally result in the cardholder being denied debit reward points, through no fault of their own, when the transaction is routed over a non-signature card network. In the end, however, Visa purchase volume goes up; STAR and NYCE purchase volume goes down.
Glenbrook’s Take on the Partnership
At first blush, this partnership is broader and more far reaching than what we were expecting here at Glenbrook. While termed an “extension of their long-standing relationship” this is actually the first time Visa and PayPal have collaborated on anything. Historically, the companies have been arms-length competitors. It’s worth remembering that Visa Checkout is Visa’s third attempt to compete with PayPal in the digital wallet segment of the payments industry. And PayPal uses MasterCard as its network partner on its PayPal Debit MasterCard, PayPal Extras MasterCard, and PayPal Prepaid MasterCard products. So, not historically partners.
The terms of the relationship are specific to the U.S. market. This restriction seems a bit odd given that PayPal and Visa both think and act globally. Maybe Visa doesn’t feel that bank account steering is a major concern outside the U.S.? PayPal doesn’t offer it in many markets. Maybe PayPal doesn’t see Visa having a critical mass of tokenized payment credentials outside the U.S.? Maybe it’s just too early to look at extending the partnership globally?
While we have cast the partnership in terms of what it means to Visa and PayPal individually, some consumers and some merchants will come out ahead of where they were prior to the partnership. From their perspective, most of the benefits will come from the elimination of bank account steering in favor of authenticated debit card transactions.
Consumers in the U.S. carrying Visa cards will enjoy a dramatically streamlined user experience (with less friction) when using PayPal to buy at any of its 14 million merchants. Some merchants that accept PayPal as a form of payment—those that do not qualify for seller protection—should see fewer ACH NSF transaction reversals. To be fair, this is likely a small number of transactions for a small number of merchants. But it may prove meaningful to some.
In the end, though, this partnership isn’t really about consumers and merchants. It’s about generating incremental transaction volume for Visa and its issuers—and unleashing PayPal to compete against Apple, Google, and Samsung at the POS.
For PayPal, what’s particularly intriguing about this tap-and-pay thrust at the point of sale is what it might mean for Venmo users. The same Visa tokens used in the PayPal app could also, potentially, be used in the Venmo app at the POS with the same constraints and same processing model. Embedding tap-and-pay functionality into Venmo would further accelerate the momentum behind Venmo and be the perfect synergistic overlap of social payments and mobile payments for millennials.
Think Venmo Pay!
This post was written by Glenbrook’s Russ Jones.