Beware the Doves?

by Scott Loftesness on June 14, 2004

in Scott Loftesness, Writings

by Scott Loftesness

Reflections on the PayPal/GE Consumer Finance Alliance

On June 8th, 2004, PayPal quietly announced it was partnering with GE Capital Consumer Card Company to begin offering credit lines to customers that want extended payment terms for any PayPal purchase. PayPal’s business members started receiving direct mail pieces the following day offering new credit lines up to $50,000.

Is PayPal’s new Buyer Credit offering simply a new technique to drive additional eBay volume—or does it have more important implications for the banking industry? This analysis considers some of these implications, exploring what PayPal’s new credit offering might mean for consumers, merchants, and bankers—and for PayPal and GE.

PayPal’s recent announcement of a credit offering can be thought of as the third phase of its evolution as a payment system. We think of PayPal’s evolution like this:

  • Phase 1: Credit Card Payments. Positioned as the industry’s first person-to-person payment system, the first phase began with PayPal providing payment acceptance services to individuals and small merchants who otherwise could not accept credit cards. Consumers registered their credit cards with PayPal and used their PayPal account to pay for online purchases, primarily for auctions on eBay. During this phase, PayPal leveraged the credit card legacy infrastructure using services such as address verification to minimize its potential risk of loss.

    PayPal aggressively used financial bounties to attract new members and build its brand, spending well in excess of $100 million it had raised from venture investors during the peak of the “Internet boom.” Several bank and non-bank competitors also launched similar email money services during this phase, under-invested in them—relative to PayPal—resulting in their eventual failure in the marketplace.

  • Phase 2: eCheck Payments. The second phase extended PayPal’s reach into consumer checking accounts. To reduce the high cost of funding from credit cards and improve its payment margin, PayPal has made heroic efforts to motivate consumers into using their checking accounts for funding their PayPal accounts—instead of using one of their credit cards.

Similar to what it did earlier with the existing credit card infrastructure, during this phase PayPal leveraged the legacy ACH infrastructure provided by the banks to create a lower-cost/higher-margin funding source.

  • Phase 3: Direct Credit Line. This new third phase extends PayPal’s utility and value to merchants and consumers alike through the direct extension of credit. PayPal is rapidly closing on having 50 million members—adding about 50,000 new customers a day—with many of those customers being a potential PayPal credit user. PayPal’s new credit partner GE Consumer Finance claims it has 103 million consumer relationships. On top of that, PayPal’s parent eBay has over 100 million registered members globally—most of them also being appropriate targets for a credit offering.

    The combined capability of PayPal/eBay and GE Consumer Finance to quickly reach millions of consumers is truly stunning. Having already acquired and activated millions of consumer members, the new credit offering from PayPal/GE appears designed primarily to drive member purchase activity—by supplementing the member’s existing credit card “open to buy” with a new credit capability.

How It Works

Over the last couple of years, PayPal has aggressively been incenting consumers to fund their PayPal transactions from their checking accounts rather than from their credit cards. This strategy is clearly working. In the most recent quarter, PayPal reported that 46% of its funding activity came from checking accounts and funds already in PayPal accounts, while 54% came from credit cards on file. As a result of its focus on reducing funding costs, PayPal currently enjoys a 2.08% margin on the payment volume it handles.

PayPal now provides another choice to consumers—a choice the consumer can select on a transaction-by-transaction basis rather than only for the complete relationship. PayPal members will now be able to pay for Bill Clinton’s latest memoirs from their checking account while using PayPal’s new credit feature when buying a new plasma widescreen TV or computer.

Buyer Credit also enables PayPal sellers to list higher priced items for sale with promotional financing, thereby helping to increase their sales. When using any of the promotional financing options now offered by PayPal, the seller pays higher fees to PayPal. For example, if a seller offers a promotional financing incentive consisting of no interest if paid in full within twelve months, the seller’s additional fee to PayPal will be 3.75% of the purchase amount.

In terms of PayPal’s profits, its most costly transaction remains the one funded from the consumer’s existing credit card. PayPal’s most profitable transactions are those funded from funds on deposit in the member’s PayPal account (actually from their PayPal Money Market Fund). Transactions funded from a member’s checking account are the next most profitable transactions for PayPal. Assuming PayPal was able to negotiate a healthy deal with GE Capital in terms of sharing in a portion of the revolving credit income stream, a PayPal credit line transaction could now become the most profitable transaction type for PayPal.

A future opportunity for PayPal and GE involves increasing the size of their revolving credit business by providing incentives for PayPal members to move any outstanding credit balances from other card issuers to their new PayPal credit line. PayPal knows the member’s card issuer (or issuers, in cases where members have registered multiple cards) through the credit card data it already has on file. For members who have registered their checking account information with PayPal, PayPal already knows the details of the member’s retail banking relationship. PayPal also has some great reputation information about each of its members—their funding preferences, purchase patterns, dispute history, and support cost.

Good for Consumers?

Over time, consumers should expect to benefit from more competition for their credit relationships. But beyond simply being another source of available credit, PayPal has several consumer-oriented features that differentiate it from traditional credit cards—features some consumers may prefer when shopping online.

For example, when paying with PayPal there’s no need to remember your card number—a PayPal member’s email address is the equivalent of her credit card number when used for making PayPal purchases. PayPal markets its trust, safety, security, and convenience features repeatedly to its members, differentiating itself from traditional credit cards.

For consumers, there is much to like about this new approach. Online shoppers benefit from integrated access to the industry’s highest return money market fund, any number of their credit cards, their checking account, and now a new line of credit—all accessible through the use of an email address (and password) without having to provide any sensitive personal financial information to merchants.

Others may not be so happy. New entrants such as Bill Me Later (from I4 Commerce) are also focused on providing per transaction revolving credit to online consumers. To date, Bill Me Later has enlisted the support of online merchants to encourage their customers to sign-up for the Bill Me Later service at checkout time—lowering Bill Me Later’s customer acquisition costs as compared to traditional credit card solicitations. Because of PayPal’s extensive reach, many of the potential customers of Bill Me Later already have PayPal accounts and may be more likely to simply choose PayPal as their credit provider rather than enroll in another offering.

Good for Merchants?

PayPal has historically focused on serving small merchants who are perhaps not able to qualify for a traditional merchant bankcard acceptance relationship. Particularly in the context of eBay, PayPal has enabled millions of regular folks to become online e-Commerce merchants, accepting all manner of electronic payments for their garage sale items. Recently, eBay estimated 430,000 people in the U.S. are now making their living through eBay—with 80% of its small business sellers having 5 or fewer employees.

PayPal has recently begun its move up market—attempting to attract some of the larger online e-Commerce merchants to its payments platform. Why might these merchants be interested in accepting PayPal? Top line revenue increases, of course! Merchants have learned that by offering consumers more payment options, they can sell more to a broader range of customers. PayPal will certainly be able to cite chapter and verse to new merchant prospects about its member demographics and their propensity to spend using PayPal when they might not spend using a traditional bank credit card. PayPal’s ability to assist e-Commerce merchants in managing down the risks and associated losses associated with payment acceptance is another important differentiator.

Merchants are also increasingly frustrated with the seemingly endless increases in the costs they pay for traditional credit card acceptance. While last year’s settlement in the debit card litigation resulted in some adjustments to the costs of debit card acceptance, merchant discount fees for credit cards have continued to escalate as credit card interchange rates have moved inexorably upward. With the specter of some Visa and MasterCard members beginning to move to co-issuance with American Express and its even higher merchant payment acceptance costs, online merchants are increasingly welcoming viable payment alternatives. PayPal certainly has evolved to become the most viable alternative—with millions of members able to spend conveniently and safely online—and who are now outfitted with new credit lines that enable them to spend even more.

To the extent that PayPal can further wean its customers off of credit card funding and on to funding from the new credit lines (or from directly from their checking accounts), it can further expand its margin on the payments it handles and potentially use those margins to reduce its acceptance fees to merchants as compared to credit cards. For merchants, what’s there not to like about this story?

Good for Banks?

The crown jewel of the U.S. credit card business is the revolving credit business. The major breakthrough that the credit card enabled over thirty years ago was the low cost extension of credit to millions of consumers. Revenues from revolving credit represent the single largest portion of current credit card issuer revenues—other fees, although not insignificant, pale in comparison to the revenues generated by the revolving credit business. The combination of PayPal and GE Consumer Finance could put at risk many of the existing relationships that credit card issuers have with their cardholders. Another side effect of PayPal’s success with merchants is card issuers losing visibility to transaction-level consumer purchase activity as PayPal increasingly becomes the “merchant” of record.

Banks have traditionally viewed payments from a consumer’s checking account as a completely separate product from payments that could involve credit. A payment service that makes it possible for a consumer to decide whether to pay from her checking account or to take out a loan for a purchase through the same interface, perhaps with rewards attached, on a transaction-by-transaction basis creates a payment service that might not make sense to the traditional banker way of thinking—while making perfect sense to consumers. Is there anything for a banker to like about this story?

What’s Ahead?

Can a physical PayPal/GE branded plastic credit card be far away—offered in addition to PayPal’s existing debit MasterCard or its Providian-issued Visa credit card? Such a card could be launched today using GE’s MasterCard issuing relationship—and GE’s currently doing exactly that with a number of its larger private label merchants. In fact, GE has told financial analysts that its “dual card” represents one of its most important consumer finance strategies.

Maybe there’s also a PayPal acceptance mark in your future? Given the right economics for merchants, GE’s private label card relationships with a number of major merchants could provide an ideal springboard from which to launch new PayPal-accepting merchant locations in both the online ecommerce and, with plastic cards also in circulation, physical face-to-face retail locations. Merchants would be interested in such an offering if it either expanded the base of potential customers (and thereby increased sales revenue) and/or lowered their cost of payment acceptance as compared to current card acceptance costs.

One could also imagine a new incentive structure being introduced designed to drive consumers more aggressively away from using credit cards linked to PayPal accounts. This would further enhance PayPal’s payment margin advantage over credit cards for merchant acceptance.

For example, consider the following potential scenario: As the PayPal member’s linked credit card account approaches its expiration date (that date is the one set by the credit card issuer, not by PayPal), PayPal/GE screens the consumer’s credit bureau information to assess extending a pre-approved credit offer to the member. If the member qualifies for a credit line, PayPal says “You may continue to use Visa/MasterCard/American Express/Discover cards as a way to fund your PayPal account—with the payment of a $20 annual PayPal membership fee—or—you can simply provide us with your checking account information or use your new pre-approved PayPal credit line and we’ll waive the annual membership fee.” What would you do?

What’s a Banker to Do?

PayPal has evolved into a significant non-bank payment service for online commerce. In the process, PayPal has taken full advantage of all of the payment card and ACH infrastructure provided to it as a merchant by the U.S. banking industry. With the recent entry of PayPal into credit—coupled with GE’s considerable prowess as a credit grantor—perhaps PayPal is evolving into becoming the most important threat to the revolving credit “crown jewels” of the credit card issuing banks, including American Express and Discover Card.

Credit card issuers are now staring down the throat of a new entrant who has partnered with one of the most capable consumer finance credit grantors on the planet. Together, PayPal and GE have the consumer reach, the necessary information about their customers’ financial preferences, and the financial resources and skills to be both aggressive and successful. After having achieved a base of initial success, a number of potential next steps then become possible, each further increasing the level of competition with traditional credit card issuers.

Retail bankers—perhaps unfairly accused by some in the industry of having left the ACH “barn door” open for PayPal to exploit as its checking account funding mechanism—continue to provide PayPal with its lowest cost funding mechanism—and, in the process, enable the shift of online consumer payments away from the much more profitable (to banks) credit card funding. Should retail bankers, as some in the industry suggest, reconsider the pricing for the kind of ACH debit transactions that PayPal uses for funding? If you’re involved with NACHA or any of the other ACH providers, should you be cheering PayPal on as a major ACH initiator—or should you be concerned?

If you’re a credit card issuer or a retail banker, are you even paying attention to those customers of yours who are already actively using PayPal as their online payment service? Don’t you have the data at your fingertips to be able to determine who those customers are and to provide them with your best competitive response? Are you acting on that opportunity—or sitting on your hands?

So What?

Can an assault on the hugely profitable U.S. credit card business really succeed when launched from the relatively insignificant market segment of online e-Commerce? After all, e-Commerce today only represents about 3% of total consumer card spending—although its growing rapidly. Based upon reported figures for 2003, PayPal handles somewhat less than 15% of U.S. e-Commerce spending. So, why worry? Or, perhaps more bluntly, get real—this isn’t a serious threat—so who cares!

A number of potential responses could be available should one of these scenarios emerge as a serious threat to industry profitability. For example, just to cite a ridiculously extreme case, given the profitability of the credit card industry today, what if, as part of a competitive response to such an emerging threat, credit card interchange went to zero? What would this do to PayPal’s payment margin advantage? How might this affect issuer decisions regarding co-issuing American Express cards? How might merchants and consumers respond?

Interestingly, the number one category in eBay sales volume is now automotive. Why would PayPal/GE stop with only offering revolving credit when an online installment loan capability would be attractive to both buyers and sellers? Similarly, there are significant new opportunities for leveraging the PayPal/GE credit business outside the U.S.—those markets being of important strategic value to both eBay and GE.

Your Turn!

Albert Camus wrote: “Great ideas come into the world as gently as doves.” PayPal’s quiet launch of credit, in partnership with GE, could prove to be one of those truly great business ideas. It certainly feels like there’s a lot hanging in the balance—especially for U.S. credit card issuers and retail bankers occupying their traditional incumbent positions.

Of course, to be successful PayPal and GE must execute extremely well. That being said, PayPal’s entry into credit seems like one of the best scary bedtime stories for bankers in years! The key elements of the story are all present: significant and overlapping customer relationships, new opportunities for meaningful disintermediation of bank/customer relationships, a new entrant riding the rails and fully exploiting the bank-owned U.S. payments infrastructure—and, with essentially a free ticket, cannibalizing the revenues of the most profitable bank payment products and gaining, as a result, an ever increasing share of the profits from the consumer payments business. What could be better for consumers and merchants? What could be worse for bankers?

Perhaps you’re in a position to continue taking that incumbent banker’s point of view. If all of this does seem a bit scary, you might try simply repeating the same mantra that bankers have used repeatedly when talking to their banking industry peers about PayPal: “It’s only auctions, it’s only auctions, it’s only auctions.”

There, now, don’t you feel better?!


  1. Feel free to post your comments about this analysis.


  1. For an overview of PayPal Buyer Credit for buyers, see:
  2. For an overview of PayPal Buyer Credit from a seller’s point of view, see:
  3. For more information about PayPal’s Providian-issued Visa card, see:
  4. For eBay’s latest investor presentation, see the PDF:
  5. For GE Consumer Finance’s most recent investor presentation, see the PDF:


My partners at Glenbrook (Carol Coye Benson, Bryan Derman, Dennis Moser, Russ Jones, and Allen Weinberg) contributed significantly to this paper. Reviewers Greg Bjorndahl and Janey Place also provided very helpful comments.

Publication History

Initial Publication Date: June 15, 2004

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