Online payment options may “knockout” credit cards

Online payment methods such as PayPal have gained in popularity over the past three years and have enough momentum to continue to steal market-share away from credit cards to the tune of hundreds of millions of dollars, according to new research.

These alternative payment methods that offer customers a way to pay for things online by signing in to an account now make up 15 per cent of all e-commerce transactions, according to San Francisco-based financial consultant firm Celent.

Payment card use has been declining for online trasactions over the past few years (Celent).

With a business model that focuses on providing better value to consumers and smaller merchants, the industry could steal away $345 million from credit cards by 2011 and up to $1.7 billion by 2015.

Online payment methods such as PayPal have delivered what amounts to a “knockout punch” to credit cards, according to Red Gillen, Celent’s senior banking analyst and report author. The strategy, he said, is to exploit the credit card’s weakness of high fees that prevent merchant discounts and not being able to offer consumers transaction-based financing.

“All of these solutions have a very secure approach where the financial information is shared with one player,” he says. “Now the question is how do your encourage me as a buyer to spend more?”

PayPal is owned by San Jose, Calif.-based online auctioneer eBay Inc. Last week, the company bolstered its online payment strategy with the purchase of Timonium, Md.-based Bill Me Later Inc.

The digital payment provider offers consumers financing programs on individual products and accepts payment through direct debits to a bank account, cheque or money order. It does not use credit cards and is already accepted by many well-recognized brand name merchants.

“On the consumer side of e-commerce it’s been centred around credit cards for the longest time,” says Jean-Yves Martineau, the co-founder of Ottawa-based e-commerce provider Cactus Commerce. “But the last couple of years, alternative methods like PayPal are becoming more popular.”

PayPal offers customers a level of convenience and security that is rare, he adds.

Users are able to collect many payment options in one place, and then use a login and password to put through a transaction. That might help convert more sales because consumers don’t have second thoughts when asked to submit credit card information to yet another source.

“I definitely see it as a disruptor from the traditional institutions and that’s a good thing,” Martineau says.

Visa Canada doesn’t seem to be losing sleep over the emergence of online payment methods. Around eight out of 10 consumers are still using a credit card when paying online and Visa gets about 55 per cent of that business, according to Stephanie Wallat, senior business manager with Visa Canada.

“It’s up to consumers to choose what they want,” she says. “If consumers pay directly with their credit card, they’ll enjoy the benefits.”

The U.S. market for e-commerce was $170 billion in 2007 and is projected to grow to about $325 billion by 2013, according to Celent.

Visa card users are protected from fraud because the company monitors transactions in real time and looks for suspicious spending. Customers often are rewarded for spending with their Visa cards by collecting loyalty points offered up by merchants.

“Rewards are a powerful tool the card industry has used in the past and they’ll continue to use that,” Celent’s Gillen says. “The card banks have to think about how much they’re going to lose to these alternative solutions.”

Online payment methods are starting to offer incentives to merchants and consumers alike. PayPal, Google Checkout and Amazon Payments are the big names in the industry and are dominating this market by offering perks. The security offered by such methods helps bring in more cautious consumers (30 to 40 per cent of Bill Me Later users are new online shoppers, Celent says).

Bill Me Later has proven to be the best at providing a sales lift to its merchants, Gillen says. The secret to its success lies in the method’s ability to offer financing on individual purchases.

“Say it’s the holiday season ad I want to get someone to buy something at my store,” Gillen says. “I can tie transactional financing to a single product, and credit cards can’t do that.”

Merchants also benefit by avoiding the expensive transaction fees. Smaller businesses often find themselves paying as much as three per cent of the transaction amount to a credit card clearing service, according to Tim Hickernell, a senior analyst with London, Ont.-based Info-Tech Research Group.

“A lot of small businesses have always had that strategy that if you pay cash, you pay less,” he says. This is just the next generation of that model.

Small businesses could even look at using PayPal as a whole set of merchant servicers, the analyst adds. Instead of managing a credit card acceptance system, the business could rely on PayPal to do so. PayPal allows consumers to choose a credit card as a payment option but doesn’t charge merchants extra if that method is used.

The payment service does discourage users from using a credit card as a payment option. A warning screen pops up, asking users if they are sure about their choice, and warns about the potential risk of paying interest fees.

Visa has no specific plans to convince consumers to choose to use their card in PayPal instead of directly using their bank accounts, according to Wallat. The company’s focus remains on providing security and convenience.

The Verified by Visa program has been growing, she says. “It provides added confidence for consumers because it helps prevent unauthorized use of their card.”

The program has consumers sign up for an account that uses a password to verify a cardholder’s identity. The consumer also is ensured they are dealing with their card issuer by seeing a secret message displayed on the screen.

But that extra step can annoy some and be difficult for consumers to set up, Martineau says.

“It took me three [tries] to get things set up right,” he says. There’s also the problem of having to remember an extra password, and if you enter it wrong, the consumer may feel like they are putting the same transaction through multiple times.

PayPal has also recently beefed up its security offerings for the more paranoid consumer, Hickernell says. The service issues a key fob with a small digital display to account holders. Users press a button on the device to have a random key generated. They then enter that key along with their regular user name and password to access their account.

“It adds the ‘what you have’ to the ‘what you know’ layer of security,” he says.

With security issues ironed out, competition within the online payment providers will focus on who can get consumers spending more money, Gillin says. “That’s where the real battle lies amongst these players.”

Payment methods that are overlaid on a retail community like eBay or Amazon will continue to fare better, Hickernell predicts. The network approach where everyone uses the same payment system is the best way to benefit from online payment methods.

But more retailers will start to offer PayPal and other similar services as a payment option. It just makes sense to avoid losing out on potential business, Martineau says.

“You’d almost be stupid not to accommodate it,” he says.

PayPal Canada couldn’t be interviewed by publication time.

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