Can PayPal/ win in mobile payments?

MGMT 731 Final Paper Esther Jang Jyotika Prasad December 19, 2013 Word Count: 2498

Introduction This paper aims to answer the question “Can PayPal/Venmo capture a major share in the mobile payments market?” To answer this question, we first determine whether the mobile payments market will have an industry leader. Next we examine the economics and drivers of user value in this market to determine what will drive the dominant design. Finally we examine PayPal/Venmo and competitors to determine which of these are best positioned to emerge as the leader in this market. The Mobile Payments market The mobile payments market can roughly be divided into three sub-markets.

 Mobile P2P remittances: Mostly comprised of small peer-to-peer (or C2C) transactions, and some bill payment.  Mobile Commerce (mCommerce): Shopping and other transactions initiated from mobile phones, including purchase of and within apps, digital content etc.  Mobile proximity payment: Retail and unattended point of sale payments.

Currently, mobile commerce accounts for 90% of the mobile payments transactions, while mobile proximity payments and P2P remittances account for 4% and 6% of the overall transactions1. Of the three, proximity payments are expected to grow fastest and account for nearly 45% of transaction volumes by 2017 (Figure 1)

Figure 1 Size and growth forecasts for different segments of the US mobile market. Source: Forrester Research US Mobile Payments Forecast, 2013 To 2017

Next we consider the economics of each segment.

 Proximity payments margins are 2.7% for PayPal Here2 and 2.75% for Square3. We use 2.75% for estimation.

1 Forrester Report: US Mobile Payments Forecast, 2013 To 2017 2 https://www.paypal.com/webapps/mpp/credit-card-reader Accessed December 12, 2013 3 https://squareup.com/pricing Accessed December 12, 2013  We use a 2.9% margin for mCommerce, since this is what both PayPal4 and Google Wallet5 currently charge.  Mobile P2P currently has almost no margins, since almost all attempts to monetize this segment have failed and most players offer this for free.

mCommerce Mobile Proximity Payments Mobile P2P

Total transaction volume in the $115,613.68 $55,210,16 $9093.24 next five years (assuming a 10% discount rate) in millions

Margins 2.9% 2.75% 0%

Expected market size in millions $3,352.8 $1,518.23 $0

Figure 2 Projected market size for different segments of the US mobile payments market mCommerce seems to have the largest revenue potential. However, there are some key considerations that the numbers don’t capture.

 Network effect: Any payments solution will need a critical mass of users before it truly takes off. To be successful a solution should have strong user and merchant networks. Getting merchants to adopt a new payment solution is generally harder. Mobile P2P being largely a free offering has lower barriers to adoption. This makes this segment strategically important since this is a way to attract and lock users in, and then use this user base to attract merchants.  Interoperability of standards: Currently there is almost no interoperability of standards. Therefore unless a payment solution provider has an offering in all three market segments, customers will be forced to use different solutions for different segments. Since payments is a sensitive area consumers would not want to trust multiple solutions and would prefer a single solution. Thus we believe an integrated play will be more powerful in this space.

The above reasons lead us to believe that the ultimate winner in the mobile payments space will need to capture all three segments of the market to win share and profits. Industry shakeout PayPal has been the dominant design in P2P payments for a while and is also the leader in mobile P2P payments currently. However as the analysis above shows, to capture a major share in the complete mobile payments market it is necessary to capture all three segments. Considering the whole mobile payments space, we believe the industry is still in its early stages and no dominant design has emerged yet. We also believe that this is an industry which will consolidate, and ultimately see one or two players dominate the entire market.

To predict how the industry will shakeout, we again look at the market by segment (Figure 3)

4 https://www.paypal.com/webapps/mpp/merchant-fees Accessed December 12, 2013 5 http://www.google.com/wallet/business/ Accessed December 12, 2013  Mobile P2P: The network effect is the strongest in this segment. Looking at other industries with strong network effects (social networking, online P2P payments), we predict that the shakeout will happen early, and only one major player will remain, who will capture most of the market.  Mobile commerce: The choice of payment solution to offer is decided by merchants based on two factors – low charges, and number of users the solution has. We expect one major player to emerge here, with a close second, and then a few much smaller players, very similar to the credit card industry.  Mobile proximity6: Most technology in this space can be divided into two classes: over- the-network and contactless mobile payment. o Over-the-network solutions are software based solutions such as Paypal, Venmo or SMS payments that use a mobile phone to initiate and authenticate payments, and require both the user and merchant to be pre-registered with the network. Given the strong network effect and user lock-in nature of this space, we expect one major player to emerge as the winner here. o Contactless mobile payments are hardware based solutions that use the merchants’ point-of-sale (POS) infrastructure to initiate and authorize transactions. NFC technology has emerged as the accepted standard in this space. Given the standardization, we expect many players in this space to successfully co-exist.

Segment Network effect Interoperability Heterogeneity of Predicted outcome of standards the market

Mobile P2P Very high Low Low 1 major player

Mobile commerce High Low Low 1 major player, a close second, and a few smaller players

Mobile Over-the- High Low Low 1 major player proximity network

Contactless Medium-low High Low 3-4 major players mobile payment

Figure 3 Predicted outcome of industry shakeout for different segments of the US mobile payments market The final shakeout depends on what the dominant design in proximity payments is. If over-the- network solutions win, the mobile payments market will be dominated by one major player holding the majority of the market, with potentially 1-2 smaller players as alternatives. If contactless mobile payments win, the mobile payments market will potentially look similar to today’s credit card market (Figure 4).

6 Forrester Report: Mobile Payments Enter A Disruptive Phase

Figure 4 Market share of different players in the US credit card market Our prediction is that over-the-network solutions will win in the proximity payments space:

1. As a hardware-based technology, NFC requires both handsets and payment terminals to be equipped with technology, which poses a chicken-and-egg barrier to adoption. 2. Critics of NFC argue that “tap-to-pay” still requires a physical point of payment, and so doesn’t improve much upon the status quo. As PayPal President David Marcus points out: “It's not a question of whether people at a payment terminal would prefer to tap or swipe, but a reality that people don't want to go to a payment terminal at all”7

Overall NFC adoption has been slow, further supporting our prediction.8

Thus we believe that the mobile payments market will be dominated by one major player, with 1-2 much smaller players as alternatives. Factors for the dominant design

Next we consider what factors would determine the design that wins in the industry shakeout. We need to consider two different user groups and what drives value to each.

Key value drivers

Merchants

7 news..com, “PayPal president David Marcus: Bitcoin is good, NFC is bad” Accessed December 12, 2013 8 news.cnet.com, “NFC mobile payments disappoint while money transfers boom” Accessed December 12, 2013 Target merchants for mobile payment solutions comprise of both mCommerce merchants (shopping sites like iDeely, services like Uber/Grubhub with remote payments etc.) and point-of- sale merchants like retail stores, taxicabs, municipal transportation etc. The main key value drivers for both classes are

1. Margin: First and foremost merchants are concerned with the margin that the payments solution takes, since this is a direct cost to the merchant. 2. User adoption: Merchants want to offer payments solutions that are already popular with a large number of users. 3. Cost to implement: Any kind of upfront cost to implement the payment solution is typically a deterrent

Users

1. Security: The number one concern users have with mobile payments is security (Figure 5) 2. Privacy: Security is closely followed by privacy concerns. 3. Convenience: A lot of consumers find existing payment methods convenient enough. 4. Rewards and value-added services: Additional services like receipt tracking and financial management tools, which card/cash solutions cannot offer, can help get users to adopt mobile payments9. Another way to draw customers is to offer reward schemes like discounts or instant coupons.

Figure 5 Reasons why respondents don't use mobile payments. Source: Accenture Report: Consumer Mobile Payment Survey

9 Accenture Report: Consumer Mobile Payment Survey The dominant design must therefore be cheap, easy to install and have a large adoption by both users and merchants. It should also be secure, respect privacy and offer additional value-added services or rewards.

Complementary assets

Aside from the above, a few complementary assets are key in the mobile payments space.

 Bank Relationships: Banks are key collaborators in this space since ultimately both customers and merchants hold their money in bank accounts.  Technical expertise: Given the sensitivity of the area, the winner needs strong technical expertise in the fields of payments, mobile, security etc.  International presence: Given that a large number of mobile remittances are cross border, an international presence is a good complementary asset to have. Current players The most significant players in the mobile payments market today are Paypal/Venmo, Google Wallet, and Square Cash. Other players include the much hyped Clinkle, Bitcoin wallets, mobile wallets associated with financial companies such as Visa, Mastercard, and Chase and branded wallets such as Starbucks. PayPal/Venmo10 PayPal launched its first mobile app in 2008. However, its interface was clunky, and PayPal mainly focused on online payments between consumers and merchants. When Venmo launched in 2009, it offered free P2P payments and was likely perceived by incumbents like PayPal as “not good enough”. Over the years, Venmo became better, cultivating a strong base of users and witnessing higher retention than PayPal. Venmo also attracted a new set of users (college students and young adults) while PayPal’s user base was aging and whose lifetime value was not as high. This was a significant reason for eBay’s acquisition of /Venmo in 2013 for $800 million. Google Wallet Google launched Google Wallet in 2011. Unlike PayPal/Venmo, Google Wallet is an NFC-based system that lets users store debit/credit cards, loyalty cards etc. on their mobile phone, and make payments by tapping the phone at any Pay-Pass enabled terminal. Users can also make payments on mobile sites and apps that support Wallet through a ‘Buy with Google’ button. Google has recently entered the P2P market by integrating Google Wallet into Gmail11. Square Square was launched in 2010 with Square Register, which lets merchants accept credit and debit cards on their phone through a small plastic device (Square Reader) that plugs into their smartphone. In October 2013, Square launched Square cash for mobile P2P remittances.

10 Interview with a Venmo employee who chose to remain anonymous 11 www.executiveboard.com, “Google and Square Enter the P2P Market” December 12, 2013 The incumbent in mobile payment space are primarily the credit/debit card companies, as they are the dominant design today. PayPal/Venmo vs. Square vs. Google PayPal is currently leading the mobile space. As of 2012, PayPal mobile had 17 million active users12. PayPal also has the highest brand recognition at 72% vs. the next closest competitor, Google Wallet, which had a brand recognition of 41% (Figure 6).

Figure 6 Brand awareness and usage of digital payment systems. Source: www.comscore.com “Digital Wallet Market Potential, Accessed December 12, 2013

All three players now have presence in the three market segments: P2P, mCommerce and mobile proximity payments. Figure 7 compares the three along the previously discussed key value drivers.

12 www.paypal-media.com "PayPal Mobile Fast Facts" Accessed December 10, 2013

Figure 7 Evaluation of major players across key value drivers (1=weakest, 3=strongest) wallet13targeting14. card15. apps16.2.93%17.

Next we consider how strong the players are in each of the three previously discussed market segments.

13 www.forrester.com “PayPal, Amazon Top Consumers' List For Trusted Digital Wallet” Accessed December 12, 2013 14 news.cnet.com “Google Wallet update upsets privacy advocate” Accessed December 12, 2013 15 thepaypers.com “Google Wallet launches prepaid debit card” Accessed December 12, 2013 16 .com “Google Wallet Launches Promotion With Popular Android Apps In A Bid To Increase Its Brand Recognition” Accessed December 12, 2013 17 news.yahoo.com “What's the best way to send money online?” Accessed December 12, 2013 PayPal/Venmo Square/Square Cash Google Wallet mCommerce Score 3 1 2

eBay mobile commerce gives PayPal/Venmo an edge here. Further, Venmo acquisition brought in a slew of mCommerce merchants through Venmo Touch – a single-tap purchase solution for mobile apps

Mobile P2P Score 3 2 1

PayPal/Venmo is the clear leader here. Square is following closely with Square Cash – an innovative P2P transfer solution that is not account-based

Mobile Proximity Score 1 3 1 Payments Square has captured a lot of small merchants who traditionally would only accept cash by removing extra fees and complications associated with credit card payments. Both PayPal/Venmo and Google Wallet are fighting hard to gain traction in this segment

Total Score 7 6 4

Figure 8 Evaluation of major players across market segments (1=weakest, 3=strongest)

We see that PayPal/Venmo has the strongest positioning overall, with a strong presence in mobile P2P and mCommerce segments. Given the expected growth rate of the proximity segment, it is essential for PayPal/Venmo to establish a strong presence there as well. The Venmo acquisition has been a strong move in this direction. PayPal has also launched a point-of-Sale (POS) payment solution with PayPal Here, similar to Square, and is also partnering with a number of POS hardware makers such as NCR, Gilbarco (gas station POS) etc18. While Square has great brand recognition and an extensive network of merchants, its merchants are mainly offline, based in the US, and view Square as a POS system rather than a mobile payments processor. Without a network of mobile apps, Square is not able to offer the seamless mCommerce payment experience offered by Venmo Touch. Nor is Square able to offer international P2P mobile transactions. As a neutral, third party player, Google could have established itself as a connector among all payments solutions. If Google had focused on the backend of standardization and tokenization, and positioned itself as the player of interoperability, the entire pie would likely be larger. Google focused on the short-term instead and launched its own mobile payments solution. Google lacks PayPal/Venmo or Square’s merchant networks, reputation for customer service, and expertise in the payments space. It also opted to develop an NFC payment solution for mobile proximity payments, which has failed to gain much traction.

18 techcrunch.com “PayPal Expands “Real World” Presence” Accessed December 12, 2013 Conclusion We believe that PayPal/Venmo is indeed best positioned to capture the entire mobile payments market. With the Venmo acquisition, it now has a strong position in both P2P and mCommerce payment, and has started gaining a strong foothold in proximity payments. However, there are a few threats to its position.  Square Cash, the P2P payments app launched by Square, has lowered the barrier for user signup by moving away from an account-based system. This strategic move could be detrimental to PayPal/Venmo. Square Cash has also leveraged its relationship with Chase bank to allow for cashing out of Square Cash funds directly into the user’s debit card.  There is a threat from new technologies like Bitcoin - an open-source digital currency, which promises better security, as well as anonymity since it is not account-based.  Players like Amazon and Facebook could pose serious threats, given their strong networks and brand perception amongst both users and merchants. PayPal/Venmo must not fall into the same lethargic state that PayPal found itself in prior to Venmo’s entry into the market. It should continue its push in the proximity payments space by offering more value-added services and rewards, and continuing to partner with POS hardware makers. It should also aim to strengthen its merchant relationships by considering lower fees/loyalty discounts. Finally, it should leverage Venmo’s merchant and customer relationships to strengthen its networks and lock users in as much as possible.