Given the still rosy and uncritical esteem in which many tech companies such as PayPal are held, you’d be forgiven for thinking that, compared with the dotcom bust of the early 2000’s, This Time Really is Different.
But if you look closely enough, there are some serious reasons to believe that the free pass given to anything emanating from Silicon Valley or similar, on the basis that it is automatically immune from the principles of supply and demand, is misplaced.
PayPal may be a canary in the coal mine. Bloomberg reported it has recently found itself ditched, ostensibly due to PayPal’s fee increases by long-term partner eBay – a decision which is heavy on the irony because PayPal divested eBay, presumably as a stock valuation play and they speculated that eBay was going to drag down PayPal. But they forgot the importance of eBay as a captive customer and brand-builder. That was a decision which is coming back to haunt them now that eBay has figured out that PayPal is not indispensable.
Increasing user fees is most certainly an issue. But it’s a little more complicated than that.
What the Bloomberg coverage missed – which we’ll fill in here – are the reasons why new so-called disruptive entrants to established markets like PayPal are having to risk alienating their customer base by increasing their charges in the first place.
A great many Internet 2.0 companies and almost all so-called disruptive Fintech have a business model which depends pretty much entirely on regulatory arbitrage or outright evasion. Plus screwing over your customers through poor service.
Taking each of these in turn, staying one step ahead of the law only works for so long. Eventually, even the slowest of regulatory enforcement catches up with you and then you don’t have a business, or at least not one which could get away with acting in quite such a cavalier fashion. When PayPal started out it got a hefty dose of largesse, but now it needs to comply with Know Your Customer/ wire transfer fraud (US) and Payment Services Directive (EU) regulation, it no longer wants many of its customers — or its customers won’t or can’t use it because it no longer offers a method of evading the kind of scrutiny on payments which traditional operators in the card merchant services providers’ market must adhere to.
And after a while either your customer base grows weary of cutting you some slack in terms of how poorly you serve your customers just because you’re new, novel or offer some minor incremental convenience or, when complaints reach a critical mass, regulators respond more formally and insist you shape up in terms of how you handle customer needs.
It is unlikely to be coincidental that PayPal is forcing through fee increases shortly after CFPB enforcement action in the US and Financial Ombudsman investigations in Australia. While – as Yves noted earlier this week in respect of serial customer and regulatory violator Wells Fargo – fines and customer redress for misconduct are pitifully small, where a perpetrator has to improve their business processes and allocate resources to improve customer service, these inevitably increase the cost base for PayPal.
What is easily overlooked when considering PayPal’s operating model is that payments is a commodity business. It’s not like they have discovered some magical elixir of cost avoidance.
PayPal has the same cost drivers as any payment and merchant services provider. The main variable cost when you act as a retail payment processor is handing the unavoidable customer queries and resolving disputes. These are often complex and not amenable to light touch resolution. Disputed transactions, payment routing errors, fraud, theft, counterfeiting and misrepresentation of goods or a myriad of similar reasons can generate long-running, documentation-heavy cases which must be resolved because they a mean that either the sender or recipient of a payment is out of pocket for the transaction amount. A payment processor cannot simply fob off the sender or the recipient to an FAQs page or a chatbot.
Once PayPal started having to pay the real costs of properly serving its user base, enforced by regulators who’d got wise to its previous backsliding, that eroded margins. As it couldn’t get something (skilled, experienced customer service staff who know how to investigate and resolve complex disputes) for nothing, PayPal had no choice but to increase its fees. But then users of its services will start to look around for either traditional payment processors who have enough maturity to have figured out – or been forced through previous regulatory action to charge – what they really need to charge to provide the services they are offering. Or they can turn to a new crop of Fintech start-ups ready to play a fresh game of regulatory catch-me-if-you-can.
And if only it was just your customers making demands to not be treated shabbily or regulators rousing themselves from their slumber. It is the card issuers and card schemes, such as Mastercard and Visa, that PayPal really needs to be worried about.
Within the industry, which outsiders probably won’t be aware of, attempts by the likes of PayPal to see-saw the cost base back to other participants in the payments system haven’t gone unnoticed and are now facing serious and concerted pushback. The Visa card scheme is in the vanguard of this initiative, which it refers to as Visa Claims Resolution (VCR). Originally slated for introduction in October 2017 but due to what Visa politely terms “response to client feedback, and to help ensure the readiness of stakeholders around the world” (translation: an almighty bun fight as industry players engage in a Godzilla-vs.-Mothra battle) it has now been postponed. But only until April this year – Visa are not going to back down on this one and other card schemes such as Mastercard are likely to follow suit.
Without getting overly technical, prior to VCR, a payment processor like PayPal could, in the event of a disputed transaction try, usually successfully, to portray itself as some sort of innocent bystander unconnected with either the cardholder or the merchant. In effect, it could say that while it processed the payment from the buyer of goods or services to the seller and used the buyer’s card to take the payment, the transaction was a matter purely between the buyer and the seller – and was nothing to do with PayPal. That gave PayPal the ability to take a transaction fee for doing very little in return – the Holy Grail of Fintech everywhere.
This convenient evasion was especially useful when processing payments for eBay where some sellers and not a few buyers are, how shall we say, not exactly always paragons of virtue.
Initiatives like Visa Claims Resolution call time on that. As Forbes describes it:
… disputes that pass through the [Visa Claims Resolution] allocation workflow’s automated checks without incident are considered to be the merchant’s liability. Merchants and acquirers may only respond under certain conditions, including instances where compelling evidence is present, data was invalid or a credit has been issued.
It is important to note that in a PayPal transaction, PayPal becomes the merchant. This means that it is PayPal which is on the hook for any chargebacks. PayPal can try to get itself reimbursed from the eBay merchant but this is a risk as there’s no guarantee at all you can get blood out of those particular turnips. And as we’ve noted earlier, there is a cost in investigating and managing the claims process for PayPal even if it can rebuff the dispute. Of course, it can only resist the dispute if the eBay merchant provides it with the “compelling evidence” demanded by Visa.
No wonder PayPal wants higher fees.
The only mystery remaining at this point is why Adyen is willing to jump into bed with eBay after it gave PayPal the cold shoulder. Perhaps they think they can replicate PayPal’s leverage of a large user base obtained by an association with eBay and are worrying about the profitability later. Perhaps they are smart enough to tempt eBay in with an initial low fee structure then try to boil the frog once they are more firmly embedded. Another possibility is that they will be far more choosy about who they give merchant accounts on the eBay seller side to and are quicker to revoke payment facilities on the buyer side once they get the first whiff of trouble from either of these parties. That would be the sensible thing to do but would hardly please eBay who just cares about sales going through its platform and wouldn’t welcome buyers or sellers – or both – being excluded by Adyen.
As Lambert would say if he were here, pass the popcorn.