Touted as electronic stand-ins for credit and debit cards on the Internet, alternative payment products are falling short of expectations. What will it take for e-cash to succeed as an online payment mechanism?
Ever since electronic commerce began to pick up steam in the late 1990s, consumers and e-merchants have been looking for a safe, secure, and inexpensive means of online payment. Credit and debit cards, while relatively safe, are considered by many merchants as too expensive to accept. And not all consumers have credit or debit cards.
The answer, some thought, was to develop new payment mechanisms—alternative currencies or electronic cash. Launched with much hope amidst great fanfare, e-currencies set their sights on capturing online market share from credit and debit cards.
But over the past year, high-profile e-currencies such as Flooz, Beenz, and CyberCash, have gone out of business. By some industry estimates, only about 10 e-cash systems remain, down from between 20 and 30 companies in the market only a year ago. That’s left many wondering if e-currencies can survive.
That’s not to say that all e-cash programs are in trouble. Person-to-person payments systems such as PayPal Inc. and Billpoint Inc., whose online payment method is now known as EBay Payments, appear to be thriving even as others falter. Indeed, PayPal in late September filed for an initial public offering with the Securities and Exchange Commission.
The magnitude of the e-currency market can be seen in PayPal’s prospectus, in which PayPal reports that in the three months ending June 30, it processed an average of 165,000 payments per day totaling $8.2 million. The average payment equaled about $50. PayPal’s target payments range from $10 to $1,000.
PayPal executives were unavailable for comment because they are in the quiet period before an IPO.
But though PayPal is making progress, industry observers warn that most e-currencies have a tough road ahead. “It’s a very young market and there’s a lot of risk,” says Elizabeth Robertson, senior analyst of e-banking at Needham, Mass.-based TowerGroup.
Person-to-person transactions, which account for the vast majority of e-cash transactions, are expected to grow to 100 million this year, and more than 4 billion payments by 2005, according to TowerGroup. That compares with 42 million transactions in 2000.
But while P2P currently dominates e-cash transactions, other types of consumer-initiated Internet payments are showing great potential. By 2005, consumer-to-business payments over the Internet are expected to increase to 31 billion, nearly eight times the anticipated P2P volume for that year, TowerGroup says.
However, at least one analyst believes business use of e-cash, in particular P2P payments, already is on the rise. “What’s grown tremendously in recent years is small businesses accepting P2P payments,” says Brendan Ford, financial services analyst for New York-based Datamonitor. He estimates that four-fifths of P2P payments are going to business.
Accepting online card payments through a P2P service can save merchants more than 100 basis points off the average discount rate charged by merchant acquirers. Banks typically charge online merchants 30 cents per transaction plus 3.2% of the transaction amount, Ford says. “That 1.3% can make a big difference to retailers, especially online, where consumers are price-sensitive, competition is high, and profit margins are low,” he says.
The Chicken or the Egg?
So why then did Flooz, Beenz, and other e-cash alternatives fail? “Part of the issue with Flooz and Beenz was that they were too specific,” says Jeanne Capachin, senior analyst at Newton, Mass.-based Meridien Research. “They weren’t able to get the mass they needed the way that PayPal did.”
PayPal, which had ten million registered users as of Sept. 1, built up its user base by offering its services at no cost to merchants and consumers. Most other P2P providers charge consumers fees to use their services. PayPal also paid consumers $10 to sign up and a $10 bonus for referring new customers. PayPal has since started charging merchants and has cut the referral fee to $5 from $10.
“They were actually paying people to use their service,” says Robertson. “Of course, that encouraged people to start using it, or at least try it out.”
During the three-month period ending June 30, PayPal’s account base grew by an average of 18,000 per day, according to PayPal’s SEC filing.
E-currency programs are facing “the chicken or the egg problem,” says Naftali Bennett, chief executive of New York-based payment security company Cyota. Merchants didn’t want to sign on because there was no customer base, and consumers didn’t want to sign on because there was no merchant network, he says.
“What Beenz and Flooz tried to do was suddenly create a whole new currency...by (spending) a hundred million dollars on SuperBowl ads and things like that to get it up and running within less than a year,” Bennett says. “Cash as it is today took thousands of years to be incorporated and they hoped to do it within a few months.”
The key to attracting users to an e-currency product is to make it as close as possible to the process consumers are most familiar with—online credit card payments, says Ann Ruckstuhl, Billpoint’s director of marketing. When customers use EBay Payments to pay for an item, a screen pops up on which they enter their cardholder information. They don’t have to deposit money into an account, which then is translated into the e-currency. “It feels really comfortable for the consumers because it’s exactly how it works on CDNow” and other sites, she says.
Another problem that hurt many of the e-cash companies that failed was that they weren’t well-positioned in the auction market, where more than 95% of P2P transactions now occur, Robertson says.
In addition, some e-currencies, such as Flooz and Beenz, had no affiliation with a financial institution that might have given them an air of legitimacy. “People don’t trust Internet entities, they trust their own financial institutions, and obviously Beenz, Flooz, and others tried to bypass that trust,” Bennett says.
In contrast, PayPal is affiliated with Providian Financial Corp., and Billpoint partnered with Wells Fargo & Co. EBay owns 65% of Billpoint and Wells Fargo owns 35%.
Being affiliated with a financial institution can help e-cash services cut fraud losses since the institution’s customers already were screened when they applied for a checking account, debit card, or credit card, Robertson says. “It’s not just any consumer coming in cold that nobody knows all of his credit history,” she says.
Many e-cash programs have been hard hit by credit card fraud, including Flooz, which inadvertently sold $300,000 of its flooz currency to fraudsters in Russia and the Philippines.
And in its prospectus, PayPal discusses a “significant fraud episode” between July and October 2000 that left the company with $5.7 million in unauthorized chargebacks. PayPal’s fraud losses dropped after it began using a new risk-management system.
Expertise
Indeed, one reason EBay partnered with Wells Fargo on Billpoint was to gain access to Well’s expertise in risk management, Ruckstuhl says. “That’s one thing that literally drove the partnership with Wells Fargo,” she says.
EBay Payments’ fraud rate is below the industry average for online cards, she says, without giving specifics.
While some e-cash providers are making headway, they’re still a long way from capturing market share from credit and debit cards. Meridien’s Capachin notes that credit cards often are used to fund the accounts.
In fact, Visa U.S.A. sees e-cash as a means of gaining access to markets where cards typically are not accepted. “It’s extending electronic payment alternatives, including credit cards and debit cards, to merchant segments that really weren’t served before,” says Stacey Pinkerd, senior vice president of E-Visa. “This is incremental volume from a processing standpoint—it extends our acceptance.”
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