The Justice Department is investigating the proposed acquisition of PayPal by eBay for antitrust concerns. The idea that eBay, the biggest online auction site (which is rapidly expanding into fixed-price sales and sales of new goods), might own PayPal, the most widely-used payment service on the Internet, is of concern to many consumers and businesses. According to rules set out by the Hart Scott Rodino Act, the Justice Department has 30 days to evaluate acquisitions of this nature and decide whether it will investigate further. Many expect that today, the Justice Department will issue a request for more information to expand its antitrust investigations.
The government wants to know if consumers would be hurt by eBay's acquisition of PayPal. Government regulators use various methods to make a determination, including what is called the 5% test. Government investigators will try to guess what would happen if PayPal raised its prices by 5%. Would customers shift to a different payment service? If so, then there is competition in the marketplace.
The Network Effect (Metcalfe's Law)
One reason contributing to the reluctance of sellers to switch payment services has to do with the network effect. Adam Cohen refers to Metcalfe's Law with regard to eBay's success in his book, "The Perfect Store: Inside eBay." Named for Bob Metcalfe, the founder of 3Com, Metcalfe's Law holds that the utility of a network equals the number of users squared. "A network that has twice the number of users as another network is actually four times as valuable."
Cohen says the success of eBay and the inability of competitors to catch up is due to Metcalfe's Law in action. The same argument can be made for PayPal and its success. PayPal has over 17 million registered users. Over 66% of eBay listings accept PayPal. PayPal has built a network of users that can easily exchange funds amongst themselves.
A corollary to Metcalfe's Law might be the Inertia Theorem: online consumers will not go to the trouble of registering for a second service when the first service provides the desired result. Or, "Why should I sign up for Billpoint when I already have a PayPal account and so does everybody else?" Adding another service provider to the host of vendors a seller must already deal with takes time and adds a level of complexity through additional invoices and statements and password maintenance.
The Strength of Brand
Cohen also quotes eBay CEO Meg Whitman as saying, "Brands are quick-drying cement." PayPal had first-mover advantage. It launched in October 1999; eBay's acquired its own payment service, Billpoint, in May 1999, but did not fully launch it until April 2000. The PayPal brand is stamped like cement into eBay users' minds.
Limitations of Auction Management Solutions
Another important factor in choosing which payment services to accept has to do with the integration of payment services into third-party auction management services like Andale and ChannelAdvisor. These firms provide tools to automate the online-auction selling process. Most volume sellers use auction-management tools to help them with inventory management, listing and end-of-transaction management. If an auction management firm does not support a particular payment service, then a seller is unlikely to accept that payment service.
Auction Management Solutions: A Guide to Tools for Managing Online Auctions reported that all of the seven auction management solutions for enterprises included in the report supported PayPal except for one, and four of them supported eBay's Billpoint service. But none of them supported Achex, PayingFast or c2it. Only one supported Amazon Payments, and another supported Yahoo! Pay Direct and BidPay in addition to PayPal and Billpoint. (This report was published in March 2002 by Steiner Associates, publisher of AuctionBytes.)
Volume sellers who wish to use a third-party auction management services are limited in the payment services they can accept. All but one of the auction management services in the report are eBay Preferred Partners and pay for the use of eBay's API. It is uncertain whether eBay pressures its partners into supporting its Billpoint payment service.
Customer Preferences
Online sellers are very aware of and responsive to buyers' preferences. Buyers pay for shipping in online auction transactions, and do not welcome additional fees. Sellers recognize this and are willing to pay a small fee for being able to accept online payments. Buyers also want their items quickly once a transaction has ended. A money order or personal check will take time to arrive in the hands of sellers and clear their banks.
This time/cost tradeoff is an enormous factor in choosing which payment services to accept. Sending a check or money order can add an additional 2 weeks to the time buyers must wait for their goods. A service like BidPay, in which a buyer purchases a money order online, speeds up the process, but buyers incur a $2.95 minimum fee.
Apples and Oranges
Proponents of the acquisition say there is plenty of competition, but they are mostly apples to PayPal's orange. One of the closest competitive offerings is CitiGroup's c2it. But there are significant differences between c2it and PayPal:
c2it is not widely used by auction buyers and sellers.
Users often complain about the registration process of signing up for c2it.
c2it significantly limits transaction amounts ($500/day sending cash and $1,000/day in getting cash).
Risky Business
One reason for PayPal's success is its daring and willingness to accept extremely high risk (read its pre-IPO prospectus). Some believe that if PayPal fees increase enough, users will shift into other services. While the barrier of entry into online payment services may or may not be low, depending on the type of service, gaining traction is difficult. The smaller services that might be willing to take on more risk have difficulty gaining traction. Larger services already in the financial industry that might have a chance of succeeding would have a difficult time accepting the levels of risk involved in a service like PayPal. It's possible that financial firms like CitiGroup and Visa and Mastercard are too staid to tackle the risks associated with creating a service comparable to PayPal.
Finally, one has to ask whether eBay's inability to make a success of Billpoint is not the ultimate proof that competitors have a tough time competing with PayPal. With its marketing savvy and influence on its own members, it could not catch up to PayPal. If eBay can't do it, who can?
