Risk to Avoid: Mobile Wallets
While the mobile wallets and Near Field Communication (NFC) businesses are currently the primary growth drivers of the $90 billion mobile payments industry, it is best that PayPal let Google, Apple, Amazon, and roughly 170 other smaller companies battle it out in an overly competitive space where margin compression will eventually overwhelm any profit potential. PayPal and Google have already tried to make inroads in this space, and have been unsuccessful. Jordan Bettman, principal at Bain Capital Ventures points out that right now less than 10% of merchants have NFC terminals (Bettman, 2014). There is simply no guarantee that consumers will shift paying behavior away from cash and credit cards to mobile wallet applications (Isaac, 2014). It is more likely that any significant IT investment in this area will drag PayPal down a path where its competitors will eventually realize that the “benefits were never there” and/or the “benefits were overstated” (Sambamurthy & Zmud, 2014).
In agreement, some analysts are not optimistic this market, now being led by ApplePay, will be as successful as many believe. Karl Denninger with MarketTicker.org notes that ApplePay and other “alternatives” are not an “escape from the fee structure of the interbank system that currently is used by various credit and debit vendors — typically 2-3% of the ticket size” (Denninger, 2014). Even with the removal of the discount rate cost of 2-3% typically charged to merchants by credit and debit card companies, merchants moving towards mobile wallet and NFC integration have to account for other hard costs such as terminal and software integration expenses, and unknown fraud/chargeback expenses. Interestingly, as it stands right now, “PayPal’s system is actually cheaper for merchants than ApplePay—since PayPal’s funding is attached to consumer bank accounts which incur lower fees as opposed to Apple Pay’s credit card based system that has swipe and merchant account fees” (Spooner, 2014).
Another major potential vulnerability includes the unknown and incomplete personal customer data that is being exposed to the merchant, as well as the unforeseen risks and liabilities that are passed on with each transaction (Denninger, 2014). Denninger suspects that a huge reason CVS and Rite-Aid parted with ApplePay after only one week is rooted in the fact that from the retailer’s point of view, Apple may be shifting critical consumer data away from the retailer back to Apple (Denninger, 2014). While Denninger is only suspicious and Apple has been very clear it is not “in the business of collecting your data,” other retailers are banding together to reject ApplePay (Boden, 2014). Walmart and Best Buy are amongst 50+ companies making up the so-called “Merchant Customer Exchange” or MCX, which is building its own mobile wallet platform, CurrentC. The objective is to not only avoid “the high fees they pay when processing credit card transactions,” but more importantly, “help retailers understand more about their customers’ shopping habits” (Isaac, 2014). As Mike Isaac with the NY Times notes, “CurrentC would also give retailers the ability to track shopping habits across the dozens of stores that belong to MCX, a data set that has traditionally been held by credit card companies, not merchants” (Isaac, 2014).
If PayPal wants to remain visible and relevant in the mobile wallet market, it should continue to partner with the Android space (but will have to repair its relationship with Google after publically rejecting Google Wallet in 2012), which represents ⅔ of the mobile industry worldwide, and let Apple do the legwork of converting the behavior of consumers to mobile wallets (Oglesby, 2012). If Apple succeeds with behavior transformation, PayPal can simply offer its own version of mobile wallet technology for close to free, and slice ApplePay margins down to zero.
Daniela Mielke, a former vice president for global strategy at PayPal noted, “The company apparently lost its chance to become part of ApplePay when it cozied up to Samsung Electronics“(Kar, 2014). Thus, it is likely most advantageous for PayPal to continue with this route as there will clearly be a demand for an Android alternative to Apple’s mobile wallet. Building such a thing is best done by a company that controls the hardware, says Mielke, because the security measures need the device and the software to work together. Further, “PayPal could bring its 150 million customer relationships to Samsung and have a pretty good start” (Brustein, 2014).
PayPal’s Braintree Unit
Bluntly stating what many within the tech community have come to believe, Tone Vays at CoinTelegraph noted, “In the case of PayPal the answers are simple, they are a dinosaur in the payments space and have lost touch with what consumers need. They can’t even have a user-friendly interface and are hence relying on a subsidiary like Braintree to make that happen” (DeMartino, 2014). Currently run by CEO Bill Ready, PayPal’s Braintree subsidiary unit may actually be PayPal’s only hope to remain relevant and dynamic in the lightning fast payments industry.
Purchased in September 2013 for $800 million, PayPal’s initial courtship with Braintree was a bet largely on mobile payment systems (BBC, 2014). Ready has been primarily tasked with integrating Braintree’s in-app payment platform into PayPal’s systems infrastructure so consumers will never have to leave an app or their mobile environment to make a payment (DeMartino, 2014). Braintree offers PayPal significant areas for innovation within the in-app and gaming market, Bitcon/blockchain protocol, remittance market, and payment security market, as is detailed in the following sections.
In-app and Gaming Market
Thus far, Braintree has had some success with its in-app payment technology servicing customers of hot tech startups like Uber, AirBnB, Dropbox, OpenTable, and others (Shandrow, 2014). With in-app purchases likely to play an ever-increasing role in digital commerce, Braintree is well-positioned both technologically and financially to be a leader in the in-app payments market, but must be ready to pounce on certain areas of the market where in-app payment demand is growing. One major market area for Braintree to immediately focus on is the $48.8 billion gaming market. PayPal already has great market share and adoption within the gaming industry due to platform partnerships with Xbox (Microsoft) and PlayStation (Sony), but should leverage its global brand with Braintree’s in-app payment technology as new consumer-rich digital gaming markets open up in places like China and Russia (Grubb, 2014).
While a nearly $50 billion gaming market is luring, Gil Luria at Wedbush Securities points out that global payment related revenues and U.S. bank fees generate approximately $300 billion and $250 billion per year, respectively. Luria estimates that these types of third party verification (TPV) markets make up roughly 20% of GDP revenues in the U.S (Luria, 2014). Expanding more broadly, RRE Ventures’ James Robinson notes that we live in a “fraud aversion society” that is “trust based,” and have had to build global industries around “accounting, vetting, [and] disseminating information around people” (Robinson, 2014). Giving an example, Robinson continues, “If you do a transaction today, it’s got to hit a database that says you are [you], it’s got to hit another one that says yes, [you] have the money covered, and then it’s got to actually transact” (Robinson, 2014).
With 20% of GDP revenues being generated by this archaic, trust-based, third-party system, it is no wonder there is both excitement and anxiety within the industry about Bitcoin. Since its inception in 2008, most people have wildly misunderstood Bitcoin for bitcoin. Smaller-case “b” bitcoin is, of course, the alternative digital/cryptographic currency that everyone thinks of due to incredible speculation and wild price volatility over the last couple of years. Larger-case “B” Bitcoin, however, is the “blockchain,” or protocol layer which is the vetting cryptographic technology that is poised to completely disrupt and eventually capture the low-hanging 20% GDP revenue fruit hanging from the vine (Robinson, 2014). For the first time ever, the computerized double-spending paradox is no longer a problem and anything digital (i.e. currency, title, contract, etc.) can be sent peer-to-peer (P2P) without the need for a trusted third party via this decentralized public ledger known as the blockchain (Wile, 2014).
While in-app payment technology integration was the initial goal of PayPal’s acquisition of Braintree, the recent announced separation from eBay may have just put PayPal/Braintree in an incredibly strong position both financially and logistically to be a trailblazer in the decentralized/cryptographic technology (blockchain) space, and forever disintermediate the legacy third party verification industry. Interestingly, Braintree CEO Bill Ready appears to grasp the blockchain’s full potential. While Braintree has only just dipped its toe into the small-“b” bitcoin space in a September 2014 partnership with San-Francisco-based Coinbase, Ready recently noted, “Bitcoin as a protocol, where there’s an alternate way to move money separate from the legacy payments infrastructure that’s built up over decades – that I think is more interesting even than bitcoin as a currency” (Wohlsen, 2014).
Commenting on this “legacy payments infrastructure,” tech analyst Reggie Middleton recently noted, “There is one thing that’s a guarantee – your margins will be cut. The only variable is who cuts them” (Middleton, 2014). Other major players in the space (Amex, Visa, MasterCard) are too big and bulky to move as quickly as necessary to adopt new disruptive technologies. As Middleton explains, companies that make a lot of money with legacy systems typically share a corporate mentality resistant to change. However, when change inevitably comes through technology advancement and margins are compressed, the best (or perhaps only) way to stay relevant and in business is to cannibalize your own margins with the respective disintermediary technology before someone else does it for you (Middleton, 2014). When it comes to Bitcoin, many in the tech community believe the blockchain protocol can be as powerful as the advent of the internet, or will at the very least, “do to banking what the cell phone did to telecom” (Frisby, 2014). While blockchain technology is in its infancy, an independent PayPal/Braintree is the clearest and most obvious player in the payments space to bring Bitcoin to the masses and immediately impact two key markets: remittance and security. Much like Apple will try to do with its ApplePay platform, Braintree should leverage blockchain technology and its first mover status to attract more customers, and spur demand for PayPal’s full suite of products and services.
Jordan Bettman, principal at Bain Capital Ventures, notes that roughly $650 billion in cross-border remittances get processed each year, and fees associated with these P2P transfers generally range anywhere from 9-11% (Bettman, 2014). Collecting these outrageous fees for decades now are intermediary behemoths like Western Union and Moneygram (Bettman, 2014). Leveraging the global prowess of PayPal and its systems flexibility at the subsidiary level, Braintree can both easily and effectively adopt blockchain technology for domestic/international P2P money transfers, and disintermediate the remittance industry systemically stuck with “hub-and-spoke” platform technology (Wile, 2014). While Braintree just announced its “first foray into bitcoin,” the currency, Ready must quickly move strategy towards Bitcoin, the protocol, and remain currency agnostic (RT, 2014). Focusing solely on bitcoin, the currency, will be ill-advised given all of the uncertainty and regulatory overhangs a new global digital currency will face. Lesser known systems (i.e. Ripple) are currently being built with a currency agnostic framework off of the open-sourced Bitcoin protocol, however, none will be as powerful or influential in the space than what PayPal/Braintree can potentially build out. As Ian DeMartino from CoinTelegraph acknowledges, “PayPal may not implement Bitcoin perfectly when they first get into it, but you can bet that they will do a better job than MasterCard, Visa, Bank of America or anyone else from the traditional financial system” (DeMartino, 2014).
As long as Braintree invests appropriate capital towards building blockchain technology infrastructure, “payment processors like Western Union probably have the most to fear” (Wile, 2014). Because decentralizing blockchain technology eliminates the fee structure around crossing jurisdictions and smaller transaction amounts, Gil Luria at Wedbush notes that “instead of paying 5% to 10% in fees to Western Union, you’re going to be 2% to 3%” (Wile, 2014). Jordan Bettman adds, however, “While Western Union and Money Gram could be at risk, they could also figure out how to be smarter, how to adopt Bitcoin earlier (Bettman, 2014). Because Western Union/Moneygram haven’t cannibalized their own business models yet, it is PayPal/Braintree’s duty to immediately do it for them. There is clearly a huge customer value proposition waiting to be leveraged, and an opportunity where unparalleled customer service around this new technology can secure 2-3% premiums for PayPal/Braintree in the marketplace as competitors eventually try to follow suit. In other words, while blockchain is open-sourced technology, PayPal/Braintree can represent the “Google” of this new payments paradigm if it moves fast and smart.
Payment Security Market
As detailed in Phases I and II, security concerns around payments are only growing and becoming more frequent. Regulatory changes like 2015’s Europay, Matercard, & Visa (EMV) integration with circuit chip and pin technology are beginning to force the hand of many within the payments industry. Enhanced security measures such as fingerprint technology with ApplePay and even “electrocardiogram” or heartbeat identification payments with MasterCard are clearly trying to address security concerns, but can be seen more as a novelty/consumer-centric approach to the changing security landscape (Rocha, 2014). While some of these personal identification metrics (i.e. fingerprints, eye biometrics, heartbeat, etc.) will be marketed as sleek and sexy, the industry must be ready for a sudden shift in consumer sentiment, and perhaps even backlash as many may view such verification methods as privacy and identity infringements. On the heels of a October 2014 Circuit Court ruling that fingerprints are not protected by the Fifth Amendment, many in the tech community are already seeing major implications for fingerprint-technology on devices like the new Apple iPhone (Clover, 2014).
Much like its opportunity with the remittance industry, PayPal/Braintree again has a clear way to differentiate itself within the payments security paradigm. Apple and others in the space have clearly rejected blockchain cryptography for its own authentication, verification, and security measures, deciding to fully employ the personal identification route (Matonis, 2012). With Braintree already showing its willingness to explore bitcoin, a move to adopt Bitcoin/blockchain technology into its infrastructure could prove to be a game-changer in the space as security continues to become more challenging and complex. Blockchain technology uses cryptography to create a globally distributed and decentralized public ledger, meaning all transactions will be forever recorded and visible, and any pinpointed attacks by hackers will become increasingly more difficult as servers decentralize (Robinson, 2014). Once transactions or “blocks” have been written into the blockchain, they can’t be unwritten, and can’t be hacked into because of these cryptographic codes. Even if a blockchain was hacked into, it would only be seen as a series of hash codes that wouldn’t reveal anything, much like the encryption of sensitive data now. As James Robinson notes, “You can’t unwind the transaction, you can’t divert the transaction, so there wouldn’t be any need to change the transaction” (Robinson, 2014).
Cost and Benefits and Embracing Disruption
While those in the Bitcoin ecosystem see the potential of the blockchain protocol to completely eliminate third party verification, it is important to keep in mind that a value-added intermediary like PayPal cannot only continue to exist, but can ultimately thrive. With its financial coffers, political, regulatory, and banking connections, global brand recognition, and renewed autonomy, PayPal/Braintree can single-handedly bridge the gap from the old legacy payments infrastructure to the new decentralized and cost effective blockchain system. Because blockchain is open-sourced and capital investment in building out physical infrastructure will be limited, costs to PayPal/Braintree will be minimal. Beyond the obvious potential downside of any technological pursuit, being a lack of adoption, PayPal has the added cost of lacking much of any proprietary information which greatly reduces the financial impact of first mover status.
However, with many others in the space, even governmental bodies like the U.K. Financial Conduct Authority, exploring all of the possible benefits of blockchain technology, the upside potential for additional innovation and revenue streams are limitless (Irrera, 2014). Similar to the adoption of the internet and e-commerce, new and willing merchants into this new payment paradigm can’t and won’t be bothered trying to figure out how blockchain cryptography works – they need to focus on running their respective business. PayPal must step in now, and take care of the rest (DeMartino, 2014). A reasonable low level upside measurement for their efforts in this space is maintaining their relative market share as a percentage of the overall payments processing industry.
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