Give Banks Their Due For Driving the PayPal Split

by Tim Sloane 0

Set of Colorful Cash with wings swiftly fly over a blue globe

As the name of this articleon Quartz implies, it identifies that “Apple Pay is such a big deal that eBayalready has had to change strategy.” Thearticle first presents a history leading up to the split of PayPal from eBayand then brings the reader up on current events, including the explanationgiven by CEO John Donahoe for the split. However Quartz believes there is an easier explanation and lays out someeconomics to back it up:

There is a shorter explanation:Apple Pay.

Apple’s new payment system, tied tothe iPhone 6, is supported by American Express, Visa, and MasterCard, andrecognized by a number of merchants including Walgreens, Macy’s, Target, andWhole Foods.

This changes the competitivelandscape in two ways.

The first is the gravitationalwell, the network effect: More participants will attract more participants. Itremains to be seen how well Apple Pay will perform, but we know the Touch IDfeature works well—better than this skeptical user expected, and better andmore securely than its current competitors.

The second way Apple Pay changesthe landscape is much more alarming to competitors: Business Model Disruption.For Apple, revenue from a payment system is peripheral, it’s yet another partof the larger ecosystem that sustains the iDevice money makers. To PayPal, ofcourse, payment revenue is all there is.

This distinction isn’t clear toeveryone. In a conversation in Paris last week, an otherwise sensible friendinsisted that Apple Pay will be a “huge profit opportunity.” No, Apple willearn about $1 for every $700charged through Apple Pay. In order to reach the $10billion “unit of needle movement,” Apple Pay would have to transact $7trillion. For reference, 2013 US retail revenue was $4.5 trillion.

According to its 2013 annualreport, eBay processed about $180 billion in payments in 2013, yielding $6.1billion in transaction revenue. For that same $180 billion, Apple would contentitself with $270 million….that’s about 0.15% of the company’s overall revenue.

When eBay purchased PayPal for $1.5billion in 2002, the deal made sense—it certainly made much more sense than thelater acquisition and disposition of Skype. In recent years, PayPal has grownfaster than eBay’s Marketplaces business, to the point where the two wereroughly equal last year ($6.1 billion vs $6.8 billion.) Today, Wall Streetvalues the combined companies at approximately $67 billion (although it will beinteresting to see how much the PayPal “half” fetches).

The fast-growth, synergisticbusiness Donahoe vigorously guarded last January has been kicked to the curbbecause its business model is threatened by Apple Pay.

It didn’t have to be that way.We’ve recently heard that PayPal and Apple had been in “massive” talks earlierthis year…until Apple found out about PayPal’s partnership with Samsung, thusending any hope of a collaboration with the Cupertino team. Recall that PayPalpresidentDavid Marcus unexpectedly left the company last June to leadFacebook’s mobile messaging initiative. The official explanation at the timewas that Marcus was simply looking for a new adventure, but it’s more likely thatMarcus was frustrated with Donahoe:

“eBay CEO John Donahoe pushed forthe Samsung deal even though PayPal president at the time, who left forFacebook following the Apple-PayPal deal collapse, David Marcus was ‘purposelycategorically against the Samsung deal, knowing that it would jeopardizePayPal’s relationship with Apple.’”

Looking at the game board threemonths later, Donahoe dissolved the eBay-PayPal union and deliberately wrotehimself out of a job—undoubtedly with the “help” of his board.

In the meantime, we have PayPal’sreaction to Apple Pay: An ad mocking Apple for the selfies fracas. Yes, anumber of individual iCloud accounts were compromised by clever socialengineering techniques and outright password theft, but no one seriouslybelieves the iCloud infrastructure itself was penetrated. Conversely, in May ofthis year,eBay suffered a massive security breach requiring all users to changetheir passwords because hackers did gain access to the company’s servers,something PayPal management chose to ignore.

Again, we don’t yet know if Apple’spayment system will live up to its promise, but with the iPhone 6 and 6 Pluslooking like The Mother of All Upgrades (two weeks after the launch, people arestill lining up outside Apple Stores), Apple Pay should be on solid ground onits rumored October 20th opening day. Nonetheless, with an ex-Amex exec at thehelm of a soon independent PayPal, the payment game is going to beinteresting.”

But Apple couldn’t challenge PayPal at all if the bankshadn’t partnered with American Express, MasterCard and Visa to enable theircards in Apple Pay, and this is bigger than Apple. The banks, through the networks, haveembraced tokens to enable a broad based mobile payments solution. This solution may appear to be the same oldpayment model as before, but it isn’t and Apple and the Banks know that, asdoes PayPal. Tokens will eventuallyconnect with iBeacons and Beacons to enable new forms of loyalty programs andincentives, and that directly challenges the existing PayPal business model.

So let’s give the banks some credit where credit is due.

Overview by Tim Sloane, VP of Payments Innovation for Mercator Advisory Group

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