Overview

Primary Questions:

• What are Alternative Payments and why are they needed?

• Why should retailers care about Alternative Payment methods?
• What are the trends in the alternative payments industry?
• Who are the key players?
• What is PayPal’s role in shaping the industry?
• What does the growth of Alternative Payments mean for Visa and
MasterCard?
• How do alternative payments work and what are the technology
constraints?
• What are the fraud risks?

Methodology:

This paper is based mainly on….

Executive Summary:

In this paper, the term “alternative payments’, refers to payment services

provided by non-banks and the paper explores how emerging non bank
payment services may threaten banks traditional role in the payments
business.
Alternative payments are online payment tools that do not use credit or debit
cards and
are designed to process transactions without direct involvement from banks.
These services also serve as an electronic alternative to traditional paper
methods such as checks and money orders. Alternative payment providers
include companies such as PayPal, which continues to grow into a major
player in the online purchasing arena.

Most consumer payments still involve some type of depository or banking institution.
Though credit cards are currently the preferred method of payment for online consumers,
this method is inherently flawed in a “card-not-present” environment. This is leading to a
dramatic rise in the popularity of alternative payment methods. Growth in alternative
payments has happened hand-in-hand with growth of the Internet as a major vehicle for
commerce.

Just a few years ago, banks completely controlled the payments system and the idea of
moving money quickly and easily, with little or no fees, would have been laughable. Now
there are hundreds of companies, from large corporations to engineers and entrepreneurs,
breaking down payment barriers and developing technologies to facilitate, easier, faster
and cheaper payments. It is estimated that nearly 20% of all online transactions are now
made via alternative payment methods. That number is expected to increase at least 10%
in the next several years.

Alternative Payments are defined as…. Current solutions….

According to Forrester Research, U.S. internet retail sales hit $155.2 billion in
2009 and are expected to reach $172.9 billion by the end of 2010. One can
assume that all of these purchases will involve an electronic payment.
Although a large majority of consumers pay for online purchases with credit
cards such as Visa, MasterCard, and American Express, many consumers
don’t have credit cards and rely on other payment methods for online
purchases. Alternative payment providers such as PayPal, Google Checkout,
and Amazon offer consumers a way to make online purchases….

The need for payment mechanisms that are faster, more convenient, and more secure, as well as those that
meet the needs of new transaction channels such as the Internet and mobile phones, and market segments
that have not traditionally had access to the payments system, is driving the payments industry to improve
on traditional mechanisms and invent new ones to meet these needs. In this report, the term “alternative
payments”, emphasises the distinction between payment services provided by non-banks and those
provided by banks, with a view to understanding how recent and emerging customer-facing nonbank
payment services may threaten banks’ traditional role in the payments business

Global card networks (e.g., Visa & MasterCard) have reasons to be concerned about alternative payment
providers competing for payments on the Internet in the medium/long term because these alternative
providers offer more flexible technology (e.g., open platforms that allow developers to customize
applications for merchants) and offerings that fill unmet needs of both merchants and consumers These
offerings are allowing these providers to gain share of payments in the e-commerce market.

“In many ways, credit cards offer the best payment form for Internet commerce. They’re
ubiquitous, familiar, and offer security features that other payment forms don’t. Still, only
53% of Internet sales in 2008 were conducted via credit card, with debit cards following at
21%, according to figures compiled by Packaged Facts. Payment services that are limited to
the Internet were a close third-place finisher, with a share of 19%. These payment methods—
which include services such as PayPal, Google Checkout, Amazon Payments, and Bill Me
Later, and ACH products such as eBillMe, Moneta, and Secure Vault Payments—have been
catching on. For e-commerce transactions, sales through “other” payment vehicles jumped
54% between 2005 and 2008, with $29.4 billion of goods sold through these vehicles in 2008.”

Interchange, in which merchants are charged a percentage of the total amount of each credit card
(and debit) transaction processed.

Merchants may receive benefits from credit cards—increased sales in particular—but they
generally aren’t enough to offset the rising costs of interchange. Also, merchants do not have
the ability to negotiate lower costs with card networks due to the networks’ vast power and
influence, and network agreements prevent them from charging a surcharge for credit card
payments or rejecting cards that carry high interchange. Meanwhile, merchants’ only
alternative to paying interchange fees is to refuse to accept credit cards, a drastic and
unrealistic measure in the modern economy.
Tech start ups are continually offering new variations on online payments and
some of these surely will catch on and continue the momentum and evolution
of the online payment landscape and help to reshape the offline scene

Alternative payment providers such as Google Checkout, Bill Me Later and of

course PayPal leverage the ACH to provide consumers and merchants with a
secure and efficient means of payment and in doing so are experiencing
phenomenal growth. For example, just in the second quarter of 2008 PayPal
processed 210.9 million transactions, up 26% over the year-ago period. The
growing attraction for alternative payments is a combination of merchants
seeking protection from increasing interchange fees and consumers demanding
more secure and flexible online payment options.
Innovative technology companies have been challenging the banking industry by
developing unique and cost efficient payment solutions, especially in the e-
commerce space. It is interesting to note that alternative payment providers
have succeeded using the banking industry’s own ACH infrastructure to capture
interchange-like revenues.

PayPal

PayPal has developed a lucrative business model leveraging the ACH network.
PayPal built a profitable person-to-person payments solution that met the needs
of the market. PayPal’s financial success can be partially attributed to its
approach of charging the equivalent of a credit card transaction fee on the front
end while processing and settling payment at reduced cost on the back end
using the ACH.

PayPal has reported that about 50% of funding is done through access to
personal checking accounts, which implies the critical nature the ACH network
has to PayPal’s operations. The network enables PayPal to offer merchant
services to online companies based on a blended rate.

While consumers that sign up for a PayPal account can utilize a credit card or
debit card to make payments, they are encouraged to directly link their checking
account by providing PayPal check routing information combined with an ACH
authorization form. The process PayPal uses has distinct benefits in winning
consumer adoption and in managing risk.

When initially joining PayPal the customer can select the payment instrument
that they are most comfortable with, including debit and credit cards. PayPal,
however, limits dollar spend and transactions until an account is “verified.”
Verification requires a check routing number be provided and that the individual
verify a $1 transaction that is implemented against the account. Once the
account is “verified” PayPal has a specific order it follows relative to funding the
account, and it is not surprising that the first source for funding is money left in
the PayPal account itself, while the second source is the ACH to the consumer’s
checking account.
An ACH PayPal merchant collects payment information and securely sends it to
PayPal for processing. If the payment is scheduled, payment information is sent
on the date specified by the customer. PayPal prepares the ACH payment
information and delivers it for ACH submission to the ODFI by electronic
transmission over a secure connection. The payment then follows the traditional
ACH payment flow as described earlier in this report with funds moved into the
biller’s/merchant’s bank account. The customer’s periodic bank statement
reflects an ACH payment and merchants are notified of ACH payments on their
bank statements.

Types of Online Transactions

• Overall, more than nine in ten Internet households have made at least one
of these types of online expenditures, with nearly nine in ten citing
purchases of merchandise.
• Two-thirds have made travel reservations online, and close to half have
downloaded music, video, or other media clips. Fewer mention online
charitable contributions or sending money to friends or relatives.
• Overall, mention of most activities peaks among those ages 35 to 49 and
increases with household income. E-commerce activities are also
generally more widespread among credit card users and heavy debit card
users

Types Of Online Transactions

Base = 1003 Internet Households

Other Online Expenditure 32%

Send Money to Friend/Relative 19%

Contribute to Charity 34%

Dow nload Music, Video, Media 47%

Travel Reservations 66%

Purchased Merchandise 86%

Any (Net) 93%

0% 20% 40% 60% 80% 100%

Bibliography

Packaged Facts April 2010. Consumer Payment Trends in the US: Chapter 7:
Online, Alternative and Emerging Forms
Synergistics Research Corporation March 2010. Evaluating Consumer
Payment Behavior. p57-58