PayPal’s announcement yesterday rolls out micropayments (transactions under $12) for online purchases, and further improves their position for a large stake in the mobile payments arena. But how would they leverage this micropayment capability at a brick-and-mortar store? One possibility is the ‘do-it-yourself’ approach, as shown in the diagram. The multi-billion dollar system that supports standard formats like MasterCard, Visa, Discover and American Express are based on two things:

1) Delivering a (nearly) instant promise that the retailer will get paid, and

2) Automatically moving your money from your account to the retailer within 24 hours of your purchase.

But what if YOU moved your money in and out of your bank account manually? The retailer could save a lot of money, which means they may be willing to give you a big “reward” or other incentive to use PayPal account to pay.

According to PayPal’s web site, the fee for their Digital Goods service is 5%, plus five cents per transaction for micropayments. They can get away with these fees because there is no lower price available online today for these types of purchases. However, there are may options available at brick-and-mortar retailers, so if Pay wants to penetrate that market someday then they have to find a way to seriously lower their fees. Here is how they are going to do it:

In the traditional PayPal model, any customer can move their money between their bank account and their PayPal account for FREE. That goes for customers, businesses, premier clients – everyone. It takes 2-7 business days to actually get move your money deposited to or from your bank account, but avoiding fees is worth the wait if you are not in a hurry. The processing is free for consumers, just like using a credit card at a retailer is also free for consumers.  However, according to the PayPal web site, the transactions greater than $12 incur a processing fee between 2.9% and 1.9% (a $0.30 transaction fee can be waived; check the fine print here) which is on par with the industry average for Visa and Mastercard branded cards.

So, in theory, all a customer would have to do is choose PayPal as a payment option using a POS device that accepts PayPal as a payment type, and your money would get moved from your PayPal Account to the retailer’s PayPal account. Even better than an instant promise to get paid is the instant payment. In this scenario the merchant’s PayPal account would almost instantly show the receipt of funds.  Of course, the retailer would need to have set up a PayPal account also, but it is all possible.

It is interesting that PayPal charges a similar processing cost to the retailer as the payments system charges because a PayPal account is not really money. It is a credit in which one credit happens to equal one US dollar, but it is just a number in a (very secure) computer.  From an operations perspective, this function is less expensive to perform than actually moving money automatically every day, like the payment system.  That means if PayPal starts getting competition from other sources outside of the payments arena, or if PayPal decides to offer lower fees to merchants to speed adoption, they will likely be able to lower their fees.  The incremental costs for each transaction by the payment companies could make it more difficult for the industry to react.

So, all of the pieces are in place for other payment schemes, like PayPal, to begin to challenge the incumbents.  There is little current evidence that multiple merchants are willing to open a PayPal account, but as discussed here, PayPal could change that mentality overnight by slashing its processing rates to the merchant and rely on its lower operations expenses to maintain a profit.  The less expensive solutions always will  draw attention, and the PayPal do-it-yourself money transfer system may be one of the things retailers are craving.

Of course, a customer can initiate the transaction from their SmartPhone if all of these other pieces are in place such as companies like Zoompass and Isis, but that is a topic for another article.

© 2011 David W. Schropfer
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