By sean

Paypal Wars was a really fascinating book, telling the story of Paypal’s early years in the late 1990s.  The most incredible part of the story to me was how Paypal began losing 3.5% on every transaction, 2.5% to interchange fees and 1% to fraud.  Over time they figured out the fraud and also began to move transaction volume away from expensive credit cards to lower-cost methods.  First, they used the ACH network, which is almost free to enable people to fund their accounts.  Second, as their network grew, they were able to internalize more transactions.  They also began charging the recipients of Paypal payments and were able to make a positive spread on each transaction by the time they went public in 2001.

Building a new payment network is extremely expensive.  It took visa and mastercard many years and hundreds of millions of dollars to build theirs.  Paypal had the advantage of being able to ride on top of two existing payment networks – credit cards and ACH – which greatly accelerated their pace of expansion, they were able to get 10M users in a few years, a feat which took visa and mastercard much longer.  However, they had to pay for that benefit, resulting in huge losses over their first years in business.

Paypal’s transaction volume is growing at an very rapid pace, reaching $60B in 2008 with plans to double that volume by 2011.  Such volumes will give Paypal clout on par with American Express and Discover, although still well short of that wielded by Visa and Mastercard.  It will be interesting to see what impact the emergence of a 5th payment network will have on the payments industry.

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