When you make a purchase online, you are presented with the option to pay with PayPal or credit card (Visa or Mastercard). Ever wondered what’s the difference? As someone who is passionate about payments and believe in understanding the basics, I have decided to write about it. In the payment ecosystem, I think it’s easier to understand credit card than Paypal. Credit card is just the network. Credit card companies connect the banks, and its model can be simplified to providing the highway, and collecting the toll for using it. Its network is used to authorize payment between seller and buyers. More specifically, this network connects the issuing bank (consumer), acquiring bank (merchant), processors, and register (POS or payment gateway for online).
Mastercard & Visa states that an acquirer must be a financial institution (i.e. bank) registered on the network as an acquirer. Most of the acquiring bank will partner a company that specialize in payment acquiring such as TSYS or First Data to provide the acquiring service. The issuing bank will also work with processor, such as TSYS and First Data to record, authorize transaction, and handle clearing and settlement.
PayPal has gotten harder to classify these days as it has taken a number of roles in the payment value chain. This aligns with PayPal’s strategy to create its own payment ecosystem. In this regard, PayPal has taken the role of
- Working capital lender
PayPal started as a payment solution to e-commerce. It allowed users to pay without giving random merchants access to your credit card number and billing info. In addition, PayPal also provided “consumer protection”, namely money back if item purchased was not received. On the merchant side, PayPal naturally offers merchant solution for payments made through PayPal. This is typically solution provided by the acquirer in credit card payment scheme. As more people use PayPal, merchants start to pay its suppliers with money they receive in PayPal. In such scenario where money flows through the PayPal system, PayPal has the advantage to either reduce fees v.s. credit card, or speed up the money transfer. PayPal also started to offer “value added services” to these merchants, such as loans.
Hence, the difference simplified:
Credit card provides the network used in payments. PayPal provides online consumers and merchants one-stop payment solution.
How PayPal moves revenue away from banks & credit card networks
Yesterday, I was at a payment event, and a couple people said even with PayPal, I am using credit card or debit card so bank and credit card network still gets a piece of the action. The answer is yes and no. If someone were to make a payment through PayPal, the credit card network may or may not be used. If you are paying with your PayPal balance or your checking account, then it doesn’t use the credit card network. In such scenarios, PayPal makes more from the transaction fee since doesn’t have to share the profit with the credit card networks (issuer, acquirer, network, and processor) or in the case of checking account, it’s using ACH, which has a much lower fee than credit card networks. Banks typically does not charge for ACH. So in general, the initial funding of PayPal or payment go through credit cards network, but once the money is in the PayPay system, and used as payments, this is where credit card companies will lose in transaction fees and where PayPal gains.
How PayPal still involved for purchase made through credit card
I want to point out here that PayPal can still be involved for purchase made by credit card, and not PayPal. This happens for online merchant that uses PayPal as its acquiring solution, with gateway included. This is not uncommon since in the early stage of online commerce, PayPal was what consumers used to pay merchants. The process would be something like:
- Buyer A shops at merchant B, and uses credit card to pay.
- PayPal will act as gateway, and connect into the credit card’s network, and wait for authorization.
- In this transaction, PayPal will collect acquirer’s fee
PayPal’s strategy vs Mastercard & Visa
PayPal and credit cards have very different strategies. First, both PayPal and credit cards make most of their money from transaction fees. So, both type of companies have goal to increase transaction volume and values.
For Visa and Mastercard, their strategy has always been the infrastructure play. They build the highway, and collect toll for using it. Mastercard’s recent acquisition of Transactis is an example of such play. Transactis help acquirers (i.e. banks) provide fully automated billing solution to merchants to with the goal to ease account receivable operations.
PayPal, true to its online origin, focus on online and mobile payments. More importantly, it is creating an ecosystem so that money doesn’t leave PayPal. This will not only increase PayPay usage, but also increase revenue, as PayPal would not need to share revenue with banks and credit card companies. Once can see this strategy play out in PayPal’s acquisitions:
Xoom is an online solution for sending cross-border remittance. Paydiant is provides white label e-wallet solution. Braintree provides all tools online and mobile business need to accept payments. Braintree also owns Venmo, an e-wallet that can be used to transfer payments between friends with a social aspect to the App.
These acquisitions show PayPal’s goal to stay as the clear leader for any online or mobile payment activities, which is important to creating the ecosystem.
In this article, I wanted to just lay out the grounds for understanding basic difference between PayPay and Mastercard / Visa. Based on such ground, looked briefly at their acquisition and strategy. In the next article, I plan to look deeper into their strategy, and what are some of the ways they can evolve the current payment system with the ultimate goal of providing the more simplified, faster, and cheaper payment solution to their customers.