EBay's Profitable Pal

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When alternative payment services began emerging in the mid-to-late 1990s, many merchants saw little benefit in allowing an unknown, untrusted company to process payments—not when most shoppers, in the U.S. at least, had viable credit cards. "In the early years, we had to do a lot of evangelizing," says Mark Lavelle, Bill Me Later's vice-president of corporate development. "Yes, your customers have credit cards, but that doesn't mean that is the only way they want to pay."

As a result of merchant reluctance, payment providers often had to tie themselves to an e-commerce mall of sorts, like PayPal did with eBay. It was that or settle for the transactions that credit-card companies refused to process. E-wallet companies such as Neteller (NLR.L) and FirePay were once listed on major gambling sites as preferred payment methods. As the U.S. cracked down on online gambling, these services were cut off from a major source of their revenue (BusinessWeek.com, 1/17/07). Several, including FirePay, subsequently closed down.

Getting More Merchants on Board

PayPal and others try to woo merchants with the promise that buyers will be more likely to complete a purchase if they can do it with a single click—say, on a PayPal button—rather than having to enter their credit-card numbers and other details. When that hasn't worked, payment services point to the fact that their processing fees are often lower than those of major credit-card providers. Some offer other incentives. For example, Google offered payment processing credits to its search advertising customers in a bid to fuel adoption of its Checkout payment service.

Such appeals are working. PayPal's off-eBay business grew 66% in the fourth quarter, processing $6.1 billion in payments for Web retailers such as Dell (DELL), Blue Nile (NILE), and Yahoo's (YHOO) shopping sites. Lavelle says Bill Me Later is available on 700 Web sites. PayPal also has helped its e-commerce penetration along by partnering with more accepted credit-card providers. In November, the company released a tool that generates a one-time Mastercard number (BusinessWeek.com, 6/15/07) on sites that don't accept PayPal, expanding its potential use to any online store that takes that major credit-card provider.

Growing concern about credit-card debt in the U.S. and lack of credit-card penetration abroad is also fueling growth. Payment systems such as PayPal-like MercadoPago, the Latin American payment system owned by eBay protege MercadoLibre (MELI), offer users in Argentina, Brazil, Mexico, and Venezuela who don't have a credit card a way to pay for online transactions. In 2006 the company processed $89 million in transactions. In the U.S., services such as Bill Me Later give users an installment plan that serves as an alternative to paying up front with a debit card. And unlike many credit cards, Bill Me Later's option doesn't carry high interest fees. "We do get people who don't have credit cards by choice," Lavelle says.

As the online payment bug spreads, eBay's Donahoe may be proved right in his assertion that "2008 will be PayPal's best year yet."

Holahan is a writer for BusinessWeek.com in New York .