PayPal and M-PESA are two major successes stories, each an example of new e-payments systems taking root in the last decade. The early development of PayPal is described vividly by an insider in PayPal Wars, and my colleague Dan Radcliffe and I have attempted to categorize the reasons behind M-PESA's success in a World Bank case study. Their design and contexts are vastly different –developed versus developing countries, banked versus unbanked customer segments, e-commerce versus remittance applications— but they share two major similarities.
The first similarity is that they both had a very specific function and powerfully targeted the proposition. At PayPal's inception, the main case was thought to be P2P (person to person) payments, with the typical scenario being friends settling the dinner tab with each other (one person puts the meal on their credit card, the others just email him their share of the bill). Then PayPal discovered that its service was being used to pay for goods on online auctions, of which eBay was the market leader. PayPal recognized that eBay had the capacity to drive viral growth, since a few thousand sellers advertising the availability of PayPal payments could promote the service with millions of buyers. PayPal was therefore able to devote all their marketing and product development efforts to make business easier for eBay sellers, a nicely compact set of super-users with defined needs. PayPal positioned itself as the friend of the micro-seller.
This is similar to the "send money home" positioning of M-PESA. M-PESA too started with a fairly generic payments proposition, but identified a sub-segment of users to whom this was going to solve the biggest problems. These were people looking for cheap and secure ways to remit money to family and friends. M-PESA counted on them to drive the growth of the system virally with payment recipients.
In the case of PayPal, eBay sellers had a much larger leverage or viral effect, because for every eBay seller there may be hundreds or thousands of potential eBay buyers who will have noticed the PayPal payment option. Consequently, PayPal needed to spend a lot less on end-user marketing than Safaricom did.
On the other hand, PayPal faced a constant fight with their ecosystem host, eBay, once eBay realized that some of the value from their customers was going to PayPal. As the owner of the platform, eBay sought to derive significant advantage from integrating its own payment engine into its marketplace website. But in the end PayPal won out because they focused unrelentingly on customer growth and getting the network effects on their side before eBay could catch up. Their mad scramble for growth paid off. Ultimately PayPal knew their continued success was going to depend on eBay not shutting them out of their auction website entirely, so they sought increasingly to diversify from eBay auctions as the primary business driver, and eventually sold out to eBay.
The second similarity between PayPal and M-PESA is that both were willing to incur huge losses to get to critical mass quickly. In its first 9 months (in 2000), PayPal lost $92 million (vs. revenues of $6 million), amounting to a loss of $23 for each of the 4 million customers they acquired over the period. And over the first 18 months, PayPal accumulated $137 million in losses, or $14 for each of the 10 million customers they acquired.
PayPal's early losses were due to three factors. First, they offered a sign-up bonus of $10 (subsequently reduced to $5) to whoever referred a new customer. Referrals tended to came from eBay sellers, so they had every incentive to promote PayPal alongside their own products through eBay. eBay sellers played an equivalent promotional role as the retail agents did for M-PESA. Second, in the early days customers funded their PayPal account from their credit cards, and PayPal absorbed the merchant fees on the card. So PayPal lost money not only each time they acquired a new customer, but also each time these customers used PayPal. This cost is equivalent to the agent commissions on M-PESA deposits, reflecting the cost of funding customer accounts. Third, PayPal had escalating fraud costs, which at one point reached 2.4% of volume transacted. This was linked to the use of credit cards as a funding mechanism: fraudsters could pump money out of stolen cards through PayPal, and then the legitimate owner of the card would trigger a reversal of the charges, causing a loss for the merchant in question -- which happened to be PayPal.
A significant difference between the two, though, is that M-PESA had a workable business model from the beginning on the strength of its P2P revenue stream, whereas PayPal had to shore up their business model in the years after its launch. PayPal was willing to ramp up such losses because their number one objective was creating a large base of users to get the network effect going. After 18 months, once they had over 10 million customers and no competitor was going to catch up with them, they started focusing on how to make money, or at least not to lose so much of it. They increased revenues by creating a new kind of "premium" business account for eBay sellers, while keeping basic "consumer" accounts free. They got their super-users to start paying for their account, partly by upgrading these accounts with useful innovative features and partly by cajoling frequent users. They also contained costs by shifting the primary funding mechanism from people's credit cards (which incur merchant fees) to their bank account, from which they could transfer funds for free through the automated clearinghouse (ACH) capability. They also became better at spotting suspicious transactions and trading patterns, and were able to reduce fraud in half.
E-payment businesses are dominated by network effects (where the value of the service depend on the number of people on it) and entail two-sided markets (buyers and sellers, senders and recipients). Both PayPal and M-PESA show that success requires (1) identifying early customers with the potential to promote the service virally and (2) having sufficiently deep pockets to drive aggressive customer acquisition.
Ignacio Mas is Senior Advisor in the Financial Services for the Poor team at the Bill & Melinda Gates Foundation.
This post draws on a revised version of Scaling Mobile Money, a paper Ignacio Mas co-authored with his colleague Dan Radcliffe and which will be published by the Journal of Payments Strategy and Systems in July.
