One of the blogging VCs I really respect is Bill Burnham.  He recently posted Uh oh eBay, Google Base is now facilitating payments and Google Base is the Merchant of Record.  Please read his posts, but essentially the point is that Google now has a payment service, and this is a threat to PayPal, which is now part of eBay.  I felt compelled to email Bill about this, and also to share my thoughts with you:

Bill –

As a veteran of the PayPal wars, I think Google is going to bust their pick on this one.  Sure, they have a lot of cash, and sure, they can afford to mess around for a while with something new that isn’t profitable, but ultimately operating a payment service is not going to work for them.

First, payments is a low margin business.  You need serious volume to make money doing payments.  eBay auctions gave PayPal serious volume long before PayPal was a part of eBay.  Of web merchants, only Amazon has the volume to make payments a business, and even their payment service was abandoned because it was unprofitable.  Remember Billpoint?  C2it?  Dotbank?  Bank One’s eMoneyMail?  Yahoo’s PayDirect?  Western Union’s Money Transfer service?  None of them had the volume to make it.  Right now Google Base is a curiosity.  There just isn’t enough volume there to support a payment service.

Google Video might be able to get to high volume, except it is so lame right now.  If Google seriously became the iTunes for video, I would change my mind on this point.

Second, fraud is a huge problem online.  PayPal’s success over a large number of competitors was largely due to their ability to manage fraud, and that ability was largely due to the account-based architecture of the PayPal service.  If Google tries to operate a payment service without stored value, they will have a massive problem with fraud.  They will rapidly become the best way to monetize stolen credit cards.  They have to be the merchant of record if they don’t have a stored value system, because otherwise their customers will bear the brunt of this fraud.

Third, there are a lot of people online who don’t have credit cards.  One of the reasons PayPal succeeded was because they enable people to make payments via ACH.  This has two big benefits, first, people without credit cards can use the service, and second, the cost of ACH is much lower than credit card exchange fees.  This is why PayPal costs 3% instead of 6% like most card-not-present merchant account services.

Fourth, PayPal had a really tight squeeze to avoid being regulated like a bank.  I really think they skated through because of the times and flying under the radar.  Google is going to be a bright flash on the radar, every banker in the country is going to want them to be regulated like a bank.  And that will mean holding reserves, smurf reporting, tax withholding, etc.  I’m not sure Visa and Mastercard are going to play along, either.  Citibank in particular may very well refuse (they switch most of the Mastercard authorizations) in order to prevent Google from becoming a competitor.

Fifth, customer support for payments is tricky.  Again, PayPal’s account-based architecture made customer support easier, because more of each transaction was “visible”.  Right now Google has zero services which require customer support, it is not a core competence for them.  They’re going to have some unpleasant learning before they master this.  And purely email-based support is not going to do it for them, either, they’ll need a call center.

I know it is a mistake to underestimate Google, they’re top-heavy with smart people.  But I also sense that they’re a bit cocky.  Payments is a mature market with a lot of entrenched competitors (banks, CheckFree), and a new entrant with a decent network effect (PayPal).  I would bet against them.

Finally, it is interesting to speculate, what should they do instead?  Accept PayPal, of course!  Sure, they would be giving away the payment revenue, but that’s not their core competence.  It would be much better for them to host content (goods for sale), use it to display advertising (which is their core competence), and let people settle the transactions using PayPal.  They could probably even cut a deal with PayPal which gives them some margin back.  They probably won’t start their own shipping service, either, and they shouldn’t; they’ll just partner with UPS or FedEx, in exchange for some margin.

Cheers,

Ole

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