A PayPal Christmas

Just in time for your holiday shopping, here’s a way to stick it to those credit card companies: use PayPal for your Internet shopping.

The New Times is reporting that high-end Web retailers are introducing promotions designed to attract consumers willing to use credit card alternatives like PayPal and Google Checkout. A quick tour of PayPal’s website shows that lower-end merchants like FTD and Avon are getting into the game as well.

Why do these retailers want to lure you away from your credit card? It’s mostly about processing fees, which merchants have been fighting with renewed vigor. Last spring the Washington Post reported that retailers were asking government to regulate per-transaction fees, which credit card companies collect from merchants each time you swipe your card. Credit card companies countered that retailers were seeking price controls. Now merchants are hoping that consumers will simply use an alternative form of electronic payment. PayPal and similar services charge merchants lower processing fees and offer other advantages, such as not requiring retailers to reimburse them for fraudulent purchases.

As David Evans and Richard Schmalensee describe in their book Paying With Plastic, payment systems are multi-sided platform networks. This means that PayPal and other payment providers are intermediaries that can make both consumers and merchants better off. But because a payment network is multi-sided, the benefit to a party of the network depends on how many parties are on the other side of the platform. In other words, consumers don’t care about how many other consumers use PayPal; they just care about how many retailers accept PayPal. Retailers don’t care much about how many other retailers accept PayPal; instead they care about how many consumers use PayPal.

This means that payment systems present a chicken-or-the-egg problem. Unless payment providers manage to simultaneously convince both merchants and consumers that they will be better off, the payment provider won’t gain a critical mass in the marketplace. Apparently lower fees and other incentives, coupled with the suggestion that PayPal and similar providers can deliver customers who would forgo an Internet purchase if they had to use a credit card, have convinced some retailers to change their Web site’s payment technology. Whether other merchants follow their lead depends on how many consumers register for and then actually use these credit card alternatives.

Right now all of this is working to the consumer’s benefit. PayPal and similar providers are expanding the services they offer to help convince consumers that the hassle costs of signing up are worth it. The retailers who have adopted credit card alternatives are offering discounts to entice consumers to register for and then actually use the new payment form.

So register for PayPal, pay a little less, and deprive those credit card companies of a few processing fees. But don’t worry too much about whether credit cards will be able to survive the competitive pressure. You can count on them to move to where the action is. Apparently PayPal has partnered with MasterCard to offer . . . you guessed it, a PayPal MasterCard.

[Update on Nov. 21: I responded to comments that appeared on this site and elsewhere here.]