PayPal May Not be the "Pal" You Think

The PayPal system is great! It allows people from all around the world to buy and sell off the internet and use a protected system that is safe and reliable for transferring money in exchange for goods. All you need is to create an account with PayPal, and give the some of your private information for security check, etc. and you can do business over the internet with anyone around the world. PayPal says the customer doesn't even have to have a PayPal account; all they need is an email address! Now that is very convenient.

Traditionally there are a few ways of making a payment: in cash, sending a checque, through a bank transfer, by a credit card.

In international business where the buyer and seller are not facing each other across a counter, cash payments are not an option. Personal checques are usually not accepted internationally in most circumstances, and if they are, they take a very long time to authorize and the service charges are extremely high. This leaves us with bank wire transfers and credit card payments.

For decades people have been able to wire transfers through banks to other people, but that has often been limited to businesses. There are many countries that will not easily allow citizens to send money out of the country (Italy is an example) so the barriers are fairly high. Also, the bank fees that are charged on both sides of the transaction to send and to receive money are very large. This can hamper small business from profiting because you can often lose more money in the transfer than your profit margin allows if your business is competitive and the margins are low. And for individuals who are paying for something from a friend who is doing them a favor, everyone loses money in the transaction using the banks.

Customers pretty much expect a business to accept credit card payments these days. Individuals who are not incorporated usually will not qualify at a bank for a "merchant account". This means they will not be allowed to accept credit card payments from customers placing orders. They will lose these customers. Only the corporations have traditionally been allowed to do this. Since a lot of business is carried out over the internet these days, if you cannot accept a credit card, you are going to have big problems getting a sale.

Enter PayPal, an online money-transfer system that Thomas Friedman, Pulitzer Prize columnist for the New York Times and author of "The World is Flat" describes as the following:

"PayPal is a money transfer system founded in 1998 to facilitate C2C (customer-to-customer) transactions, like a buyer and a seller brought together by eBay."

Yahoo! has a similar system and I would not be surprised if Google.com does not come up with an innovative way to do C2C business in the very near future.

The tools of the internet have allowed the "small to act big" in this respect because there are several companies now on the internet that will act as a "broker" for you, allowing you to accept credit card payments through their account. This will let you receive payment from customers without them having to do a bank transfer (which costs them money at the bank). Customers expect merchants to accept credit cards these days, and a variety of them. It is de rigueur for contemporary business. They also do not expect to pay a service charge for using their credit cards as retailers often charged in the past to help offset their fees to the banks for accepting credit card payment.

Of course, to use these services there are fees. It is only natural. Here is what Paypal says about their fees for using their secure online payment services:

"PayPal charges Premier and Business accounts to receive payments. Personal accounts are free, but may not receive debit or credit card payments."

There are limitations to this system that I would say prevents it from being truly globally modern, though. For Americans having bank accounts in the USA or other citizens who are allowed to have USA-based bank accounts, the payments you make can be automatically taken from your bank account at a very low fee or free if you have a "personal account".

If you are an internationally located person, and do not qualify to have a USA-based bank account, or wish to accept credit cards you must register your PayPal account to accept credit card payments. Only business and merchant accounts are allowed to have credit card authorization and the subsequent service fees charged for each transaction are significantly higher than the personal account. Here in Japan for my business there is a 3.9% transaction service fee as well as a JPY 40 per transaction flat fee to accept payment from basically everyone.

In addition to that, if there is currency conversion (i.e. billing in JPY, payment in USD, translated back to JPY for my Japanese account), PayPal says, "it will be completed at a retail foreign exchange rate determined by PayPal, which is adjusted regularly based on market conditions. This exchange rate includes a 2.5% spread above the wholesale exchange rate at which PayPal obtains foreign currency, and the spread is retained by PayPal." This usually works out to about 5% higher than the actual bank rate.

How this works is like this: I bill you in Japanese Yen for the product from Japan that I am selling to you. You get the yen invoice automatically converted to USD by PayPal (great guys!) for your credit card payment. If you are in the USA you pay in USD on your credit card, and it gets converted back to JPY to put into my Japanese PayPal account. I get hit twice by this conversion.

If we add these percents up, PayPal is making about 9% profit on every item I sell to you.

Now keep in mind that PayPal is taking this service fee from the total invoice sum which includes product PLUS SHIPPING. Usually companies do not overcharge on shipping (I only charge the cost). Using PayPal, my cost to send a product becomes 9% HIGHER than the actual cost, which means I am LOSING even more money from my profit margin.

Let us look at an example of what is really happening: 
(please consider the current exchange rate of JPY 100 / USD for simplicity).

I sell beautiful Japanese bamboo carved dolls for JPY 25,000 on my website. 
You, from the USA, want something Japanese, you look for "Japanese arts and crafts" on Google and you find my site. 
You decide you want to buy the Noh Doll at the cost of JPY 25,000 + Shipping (I cannot bill you sales tax internationally although I must pay it here). 
Boxed for international shipping to prevent breakage, the gross weight is about 2.5kg 
The shipping of EMS (registered postal tracking) is JPY 5,000. 
Packing for shipping will cost about JPY 400 for a box and bubble pack. 
The total retail sale is product + shipping which amounts to JPY 30,000.

Let us say my profit margin is, 20% of the product, so my total cost to buy the doll is JPY 20,000 and my gross profit is JPY 5,000.

I send you an invoice through PayPal in Yen, and you receive the total amount your credit card is billed (in US Dollars). You hit the "Pay Me" button and the transfer is complete.

I get an email saying that you paid my invoice. It also tells me what the exchange rate was, and how much they took off in service charges. I see a total amount that has gone into my PayPal account.

I go to the post office and ship the product, and it is on your coffee table for everyone to admire in about five days.

PayPal will take a service charge of total 9% of JPY 30,000 which amounts to JPY 2,700.

Total Profit (TP) = Total Sales (TS) - Total Costs (TC)

TS = JPY 25,000 + JPY 5,000 = JPY 30,000

TC = JPY 20,000 + JPY 5,000 + JPY 2,700 + JPY 400 = 28,100

TP = JPY 28,200 - 28,100 = JPY 100

This amounts to an actual profit of 0.3% from retail price.

Paypal has just reduced my profit by 100%!

You paid me JPY 30,000 for the doll, and I have zero to show for it (aside from a happy customer)!

I cannot do business using this "amazing tool" at a 20% profit margin (which is not an unreasonable percentage in ordinary business), because PayPal would put me out of business with their very high total service fees. Unless you try the system, and look at the actual costs involved, it is very difficult to see this is happening.

The profits mentioned above of course do not include the "economists costs" or time invested in communication, the gasoline to pick up the product and deliver it to the post office, lost revenue from other business you might have been doing instead and other hidden costs that do not show up in accounting ledgers. If you figure in all of this, by selling Japanese bamboo dolls using PayPal to receive payment, I am putting myself out of business.

Now for a client to send a telegraphic transfer between bank accounts (the old way), it will cost them about $20 to wire me the money plus the time and effort required to go to the bank and fill out the forms after waiting in line. It will cost me about JPY 4,000 in bank service fees to receive it. Instead of being at +/- 0% for the sale, I would be at a loss of about JPY 1,300 and slitting my throat. The red ink would be my blood.

The internet allows us to do things never before thought possible. It certainly has "flattened" the way we can do business and has allowed the small to act large. But at what cost? The real cost for this "greatness" may be too large for small businesses to handle.

Low profits seriously hamper companies from growing larger because they cannot get a large enough return to invest in growth. Low profits reduced further through high service fees can kill a company without them even realizing it. Hopefully your online business using the flattening tool of online e-payments with this amazing global system is allowing you to make substantial profits to cover the substantial costs of doing such business.

Service companies who charge for their time and do not have physical products that they must buy from someone to resell may possibly benefit more from this system. For the little competitive company selling small products at small margins in order to keep the retail prices low enough for consumers who are always looking for the lowest price, it still has a way to go.

The real winner in this "PayPal system" is PayPal. Everything is automated for them, making their total-running costs for overhead extremely low per transaction. They have "economies of scale" going for them because millions of people are using PayPal around the world. PayPal has developed a system where you do all the work and they take a tasty profit from your efforts. Your overhead costs are very high using this system. PayPal can potentially make a higher profit from your hard work than you may be doing! It is no wonder they have gone into this business of "helping" C2C business take off on the internet.

From this perspective, I would have to say that online payments using such services as the revolutionary PayPal are still in beta testing stage. Consumers and businesses will not be able to fully take advantage of these systems until more competition in this market exists, and they too are forced to decrease their profit margins to "get the order" just like everybody else. After all, if competition is supposed to benefit everyone, surely it wouldn't hurt for the PayPals of the world to face some tough times of their own, and let us make a little money from our hard work, yes?

Don't despair; as in all business, competition will surface and the consumer will benefit in the end. Keep using this beta system, and it will show other companies that there is a market need for providing more e-banking solutions to global clients in the global world where the walls are being taken down and the playing field is being leveled.