PayPal Holdings Inc. Case Analysis Part 2

This is part 2 in the PayPal Holdings Inc. Case Analysis. If you have not read the first part, here is the link: https://steemit.com/business/@dailystudent/paypal-holdings-inc-case-analysis-part-1.

1. External Environment (Opportunities and Threats)

2.1 General Environment—Political/Legal

Since MSBs (Money Service Businesses) do not engage in fractional-reserve banking, they are not regulated like banks. However, there are several political and legal factors that affect the money services industry.

Government regulations are strictly enforced to prevent money laundering, fraud, and other financial crimes including terrorist financing. MSBs must comply with OFAC (Office of Foreign Asset Control) requirements and global sanctions. Industry participants must have robust policies and procedures to detect, prevent, and report suspicious activity. Additionally, participants must successfully file and comply to state enforced acts such as Transmitter of Money Act, Uniform Money Act, Transmission of Money Abroad Act, Escrow Business Act, and many more.2 Further, new financial regulation is a potential threat to innovation in the financial services industry. The financial crisis of 2007-2008 led to the creation of the Consumer Financial Protection Bureau, which is responsible for ensuring that MSBs are compliant to the Electronic Fund Transfer Act or Regulation E. Under this act, consumers are protected when using point-of-sale terminals, automated clearinghouse systems, remittance transfers, and other electronic fund transfers.

Ultimately, the industry is regulated by the United States Treasury Department, through FinCEN (Financial Crime Enforcement Agency) and OFAC (and its international counterparts).

2.2 General Environment—Economy

There are several economic factors that can affect the money service industry.

Firstly, the United States and global economies are growing. This is boosting consumer confidence and increasing consumption for goods and services. Secondly, the cost of borrowing or interest rates are low which is incentivizing consumers to spend rather than to save, resulting in increased spending. Thirdly, the unemployment rate is low—more people working means more people involved in the economy. Fourthly, lower tax rates are leaving more disposable income in the pockets of consumers.

Finally, all these factors together are leading consumers in the economy to spend more. As a result, money service businesses will see an increased number of transactions. Each transaction that a merchant processes using a money service provider will be charged a fee. The fee is collected by the service provider. In this growing economy, MSBs will see an increase in fee revenues. On the contrary, if inflation starts to pick up and the Federal Reserve moves away from gradual interest rate hikes to sharp hikes, the economy can potentially start to falter.

2.3 General Environment—Global

Financial services, more specifically, MSBs are increasingly becoming global. Between 2011 and 2014, the number of people worldwide having a money account increased by 700 million.3 Developing countries that used to be unbanked are now taking steps toward financial inclusion. Digital money platforms are opening the door to new global entrants. They are bringing down the cost of domestic and cross-border transactions, flattening the money services industry. Citizens in developing nations are adopting digital and mobile first platforms for their money accounts because there is a lack of commercial bank branches. Furthermore, globalization is impregnating the international money service industry by increasing the demand for their services. Emerging economies in Latin America, Asia, CEMEA (Central and Eastern Europe, Middle East, and Africa) are outpacing growth compared to developed economies. As a result, merchants and consumers in emerging economies are further relying on the digital money platforms to facilitate and clear transactions because they require global services. Global non-cash transaction volumes are reaching record highs and experiencing double-digit growth.4 Cleary, the demand for digital money services is a major opportunity.

2.4 General Environment—Demographics

Millennials (populous of 83.1 million and age range of 18-34) are replacing Baby Boomers (populous of 74.9 million and age range of 51-69) as the new working-class. Millennials are more diverse than their predecessors. 44.2% are of a minority race or ethnic group. Diversity among millennials, is due to fresh immigrants entering the country seeking education and job opportunities.5 Millennials pose a significant opportunity for digital MSBs.

According to the United States Census Bureau, in 2016, medium household income was $59,039, an increase in real terms of 3.2 percent from the 2015. Real median household income (married-couple households and households maintained by women with no husband) increased by 8.8% combined. The total number of men and women working full-time increased 2.2 million. The poverty rate was 12.7%, down from 2015.6

2.5 General Environment—Sociocultural

There is a major sociocultural shift occurring in the general environment for financial services. The current and largest demographic is adopting new forms of digital money services. Visiting a bank branch or financial intermediary for simple tasks like depositing, withdrawing, transferring, sending, or receiving money will soon be obsolete. There is a switch in preferences to digital and mobile money service platforms for basic financial services. Recognizing and developing a plan to capture this shift is an opportunity and a threat for established institutions.

2.6 General Environment—Technology

Global smartphone adoption is growing at double-digit growth. Future growth is expected to be even higher. Currently there are estimated to be two billion smartphone users worldwide. By 2020, that number is expected to reach four billion or 80% of all adults in the world.7

The adoption of smartphones is contributing to two major waves—access to e-commerce and digitized goods/services. According to McKinsey and Company, “approximately 12% of all global goods trade is conducted via international e-commerce” and “by 2020, cross-border e-commerce sales to consumers are projected to hit $1 trillion, accounting for almost 30 percent of total B2C sales.”7 Beyond e-commerce, digitized products like apps, online games, MP3 music files, E-books, streaming services, cloud computing services, and freelance services can be accessed anywhere with an internet connection. It should be noted that 50% of the world’s traded services are digitized.7

The adoption of smartphones, along with the usage of e-commerce and access to digitized products in emerging and developed economies, is paving the way to better financial infrastructures powered by internet technology. The shift from face-to-face to face-to-screen is a major contributor to the development of digital and mobile first platforms—presenting an opportunity to MSBs.

In recent years, we have witnessed a large number of company hacks attributed to poor security. Protecting consumer information is a major concern for the money service industry. Perhaps, one of the most understated technologies of our time is blockchain (the technology powering cryptocurrencies like Bitcoin, Ethereum, Litecoin, and Dash). Blockchain is an immutable ledger that records transactions chronologically into “blocks” forming one after another into a secure “chain”. Blockchain is the most secure form of recordkeeping because it decentralizes information across multiple databases and uses cryptography. The adoption of blockchain is an opportunity for MSBs to build trust through security.

This concludes the general environment analysis. Next, the money services industry will be analyzed using Porter’s Five Forces Model.

2.7 Porter’s Five Forces Industry Environment—Threat of New Entry

The threat of new entry into the money services industry is low.

PayPal has invested heavily into making its platform available to multiple devices including desktop computers, laptops, iOS, and Android. Not only is the application easily accessible, but the platform is integrated into 18,000 retail stores (Starbucks, Best Buy, Home Depot, JC Penny, and many more) in the United States and millions of e-commerce websites worldwide. PayPal is available in more than 200 countries and supports 25 currencies, allowing users to send money across borders securely.8 PayPal has achieved economics of scale and lowered costs by building a vast network that facilitates many transactions per second.

Evidently, the barriers to entry are significantly high for the money services industry. Firms wanting to enter or expand into this market must invest in technology, develop partnerships, attract diverse human capital, achieve economies of scale, and have access to distribution channels. Firms must also acquire the licenses mentioned earlier and comply with strict governmental regulations. Therefore, the threat of new entry is low.

2.8 Porter’s Five Forces Industry Environment—Threat of Substitutes

The threat of substitutes is medium to high.

PayPal offers a variety of full service solutions to merchants and consumers through its platform and partnerships. Small business owners can use PayPal’s platform to install point of sale (POS) systems that are designed for the restaurant or retail industry. Payments can be accepted by credit cards, debit cards, Apple Pay, and other credit firms. In return, their customers can use credit cards or debit cards with chip readers to buy products/services. Additionally, customers can pay in store using mobile wallets or checkout online.

PayPal’s offerings may appear unique but ultimately, the business is a platform that offers money services. However, Bitcoin and other cryptocurrencies, powered by blockchain technology, are beginning to impact the money services industry. Essentially, Bitcoin can achieve everything that PayPal has to offer but more. Bitcoin removes the need for trust in a company/platform to clear transactions because the currency itself is the platform. This poses a significant threat to PayPal and the industry. As millennials lose their trust for financial firms and become aware of blockchain, we may see a major sociocultural shift towards trustless platforms using Bitcoin or other cryptocurrencies. Therefore, the threat of substitutes is medium to high.

2.9 Porter’s Five Forces Industry Environment—Threat of Rivalry

The threat of rivalry is medium.

The money service industry is highly competitive. PayPal competes “against a wide range of businesses, including banks, credit card providers, technology and ecommerce companies and traditional retailers”.9 PayPal mainly competes with Square, Stripe, Visa, Google Wallet, Shopify Payments, Amazon Pay, and Ali Pay. Numerous competitors allow companies to go undetected and lead the way to better services. This can be a rewarding opportunity for companies if they can continue to innovate and attract new users. Fast growth in the industry allows competitors to focus on developing their platforms to provide services rather than fighting for market share. Consequently, the industry has low fees and switching cost. The only burden for merchants and consumers to make the switch is downloading the new platform.

Despite stiff competition, PayPal achieves product differentiation by integrating its platform with thousands of e-commerce websites and by developing strategic partnerships. Recently, to further its product differentiation, PayPal has integrated its platform with Facebook, a social media platform, to help facilitate peer to peer transactions on local goods/services.10 PayPal has also partnered with Acorns, a hot investment app that is popular among Millennials, to contribute investment capital and monitor their investments directly from PayPal’s platform.11 Strategic partnerships like these, allow PayPal to increase their access to distribution channels, providing product differentiation. Therefore, the threat of rivalry is medium.

2.10 Porter’s Five Forces Industry Environment—Threat of Buyers/Users

The threat of buyers is low to medium.

Between 2015 and 2016 financial institutions experienced a 40% increase in the number of data breaches and a 68% increase in the number of network disruptions caused by hackers.12 For fear that their financial service provider may get hacked, consumers are demanding higher quality platforms that are more secure. As mentioned earlier, low switching costs can lead consumers into more reliable and secure MSBs. This increases the bargaining power of buyers. However, since there is a large quantity of spread out users, this lowers their power. Buyers do have alternatives like Bitcoin, but they are not widely accepted and used by the general population. Therefore, the threat of buyers is low to medium.

2.11 Porter’s Five Forces Industry Environment—Threat of Suppliers

The threat of suppliers is low.

PayPal offers a wide range of financial services and needs to be supplied with internet and data services. PayPal suppliers include companies offering servers, cloud storage, power, data centers, software, hardware, middleware, technology, and office supplies. The supplier group is dominated by a few key players such as Amazon Web Services, Microsoft Azure, and Google Storage, and Equinix. These suppliers offer a service that is pertinent to PayPal, but since the suppliers are concentrated, they compete to supply PayPal. Total payment volume in 2016 was $354 Billion in over 200 countries, which translates to millions of petabytes of data. PayPal is a valuable buyer for their products. Therefore, the bargaining power of suppliers is low.

This concludes Porter’s Five Forces Model.

On the next page, is an overview of the opportunities and threats constructed using the general environment analysis and Porter’s Five Forces Model.

Figure 1 Overview of Opportunities and Threats