FOOL ON THE HILL
MasterCard's Mysterious Move

MasterCard says it will soon put a halt to third-party transactions, shutting out such popular services as PayPal. The company says it's trying to curtail fraud and identity theft, but other card issuers are managing without such drastic measures. In the end, the move might hurt MasterCard more than anyone else.

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By Rex Moore (TMF Orangeblood)
April 22, 2002

There is some unease floating about in e-commerce land this week. Last Friday, USA Today ran a story on MasterCard's intentions to put a halt to "third-party" transactions as of May 1. If the plan takes effect unaltered, companies like PayPal (Nasdaq: PYPL) could suffer a serious revenue hit, and the repercussions will be felt by such giants as eBay (Nasdaq: EBAY).

Background
According to the story, MasterCard will no longer allow its 15,000 credit card issuers to process transactions from third parties like PayPal. To explain this better, let's follow an imaginary transaction. Let's say light-hitting Cubs infielder Augie Ojeda decides to purchase an instructional batting video in hopes of improving his .201 lifetime average. If he buys from a merchant on the Internet and uses his credit card, the merchant is charged a fee by the card issuer -- typically 3.5%. There are also other expenses involved that drive the percentage per transaction even higher.

Now let's say Augie won the video on eBay (Nasdaq: EBAY) from a small seller who put the tape up for auction while cleaning out her basement. The seller, however, is not set up to accept credit card payments. Before PayPal, Augie would have had to send a check or money order in the mail. Before shipping the video, the seller would likely wait until the money order arrived or the check cleared, adding several days to the delivery time. Now, however, Augie can quickly establish a PayPal account (if he doesn't already have one), and pay the seller instantly. PayPal will simply charge his credit card, and forward the payment to the seller (who must have an account in order to receive the funds but that, also, is a simple matter).

A user can also pay via PayPal by having money withdrawn from either a bank account or an account set up with PayPal. Approximately 25% of payees use each method, and about half use credit cards.

If a credit card is used, though, PayPal incurs processing and interchange fees of 1.9% of the payment amount plus $0.15 per transaction. In turn, the company charges the seller anywhere from 2.2% to 2.9% plus $0.30 per transaction.

So PayPal, being cheaper and more convenient, allows thousands of small sellers to accept payment via credit card.

MasterCard's Decision
The USA Today story says MasterCard's change in policy is designed "to protect financial institutions and cardholders from fraud and identity theft." In a curious twist, a version of the story running on the Yahoo! (Nasdaq: YHOO) news service contains the following sentence:

"The change would not, MasterCard says, affect people who occasionally use third-party services to sell goods online -- only entities who sell goods or services ''on an ongoing basis,'' according to a MasterCard memo."

That sentence is now gone from the "official" story on the USA Today web site. Has the company changed its mind about "occasional" users? How does it define an occasional user? MasterCard is doing little to clarify the confusion. When I contacted company spokesman Alex Lau, he referred me to the following statement:

"MasterCard rules are designed to protect its cardholders, merchants and member financial institutions by ensuring, among other things, that all companies who hold themselves as a participant in the MasterCard system are entitled to do so. This requires that all MasterCard merchants have a valid agreement in place. More than 23 million merchants around the world accept MasterCard, and no card is more accepted. It is MasterCard's policy not to comment publicly on specific rules and requirements."

If the company won't comment beyond that, it leaves many questions unanswered. Namely, what exactly is the problem here? How will shutting out small sellers on eBay -- and the 25,000 websites that currently accept PayPal -- help prevent fraud and identity theft without throwing the baby out with the bath water?

Fallout
This issue has wide-reaching implications. Not surprisingly, PayPal stock dropped on the news, losing about 8% after the story broke. eBay also has some cause for concern. Not only does it operate a third-party service of its own, PayPal competitor "eBay Payments" (formerly Billpoint), but it also has to worry about PayPal being disrupted. That service is wildly popular on eBay, offered as an option in about 71% of all auctions, while eBay Payments is offered in only a quarter of auctions.

Put simply, if people can no longer use MasterCard to pay via PayPal, it seems logical that both eBay and PayPal will lose some revenue.

But how much revenue is the big question. Although PayPal dropped on the news, an 8% dip isn't exactly dramatic, and it has since recovered some of that. eBay's stock wasn't affected at all. Perhaps the mild reactions suggest investors feel PayPal will be able to strike a deal with MasterCard. Indeed, the newspaper story says PayPal is working hard toward that end.

Another possibility is that folks see that MasterCard is shooting itself in the foot with this issue. Visa and American Express are still allowing third-party transactions, fighting fraud and identity theft without halting third-party transactions. Unless either of them follows up, MasterCard may decide to reverse course. After all, if you're ready to pay for the set of 1968 Ford Mustang hubcaps you just won on eBay, and PayPal won't let you use your MasterCard, you'll switch to Visa if you have one. If not, you'll likely get one, while cursing MasterCard under your breath.

I'll leave it to a member of our Fool Community to sum it up. "My MasterCard just went bye-bye, and I don't even own any stock in PayPal yet," said cookedstock. "I just want to be able to use it, when I want, with my credit card. I don't like the idea of MC shutting me out."

Rex Moore can't get enough of this new-fangled Internet thing. At press time, he owned shares of eBay. The Motley Fool disclosure policy is naturally sugar-free.