Discovering PayPal’s Golden Niche
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The announcement that Discover Financial Services (NYSE: DFS) will now make it possible for PayPal, a unit of eBay (NASDAQ: EBAY), to be used in stores seems to have received only tepid excitement. Much of what has been written about the deal seems to focus on the problems consumers have had with PayPal in the past, and the expected barriers to adoption that exist. While many of these positions have merit, the real genius of the deal seems to have been overlooked. In addition to allowing the company to take aim at the digital wallet plans of Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOG), the partnership opens up a completely new niche to the retail sector that should not be ignored.
Before exploring the real potential of this partnership, it will be useful to consider and address the two primary arguments as to why the news is of limited interest: historical problems with PayPal and barriers to adoption. A recent article in The New York Times, “Some PayPal Users Criticize Antifraud Measures,” detailed several examples of instances in which PayPal users had funds held by PayPal and the cascading problems the hold caused. While it may seem too expedient to gloss over these problems by noting that any burgeoning technology is going to face growing pains, the answer is essentially that simple. The company’s track record is not without fault, but as its visibility grows, not only will these issues be addressed, they will be corrected at an increasing rate. If not, as is the case with any company, the rest of the conversation is for naught.
The concern over the adoption rate centers around the fact that existing PayPal account holders will need to obtain a card from Discover before the process will be complete. There are plans to allow these consumers to access their funds more directly, but that is the second phase of the rollout. The answer to this concern, addressed in far greater detail below, is that the consumer group most likely to use this technology will both take the needed step and be early adopters of the digital wallet version. As a small preview companies, including Aeropostale (NYSE: ARO), are already accepting PayPal, both online and in stores. The company reports great success with this option, as well as with promotions centering on the progressive payment method. For example, this summer, the company offered customers $20 off purchases of $100 or more when payment was made through PayPal.
The Golden Niche
The group that is most likely to use this technology and to become early adopters is not large corporate clients, or even seasoned consumers that are already armed with several major credit cards. The segment of the consuming population that is likely to quickly transition to this form of payment is teenagers and young adults. Suddenly a group of consumers that had to rely on cash or collaboration from their parents to obtain a credit card will be able to head to the mall and buy things in a new, progressive way.
I am not prone to personal anecdotes in this context, but in this case it applies too well to ignore: In a recent back-to-school shopping trip with my daughter to Aeropostale, when it was time to check out, she saw the “PayPal Accepted” sign at the register and asked if we could just “PayPal it.” In my amazement both that she was aware of PayPal and that it might be becoming a verb – just as googling has – I asked why she cared. “It’s just cooler, dad.” There ends the lesson. If the teen population adopts even the concept, not only will they use it as a method to pay themselves, they will put pressure on their parents to adapt and grow with the technology.
The Digital Wallet
Another reason that this news deserves far more attention than it has received is that the digital wallet has the potential to be the next big thing for both Apple and Google. Apple is particularly in need of this type of catalyst, but the competition in the space is fierce. Where Apple is centering its efforts on iTunes becoming the central hub around which the digital wallet is constructed, Google is taking a different approach with plenty of potential. With these two behemoths battling for supremacy in this critical growth area, if PayPal can gain the first mover advantage, it may derail the efforts of the others, or, at least give PayPal the chance to define the space on its own terms.
Given the importance of this development, initiating a position in either Discover or eBay can be well justified. Discover looks particularly attractive at current valuation levels, especially given the differentiation element that this development gives to the company. While it will be important to vigilantly monitor the development process between the two companies, this is investment-worthy news that should not be allowed to quietly slide into the background.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Aeropostale, and Google. Motley Fool newsletter services recommend Apple, eBay, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.