Alternative Payment Methods Part II: How To Evaluate

Editor’s Note: This is Part 2 of a two-part series on alternative online payment methods. The author is Michael E. Shatz, a consultant and an expert on online payments. Part 1, “Alternative Payment Methods Part 1: What Are They, How Do They Work”, defines alternative payment methods and explains the two major types. Part 2, below, evaluates the claims made by each method, to help merchants identify which, if any, of the methods could help them.

Because many alternative payment methods use differing metrics, it can be difficult to determine which payment will prove most beneficial. I generally have two pieces of advice for most of my merchant customers. First, understand the meaning of the claims and how they are measured. Then, before committing to any vendor, validate these claims by speaking with others using the same payment method. Let us start then by quickly reviewing these claims.

Typically, all of the major alternative payment methods (APMs) make claims similar to those listed below. They typically assert that the APM:

• Increases the merchant’s sales volume
• Increases the merchant’s average order value (AOV)
• Increases the merchant’s checkout conversion rate
• Increases consumer purchase frequency
• Lowers the merchants transaction fees
• Enjoys a large consumer base
• Enables a merchant to offer consumers a more secure way to shop
• Enables a merchant to offer consumers an easier way to shop

The following chart depicts some metrics that these companies have made public, either on their websites, in promotional literature or through interviews with the press (including Practical eCommerce). Unless otherwise noted, the source of the metric is from the particular APM’s website and reflects a blanket claim. Grayed-out cells indicate that the data was not readily available, or only available in particular case studies. In the case of transaction fees, “N/A” indicates that fees for the service approximated the cost of processing credit cards.

Understanding a Claim: An Example

There are two types of claims that most alternative payment providers assert: (1) sales increase, and (2) processing fee savings. As we will see, sales increase claims are frequently considerable, so payment processing fees – which are usually orders of magnitude lower than the average sale – are not nearly as significant. Still, in some cases, fees should not be overlooked.

The biggest claim made by most of the APMs is that use of their service will increase a merchant’s sales, also known as sales “uplift.” This is a good example for us to demonstrate what we mean about understanding claims. On its website, for instance, PayPal claims “Small-to-medium-sized businesses get an average sales lift of 14% by accepting PayPal.” This claim is based on a, “Q1 2006 PayPal phone survey of small- and medium-sized business doing a minimum of $120,000 USD in annual online sales.” Bill Me Later, on the other hand, simply claims that, “33% of Bill Me Later sales are incremental to the merchant.”

It appears that we are comparing two different metrics, incremental sales for Bill Me Later versus average (or presumably overall aggregate) lift for PayPal. The Bill Me Later claim leaves us wondering, “33 percent of what total uplift?” In fact, we would need to know both metrics for each APM to understand how they stack-up together.

In other words, if Bill Me Later sales accounted for 10 percent of a merchant’s overall sales and 33 percent of that 10 percent are incremental (or new) sales, that would mean that Bill Me Later produces a 3.3 percent (33 percent x 10 percent) sales uplift, versus PayPal’s claim of a 14 percent uplift.

So, the following claim would be much more meaningful: “BestAPM delivers an average sales lift of 12 percent, of which 75 percent is incremental [new customers] to the merchant.” Although this is easy to understand, it is also potentially ominous. What this tells us is that 25 percent of the average sales lift occurred when customers switched payment types. This is known as cannibalism, and can affect the average payment fees a merchant pays, and can also introduce some more insidious consequences. In particular, merchants utilizing recurring payments should be cognizant of the fact that under certain circumstances APMs can cause relatively high refund rates. Higher refund rates can undermine the lifetime value of customers. This is discussed in further detail in The Merchant’s Guide post, Alternative Payments and Credit Card Cannibalism.

Payment Processing Fees

Given that claimed benefits surrounding sales uplift with APMs are so significant, and that on average the associated fees are orders of magnitude lower than these sales increases, fee savings only come into play in marginal situations. The chart above depicts pricing from three popular brands.

Assume that we are examining a merchant selling $50 items whose base annual sales were $110,000. This merchant then experienced an incremental sales lift of 10 percent due to an APM, resulting in sales of $121,000. The transaction savings on this incremental $11,000 would amount to only $132 (1.20 percent) for Bill Me Later, and $22 (0.20 percent) for Google Checkout. Even if the uplift were not incremental, the merchant would still save the same amount of money on transaction fees with these APMs. So, although savings are touted as a benefit, only the largest merchants would see any meaningful benefit in absolute terms.

The only caveat is with APMs that include relatively high per-item fees. This portion of the rate has a negative impact on merchants selling products with low average ticket values. Using the rates above PayPal and Google Checkout, merchants would have zero cost savings selling items at $25.00. Those selling items at $10.00 would see an increase transaction cost of $66 (0.60%) on incremental sales of $11,000. Again, this is meaningless given the magnitude of incremental sales. This would only have an effect on very large merchants where the APM uplift came at the complete expense of cannibalized credit card transactions. So, as it turns out, claims regarding lower fees should not be overly scrutinized.

Summary

In summary, there is no general advice regarding APMs that will apply to all merchants other than due diligence and testing. Merchants should focus on incremental sales uplift, while measuring cannibalism rates. Merchants should also pay attention to conversion rates and benefits related to integrated keyword advertising programs. Certain features like paying over time, security, privacy, and ease of use will appeal to certain customer demographics. It’s up to the merchant to understand the claims, know its customers, and seek advice from others who have successfully implemented APMs.