Friday, July 30, 2010

Benefits of closed-loop payment networks

I was surprised to note the continual downward trend of fraud figures reported by PayPal (see graph [includes some interpolation]), including their recent figures of 0.18%, which is about 1/3rd less than comparable figures with Visa/MC.  This is one of the obvious value-adds of closed-loop payment schemes.  PayPal is an example of a [dominantly] closed-loop scheme, in which the merchant and the consumer use PayPal for payment, thereby making it easier for the scheme provider to detect fraud.

Merchant Discount Rates (MDR) for online retailers are about the same, for either open-loop schemes (e.g., Visa, MasterCard) or their closed-loop counterparts (PayPal, Amazon...).  In addition to the MDRs paid by online retailers, they also incur costs associated wtih charge-backs, shopping cart abandonment...  This can add another 1% to the costs of accepting online payments.  In case of closed-loop schemes, IF you follow the rules, the scheme provides you a payment guarantee at no additional cost.  This is a big allure to online retailers.

As you would be aware, fraud rates of less than 0.5% was part of the differentiation in PayPal's business model.  Needless to say, skeptics take these published numbers with some amount of salt.

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