Dear friends,

In JC’s Newsletter, I share the articles, documentaries, and books I enjoyed the most in the last week, with some comments on how we relate to them at Alan. I do not endorse all the articles I share, they are up for debate. 

I’m doing it because a) I love reading, it is the way that I get most of my ideas, b) I’m already sharing those ideas with my team, and c) I would love to get your perspective on those. 

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I want to share a great book that provides a behind-the-scenes look at the early days of e-commerce and the rise of PayPal as a major player in the online payment industry: The Paypal Wars, by Eric M. Jackson.

With its intense competition, legal battles, and lessons on building a successful tech company, this book is a must-read for anyone interested in technology and entrepreneurship.

I strongly recommend to buy it and get your business to the next level !

🔎 Some topics we will cover this week

• How Paypal used referrals at scale to fuel growth.

• Understanding the need for working with influencers is key to avoid an epic fail.

• How to leverage another platform to maximise your growth, like Paypal did with eBay.

• The intense competition in the online payment industry and the challenges PayPal had to face.

• The challenges of scaling a business, including the importance of unit economics and profitability.

Growth

Referral 

❓ Why am I sharing this?

• PayPal is known for being the first one to use referrals at scale to fuel growth.

• Knowing their story and how much it cost us is a good playbook for companies.

I opened the inbox of my personal email account and I came across an unusual message. The e-mail’s subject line curiously exclaimed “PayPal User Beamed You Money!” The title sounded like spam—I had never heard of PayPal before. But given the lack of competing demands for my time at that moment, I opted to see what it was about. “Ken Howery has just Beamed you Money!” the message’s text read. “You now have $1.00 waiting for you at PayPal. Visit www.PayPal.com to set up your PayPal account today!”

The cost of referrals

Then there was the matter of cash. Despite raising $23 million the prior month, our rapid user growth meant that we were paying out over $100,000 per day in bonuses to our customers.

Scotty event failure

❓ Why am I sharing this?

• You need to understand why you work with influencers and what difference it makes to your business, otherwise you have a risk of an epic fail.

PayPal.com introduced James Doohan—widely known for his role as “Scotty” on Star Trek—as the company’s official spokesman. “I’ve been beaming people up my whole career,” Doohan quipped, “but this is the first time I’ve ever been able to beam money!” While remarking on PayPal.com’s cutting-edge technology, Doohan also stressed how easy it is to use… [H]is“Scotty” character may have explored the frontier of space, [but] James Doohan and PayPal.com are heralding a new frontier of wireless, person-to-person payments.

[...]

The following day our extravagant room at the Saint Francis was sparsely populated. Confinity employees outnumbered the media four-to-one. And none of the half-dozen reporters who stopped by to munch hors d’oeuvres went on to write about the event. 

Loss leader product 

❓ Why am I sharing this?

• Having a loss leader product that you can leverage then to upsell customers is also a good strategy, especially in a world with a lot of incumbents. 

X.com also generated some additional buzz toward the end of 1999 with a no-fee, no-minimum balance S&P 500 index fund, the only one of its kind. This loss leader product had been rationalized as a way to attract new users who could be up-sold to X.com’s other financial products, including its bond and money market funds, interest-bearing checking accounts, and low APR credit lines. 

eBay headers

❓ Why am I sharing this?

• How to leverage another platform to maximise your growth? That was the key element of success for PayPal.

As it turned out, including a reference to PayPal in an eBay auction was simple. While the top of an eBay auction is a standardized header that includes the auction title, the seller’s feedback rating, and the high bid amount, the body of the listing is customizable. With some simple HTML, a seller can design unique backgrounds and images for his listing. Item descriptions can be long and detailed, often running the length of several screens, or as terse and direct as just a couple of sentences. 

The race

Tempo

Peter instructed Jamie to have the engineers get the “dotBank features” live on PayPal’s site before anyone took time off for Christmas, by then less than a week away.

Competition

❓ Why am I sharing this?

• Seeing the dynamics about how the competition reacted, why they were forced to merge, how they ended up being acquired by eBay is a fascinating business story.

• At the end, you win if you have superior product & distribution. How to build both is the job of companies. 

Outgrow them

For their part, Sacks and the rest of the management team stressed the need to focus on live opponents like X.com and dotBank and not worry about hypothetical future competitors. And the way to beat those opponents was simply to outgrow them.

eBay reaction

The prospect of saving money attracted a fair amount of seller attention. Within the course of a day, Billpoint’s penetration of all eBay listings rose from under 1% to 10% of eBay’s 4 million auctions. To put this gain into perspective, this free listing day propelled Billpoint to a listing share level that took PayPal a month to reach after we began focusing our efforts on eBay. It was utterly demoralizing.

Focus on product

Our primary focus remained on developing the product and with good reason—it offered a true competitive advantage over Billpoint. EBay could always outspend us on ad purchases and throw dozens of marketers at sophisticated campaigns, but its ponderous pace over the past twelve months indicated that eBay could not innovate as quickly as we could.

Growing pains

❓ Why am I sharing this?

• Exponential growth has a cost. Knowing very well your unit economics and how to get to profitability is the mantra of scale-ups right now. 

• Understanding the playbook of Paypal for price increases in this context can be useful to some companies.

Cash burn

The sea of red ink produced by the company’s operations rose in tandem with the thousands of new users signing up for PayPal. Our burn rate averaged $10 million a month in the second quarter and continued to increase. [...]

With our average daily payment volume reaching $4.6 million, up 70% from the prior period, it meant we were losing $150,000 every day just from ordinary business operations. As Peter’s $100 million in venture capital began to dissipate, Elon realized that X.com was living on borrowed time. [...]

We had racked up $92 million in operating losses through the first three quarters of the year against revenues of just $6 million. CNET, The Red Herring, and other media outlets had every right to sink their teeth into a company with such a dangerous burn rate, especially since 4 million customers depended on our service. 

Margin

During the second quarter, the margins on PayPal transactions plunged to a jaw-dropping -3.5%. The company paid about $2.50 in credit card processing fees and lost another $1.04 to fraud on every $100 in payments that flowed through our system. 

Price Increase and stickiness

The text explained that since Visa and Mastercard charged paypal a fee every time we processed a credit card transaction we could not indefinitely afford to provide a free service to our sellers. 

Customer reaction was intense. [...] 

Despite some customer backlash, about one-fifth of our targeted sellers voluntarily upgraded while only 0.1% closed their accounts.  [...]

We agreed it was critical not to block credit card payments to sellers who surpassed the receiving limit—this would disrupt their operations before they even had a chance to choose whether or not to upgrade. Instead, buyers should be able to continue sending payments to sellers who had passed the limit with those payments classified as pending and the funds held in limbo until the seller opted either to accept or to reject them. Accepting the payments would upgrade the seller’s account while rejecting them would refund the money and send a notice to the buyers that the seller needed to be paid a different way.

A deluge of complaints triggered by the announcement poured into our customer service center and onto every auction message board. The bait-and-switch allegation that we had heard when we first hinted at a forthcoming policy resurfaced. 

While many sellers voiced loud objections, the initial furor gave way to grudging acceptance. Obviously none of these small business owners were enthusiastic about paying for a previously free service, but they understood that PayPal needed to book revenue to survive.

When Paul activated the enforcement of the new policy later in October, the rest steadily began to upgrade and, within a month’s time, 95% of the targeted personal accounts had switched to business status. 

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