This paper examines the 2002 merger between eBay, the dominant online auction platform, and PayPal, the leading Internet payment service, for $1.5 billion in stock. It explores eBay's business model and growth trajectory, PayPal's controversial customer service practices and fee structure, and the strategic rationale behind the acquisition. The paper analyzes competing analyst views on the deal's valuation, shareholder reactions, legal challenges from both shareholders and Bank One Corp., and the implications for fraud protection. It concludes with broader reflections on product life cycles in the technology sector and the long-term sustainability of Internet auction businesses.
Growth in business comes from the joining of synergies to produce savings and, necessarily, growth — leading to better profits. eBay is one of the greatest creations of the Internet era in buying and selling, and it appears to be a continuously growing operation. The approach to potential users is extremely friendly; the site offers good-quality products that build customer confidence, and there is regular interaction between buyers and sellers that helps to advertise the site extensively. The user pays only a small fee for listing a product to be sold and then a further fee upon completion of the sale. It is possible to sell practically anything on the site, from old cars to baseball game tickets. The prices realized depend on consumer demand for the product.
The objective of the site is to meet the miscellaneous requirements of consumers, which is reflected in the fact that there are over 100 million items listed on the site at any given time. PayPal, on the other hand, is a funding organization for sales and purchases on the Internet through eBay. It was not originally a part of eBay, and financial transactions could be completed anywhere after a sale or purchase was made on eBay. With the merger, it was expected that both the buying/selling and the payment would be completed within the eBay ecosystem through the tie-up with PayPal. eBay and PayPal had always been complementary operations, and the merger was seen as something that could only help both platforms grow.
There are many reasons that can be attributed to the success of eBay. The company maintains no warehouses or inventory, which adds nothing to their expenses for storing items. Everything they sell exists only as entries on the Internet — physically, this amounts to a certain amount of computer storage capacity. Their computer operations are based on the latest programming, which enables them to track every auction conducted on the platform. They monitor all auction and trading activity on the Internet, keeping them in contact with all buyers and sellers. This knowledge is later used in the buying and selling of goods entrusted to them for sale.
The first step for anyone wishing to sell through eBay is to fill out the ready-made forms available on the site. Similar forms help potential buyers locate whatever they wish to purchase. There are no fixed terms that all parties must accept. Once an auction ends, the buyer and seller settle the deal regarding payment terms, shipping method, and shipping location. All these records are stored on the eBay site, which demonstrates to other buyers and sellers that the parties involved are reliable. The availability of this information also encourages further purchases and sales.
eBay employs as many as 2,400 people — more than most companies in the dot-com world. It has also become a highly profitable company, recording a total profit of $129 million in 2001 on a turnover of $740 million. This performance boosted the share price to a price-to-earnings ratio of 143. The market capitalization of eBay is very high — greater than the combined total capitalization of K-Mart and Sears. The company is still in an expansion phase, forming tie-ups with companies such as Home Depot to more effectively utilize available platforms. Capital market experts believe the company has existing potential to grow and develop further.
The concept of a site like eBay is especially ideal during the holiday season. The Internet operations of Yahoo had not been making much profit at the time, and even Amazon.com was only beginning to turn a corner despite enormous attention. Jeff Bezos, then a director of Amazon.com, and Tim Koogle, then a director of Yahoo, are on record as having praised eBay as a dream come true for the Internet world. eBay had adopted a business model that worked, with profits continuously increasing. The profits for the third quarter of 2002 were 24% higher than the results achieved in 2001. Even the devastating terrorist attacks of September 11, 2001 pushed down sales for only two weeks, after which they recovered. In every quarter there has been increasing sales, with the fourth quarter consistently the strongest due to the holiday gift-giving period.
Compared to the creative idea behind eBay's auction website, PayPal is only a payment mechanism, and it does not carry as strong a reputation. Once a person accepts PayPal's Terms of Service, that person automatically waives all rights under credit card consumer protection laws. In the case of credit cards, the customer is allowed to charge back anything they are not satisfied with — but this facility is not available under PayPal. The legality of this position is questionable, yet PayPal imposes it according to its stated policies.
It has been claimed that PayPal does not readily disclose its telephone numbers and provides only form emails for customers to contact them. Representatives have reportedly stated that the phone number is intentionally hidden. To find it, a customer must click on "Help" at the top of the webpage, then "Contact Us" at the bottom left of the next page, then "Customer Support Enquiries" near the middle of the following page, and finally "Help by Phone" in the Service Center section at the bottom of yet another page. Only then is the non-toll-free number displayed. In an era when people expect fast service, this is a particularly drawn-out procedure.
Beyond the difficulty of reaching customer service, PayPal does not clearly disclose its service conditions, nor does it inform potential users that all risks are borne entirely by the customer. This has led to situations where PayPal has withdrawn all money from a customer's accounts — not just credit card accounts but savings and other accounts as well. Due to the signed agreement, customers have no avenue of appeal. PayPal also does not respond meaningfully to customers it believes have taken questionable action, does not share the viewpoint of the customer, and does not provide details of any investigation conducted. A typical response reads: "Thank you for contacting PayPal. We apologize for the delay in responding to your service request. After review, the decision has been made to keep your account locked. This decision cannot be appealed." There is generally no further correspondence.
PayPal holds customers responsible if someone pays them with a fraudulent credit card, and has stated it will treat such an account as engaging in criminal behavior and will confiscate any money held in that account. The same consequence applies when a customer disputes a charge made by PayPal.
The cost of funding through PayPal is also high, at 2.9% plus $0.35 per transaction. This compares unfavorably with bank charges of approximately $0.05 to $0.12 per check processed, money order charges of roughly $0.50 to $1.00, and decent credit card rates of about 2.3%. PayPal's total charges amount to approximately $3.00 per $10 transacted — once very cheap, now quite expensive.
A further concern is that PayPal applies the same fee structure to non-credit transactions as it does to credit card transactions. A fee on credit card deals is understandable, since the card issuer will charge fees to PayPal and credit card fraud is common. However, when a payment is made from one PayPal account directly to another, no credit card is involved — the money simply moves from one account to another as a computer entry. Yet the same fee applies. These types of transactions generate significant revenue for PayPal while requiring minimal actual service.
Ultimately, eBay decided to acquire PayPal's stock for a total consideration of $1.5 billion, which gave rise to considerable controversy over the price fixed. It is true that these companies share many common areas of operation — something that was not present in other mergers occurring around the same time, such as the AOL–Time Warner merger, which combined a content provider with a content distributor. The result of that deal was plain for everyone to see: a quarterly loss of $54.2 billion. One reason for that outcome may have been that the two companies had little prior interaction before merging. This was not the case with eBay and PayPal. PayPal had already handled a large volume of transactions for eBay, leading AMR Research analyst Louis Columbus to conclude that for the majority of eBay customers, PayPal had become the de facto payment service — making eBay's acquisition of PayPal a comparatively lower-risk move. He believed the price paid was fair, though he still felt a higher price would have been undesirable.
"Analyst debate over merger price and rationale"
"Shareholder vote, lawsuits, and DOJ review"
"Expanded fraud protection and consumer unease post-merger"
One well-known management consultant used to say that any business organization is like a living being — it takes birth, grows, reaches maturity, and then finally declines. This pattern has been observed across all industries and even in the broader industrial development of entire countries, and it holds true at the level of individual companies. Consider IBM: that company dominated the world of computing for decades, but after the advent of personal computers it was never able to return to its earlier position of total dominance.
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