Tuesday, July 09, 2002

Why did eBay buy PayPal and Billpoint About six months ago, eBay bought online payment system Billpoint sending rival PayPal's stock price down 15%. Six months later, eBay buys PayPal anyway. Why?

PayPal was clearly the prefered way to pay for goods on eBay, but that alone does not explain why the two should integrate. After all, eBay offers other payment options and would clearly like that complementary function to be commoditized. But the eBay user experience, while not great, could be improved by better integration with PayPal ( combined eBay/PayPal accounts, for example) and owning the company makes that easier to do. eBay initially hoped to do this with the cheaper Billpoint, but when that didn't work out, they stumped up for PayPal.

Another reason is that PayPal's large number of established accounts gave it some pricing power through charging higher service rates, just as eBay's market power for unique items lets it charge higher auction rates, and summing the two markups lead to higher prices than was optimal for the system as a whole. eBay corrected this by buying PayPal and (I'm guessing) will lower the (combined) transaction prices.

The harmful effect created by stacking monopolies on top of each other is called double marginalization and is fixed in a free market by one monopoly buying the other. Essentially, as monopoly markups sum linearly (x), the sum of the harm they cause grows to the square (x^2). By one monopoly buying the other, they can eliminate the double markup and merely charge a (lower, less harmful) single monopoly price that is also more profitable for the monopolist.


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