Payments Views


How Tolerance for Risk Can Really Affect Outcomes

Recently, I’ve been studying innovation in payments – trying to identify the factors that influence market success (rare) vs. market failures (much more common). Certainly, the story of PayPal (as the most successful payments innovation in a long time) is at the center of my analysis.

On his Redeye VC blog, First Round Capital’s Josh Kopelman writes from his days behind the eBay corporate curtain about the days in the early years of this decade when BillPoint and PayPal were slugging it out in a contest about who was going to end up winning the online auction payments market. With his comments, Josh illuminates a fascinating case study in innovation in payments.

Josh says:

“There are many reasons why PayPal won — but I think it really came down to the differences in “risk tolerance” between a startup and a large public company. … It was clear to me (from inside eBay), that the Billpoint team knew exactly what they needed to do in order to offer a comparable product to PayPal. They just were unwilling to accept the risks of doing so.”

I have often told friends that I’m sure the venture investors who funded BillPoint were proud they had been able to recruit such an experienced team of former bankers. It’s that team who eBay acquired when it acquired BillPoint less than a year after BillPoint’s founding.

As it often turns out, the “tyranny of the experts” – those of us who know all the reasons things just can’t be done the way the market seems to be demanding – are responsible for restraining innovation rather than fostering it. Sometimes, we just know too much and seek to “manage” (reduce or eliminate) risk – where that risk is a core component of the actual market opportunity!

This is, of course, especially hard in financial services – as the regulatory regimes can certainly be daunting. What’s the latest example? Our friends in the peer-to-peer lending space who found a Federal regulatory (the SEC) very focused on their particular innovation and attempt to remove friction and enable a more market-driven response.

Think about your own experience – where and when were you most innovative? Was it when you knew enough – but not too much, when you weren’t worried about corporate rules, etc.? Or, when you were the expert, part of a big company, navigating the political waters? Eh?

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Philip Andreae
11 years ago

Great to see that the idea of risk acceptance still drives success and profit. I look forward to following your discussions on payment innovation and look forward to finding interesting organizations. In particular Mobile Money Transfer and International remittance is one domain that I would suggest be part of your review.

I would also be interested in reading on the global implications of regulatory oversight of interchange and teh growing consumer reaction to credit card fees in a time when banks, derivatives, sub-prime mortgages and other overly risky and imprudent products have created the economic calamity we hear about each day. Will this drive Card issuers to focus on increasing credit/debit card revenues to shore up their balance sheet at the expense of the consumer.

Then products like PaymentFlex are driving banks to look at how they manage revolvers with interest rates that feel more like a line of credit.

Rich Brennan
11 years ago


I agree that risk tolerance is a requirement for true breakthrough innovation and that sometimes too much knowledge is not a good thing. In the past we used to seed teams with really smart individuals that did not have deep experience in a particular functional or technical area to try and break some of the constraints put in place by the ‘old guard’. Sometimes it worked and sometimes it didn’t.

Another missing ingredient of innovation inside of large or established companies is consequence. In other words, if this product doesn’t truly take the market by storm what is the consequence. In a large company the team would move onto other initiatives inside the corporation and continue to draw a paycheck. There is limited consequence to failure – or being a close follower to the market leader. In a start-up failure is met by reduced funding from investors (or customers) and no paychecks.

Clayton Christensen’s books Innovator’s Dilemma and Innovator’s Solution do a great job of explaining why established corporations can rarely create sustainable innovation. Great topic and I look forward to reading more on it.

Tom Cleveland
11 years ago

Scott –

Your hypothesis has even more credence if you go back to the market reasons that fostered the creation of BillPoint and PayPal. If you recall, the banking establishment refused to modify their “Card Not Present” rules related to card usage on the Internet during the early days of online shopping. Their reason was that they had no tolerance for the risk that would surely evolve from the merchant community at that time. Their reluctance provided the “loophole” for someone willing to “arbitrage” that risk barrier to consumer acceptance. PayPal and BillPoint merely inserted another level of cost in the process, but provided the convenience to consumers, a benefit that was ultimately rewarded by the marketplace.

And where are our wonderful “risk taking” bankers today? Not only did they allow a predator into their payment business, lose valuable transaction fee revenue, and miss out on a chance to support the cross-border payment needs brought on by globalization, they now must clean up their mortgage-backed securities fiasco, not to mention their growing credit charge-offs in their card programs. But, that is the history of banking in the United States – build a successful service, then milk it for all its worth, without ever looking ahead or tolerating the risk it will take to innovate and compete.

John MacAllister
11 years ago

Great post. Back when I was a banker before deregulation we had a senior credit officer who used the time-worn phrase “rate, term, and conditions – we can afford to concede on two but not three.” Conceding all three is what got us the mortgage melt down; conceding none led to BillPoint’s early exit. If we’re lucky, the Fed/FDIC’s PPIP will be successful through adherence to my old colleagues bromide. Otherwise, maybe not.

Broox Peterson
11 years ago

Interesting questions, Scott. I am interested in understanding the extent to which payment industry innovation will be harmed by increasing pressures on pricing practices, especially Association issuer reimbursement fees. I have wondered for some time whether the reduction in those fees will adversely impact the ability of future alternative payment systems like Paypal to achieve lift-off. The level of current Association interchange reimbursement fees provides a nice cushion of pricing flexibility for start-up payments providers that might disappear if the issuer reimbursement fees are greatly reduced. Another interesting aspect of payments innovation is the extent that it relies on and sometimes exploits existing infrastructure. Paypal did this initially by using credit cards as a funding mechanism, ironically “innovating” within the context of the credit card in a way that the Associations would (could?) not. Paypal broke a few eggs on the way to its success, and although suffered regulatory consequences in one instance (failure to obtain money transmitter licenses because “we’re different”). The money transmitter licensing laws are probably the most anti-innovation laws on the books, since they are ambiguous, onerous, disproportional, and a deal-killer for small start-ups that need multiple state licenses. Luckily there are ways to structure a business model in payments to comply without great expense. So in a sense, lawyers can actually promote innovation! Extremely counterintuitive, eh?

Scott Loftesness
11 years ago

Wow, thanks very much for sharing your comments! Some individual responses below.

Philip – it sure seems like M-Pesa in Kenya is the star performer in terms of mobile money transfer success. Remittances seems much more of a legacy space – with the big players (WU primarily, also Moneygram) holding their own – even with their “price umbrellas” under which many new entrants have tried to find success.

Rich – yes, the corporate intrapreneur frequently isn’t as fully committed as the startup entrepreneur. Reminds me of the old comparison between the chicken and the pig – the pig being fully committed but the chicken is only “involved.” I remember talking with Dick Kramlich from NEA years ago. He shared his feeling that investing in great “open field runners” was the key – entrepreneurs who were wed to their original business plans more often than not failed.

Tom – thanks for extending the timeline back to what the card incumbents were doing (or not doing) and how that created a vacuum that the new entrants were able to fill! At the time, there was a lot of effort being poured into SET – a major market failure indeed. In my opinion, much of the reason SET was so heavyweight and failed was that it tried to solve too may problems – ironically including blinding the card account number details from eCommerce merchants! Now we have PCI-DSS in response.

John, your three dimensions remind me of the old software developer maxims re: schedule, cost and functionality!

Broox, yes – agree with you that today’s interchange rates provide a “price umbrella” for new entrants – particularly when they can arbitrage the ACH. More trouble is your comment about the money transmitter laws and the patchwork quilt they represent. Combine that with the SEC’s recent actions taken in the P2P lending arena and you could get pretty pessimistic about the hurdles on the road to success for new entrants.

Albert Drouart
11 years ago

A couple of thoughts come to mind: innovation is helped with diversity, and riding the edge is important.

Building on Broox’s comment about lawyers being the ones who might be a source of innovation, and also the idea that you know too much to innovate; I think the role of the “outsider” or contrarian is very powerful in driving innovation. Not an outsider that doesn’t share experience in the domain/space being thought about, but an outsider who might see the friction points of the market/problem differently. I think what it boils down to is building groups that are diverse, but deeply experienced where all parties respect each other. You always need the smart banker, and the smart lawyer, and it is in having both of them in a room where it becomes clearer where the opportunity might be and how to solve it. In my experience, as I’ve moved from pure tech, finance to payments with many stops in different startups along the way, it’s been about getting diverse intelligent teams and being prepared to execute (which is perhaps a different group of people 🙂 ) once the sparks fly.

Second thought is that you need to ride the edge… most of the boundaries legal or otherwise are mutable, and those that are willing to crawl, walk, run in quick iterations can sometimes be positioned to define and change the space rather than be held back by the “rules”… Easier said than done!

Broox Peterson
11 years ago

Well said

Leslie Michelassi
Leslie Michelassi
11 years ago

Scott, this was a great and thought provoking post. I also was impressed with Tom Cleveland’s statement
“Their reluctance provided the “loophole” for someone willing to “arbitrage” that risk barrier to consumer acceptance.”

I believe we will see many new innovations in the coming year or two from just such people who are able to arbitrage the risk barrier for consumers no longer fitting squarely in to the “perfect” customer definition as our economy continues to deteriorate. This is very fertile ground for great ideas to be planted and fertilized and some of our larger institutions may not be able to respond rapidly enough to catch this next wave.

Thanks, as always for you insight, Soctt.

Leslie Michelassi