How does PayPal Wallet work?

My focus is to review the two implementations of the digital wallet PayPal is currently developing/implementing for off-line shopping and how the company's acquisitions will help enrich the experience.  This means not discussing other PayPal efforts in the mobile space such as PayPal Here.  

PayPal Wallet on PayPal Rails - This is the implementation of PayPal Wallet that is currently available to be used at Abercrombie & Fitch, Abercrombie Kids, Hollister California, The Home Depot and Jos. A. Bank.  

1)  It is a cloud-based digital wallet that you can access at the merchant's point-of-sale by entering your phone number + password or swiping your PayPal card + password.  The phone number and the card are just different ways of entering the token that identifies a wallet in the cloud (there is a unique link between an ID and a wallet).  The password is the way to authenticate the user. 

In fact, the cloud-based digital wallet I am talking about is the same PayPal account that many of us are accustomed to using for certain online transactions.  Allowing users to access it at the point-of-sale is a 'natural' extension of its traditional functionality, although it requires new technology and new partnerships to implement.

2)  Off-line transactions, just like on-line transactions, travel on 'PayPal's rails' and are also processed by PayPal.  Changes in the software running in the point-of-sale devices and in the middleware that connects the merchant with its processor, along with back-end integration with the merchant systems, is what allows acceptance of phone number + password and the direct connection between the merchant and PayPal.  

PayPal's agreements with hardware manufacturers - such as Verifone and Ingenico - and middleware providers - such as AJB - have made this system possible.

3)  PayPal is the merchant of record for all transactions.  In fact, in the 'Account Activity Summary' (step number six in the app sequence provided at the end of this post) the user can see all the steps the payment process goes through.  First, it is instantly authorized by the issuer of the card linked to the account.  Hours later (as part of a batch process), there is first a cash transfer from the card issuer to a PayPal account and then a cash payment from the PayPal account to the merchant account.  

The graph below illustrates this process - in a very simplified manner - using the example of MasterCard as being the preferred method of payment.

4)  It is not an NFC-based solution.  PayPal is developing a truly digital wallet, not a mobile wallet.  As such, the company wants to enable users to pay without using any device (as is the case with phone number + password), which precludes it from utilizing NFC technology.  

One could easily argue that swiping a PayPal card breaks this paradigm but, most likely, allowing for this method of payment is just part of the educational process.  The company's first priority is to teach consumers to think about PayPal when paying at the store, swiping is what most people are comfortable with doing.  

Another reason that may be behind the issuance of the cards is that only the most advanced POSs can support the upgrades required to accept phone number + password as method of entry.  The changes required to accept the card are simpler.

Below are pictures of the PayPal card.

5)  The phone plays a limited role (please refer to the bottom of this article for a description of the steps required to make a payment using PayPal).  When checking out at a store, the consumer is interacting directly with the POS.  It is only after the transaction has taken place that the user will receive notifications on her phone regarding transaction status.  She will also be able to see a form of electronic receipt with full information on the merchant, amount paid (broken down by retail price, sales tax and other expenses such as handling, shipping or insurance) and item description.  

6)  The wallet can house loyalty / reward cards and coupons.  These benefits will be used automatically at POS.

Although the on-line account has been revamped for users of PayPal's off-line services, no options are yet available to set preferred method of payment based on merchant or amount.

PayPal Wallet on Discover Rails - This implementation of the wallet is enabled by the PayPal / Discover agreement made public on August 22nd of this year.    Let's focus on the differences:

1)  This deal enables PayPal to ride Discover rails once the system goes live (spring 2013), thus no new hardware or software is required for merchants to accept PayPal's card.  Loyalty, gift, coupons and offers will be easily displayed and redeemed through the wallet.

PayPal will continue to process the transactions.

2)  PayPal will issue payment cards to its more than 50 million active users in the U.S as soon as the deal goes live. The new card will have a Discover Issuer Identification Number, or IIN, a code that identifies the card holder, and will allow users to buy from the merchants that are part of Discover's network. All that the user needs to do is swipe the card at the existing check-out machine and enter a four digit PIN. 

3)  PayPal will charge merchants when users pay with the new cards, and, in turn, will pay Discover for access to its network, on a per-transaction basis.  PayPal will define charges based on merchant type and will probably also negotiate special deals with certain merchants.  

4)  This deal places PayPal in the same league as the issuing banks in terms of its ability to issue a card that is accepted over an open-loop network.

5)  This solution, which only works with a PayPal card, completely violates the digital wallet paradigm we discussed above by not giving the choice of using a phone number instead of the wallet.  Again, PayPal's vision is a digital wallet but its first priority is to win share-of-mind in off-line payments.  The solution is clunky but it is a first step.  Additional iterations may provide much more utility.

Once again, the graph below illustrates this process - in a very simplified manner - using the example of MasterCard as being the preferred method of payment.

Note:  What is in it for Discover?  The company should pick up additional transaction volume as result of this deal while allowing the card network to fully participate in this new growing payments ecosystem.

How does Google Wallet 2.0 'stack up' against the criteria listed at the beginning of this series (click here to review the list)?

The intention is to 'rate' the solutions as they exist today.  In most cases, the wallets I am reviewing are flexible platforms that, with the right partnerships and infrastructure in place, can provide a very enriching shopping and payment experience.  But that is all in the future.  As promising as they may sound, I am comparing them against each other as they stand today.  

For this reason, this table only includes PayPal Wallet on PayPal Rails, considering the locations where it is currently available  (Abercrombie & Fitch, Abercrombie Kids, Hollister California, The Home Depot and Jos. A. Bank).  Hopefully, I will update my review in 2Q2013 after PayPal Wallet on Discover Rails launches or earlier as the number of features and relailers increase.

Reliability and Transaction Speed
It is as reliable as the well proven and tested on-line solution.  It is also a lot faster than the on-line solution, to the point that, as far as I can see, there is no noticeable difference in transaction processing speed compared to a traditional card.

Security
From a transactional perspective:  The security level when swiping the card is actually higher to the security achieved with a  traditional mag-stripe card because it uses swipe + pin rather than swipe + signature.  Unfortunately, there is quite a bit of concern around entering phone number + pin given that a) a person's number is often a relatively 'public' piece of information and b) the more information you have to enter on the key pad, the more difficult is to protect yourself from eavesdropping.  In any case, there is no dynamic authentication mechanism embedded in the process.

From a storage perspective (i.e. keeping payment credentials safe):  The fact that all credentials are in the cloud and that you need to use an ID + password to log into your account (whether on-line or on your mobile) makes the solution very safe.

In addition, it is the first non-banking payments mobile service that I have signed up for where you can feel they take 'know your customer' requirements extremely seriously.  Before allowing me to open an account, I needed to upload photos of my driver license, my social security card and a utility bill.  Inconvenient but important.

Ease of Use
The fact that the wallet must be managed on-line is a disadvantage.  The mobile app allows you to send/request money to/from another consumer, to find local businesses that accept PayPal and check in with them and to view your transactions.  Any changes you may wish to make to your payment methods (include a card, change preferences...) needs to be done from their website.
 
Wallet Functionality
It is good from the perspective that you can include all types of credit/debit cards, bank accounts, loyalty/gift cards, coupons...  The experience could be improved in three ways:  1)  Although it is in the roadmap, at the moment, you cannot set payment rules based on merchant or size of purchase;  2)  The user cannot override the preferred method of payment at the POS (via the POS or the mobile app) and not everyone is granted the 'grace period'; 3)  Issuer presence is kept at a minimum (totally absent from the mobile app and only in the form of digits, no branding, on-line), making PayPal a relatively unfriendly channel for banks that are struggling to keep customer's share of mind.

Acceptance
It is only available at a handful of stores (Abercrombie & Fitch, Abercrombie Kids, Hollister California, The Home Depot and Jos. A. Bank), none of them day-to-day retailers.

Device Availability
The app is available for iOS-, Android-, BlackBerry- and Microsoft-enabled devices. 

Valud-add Apps
Although PayPal (or eBay) has acquired a large number of companies that can bring a lot of value to the wallet (Where, RedLaser, Zong, Milo, Card.io...), none of them are yet integrated in the wallet.  Although X.commerce, a development plaform, launched over 9 months ago, it is difficult to find value-add apps built on the wallet.

Food for Thought 
I believe that we all agree that the consumer needs to be educated about mobile and digital payment options.  For this reason, I was surprised not to see any posters explaining about PayPal as a payment option at the till or even brochure on the topic.  Talking to one of the cashiers (Thank you Mary!  You know who you are) I found out that PayPal employees had visited the shop the day PayPal launched at Home Depot but that they had not visited the store since (at least, as far as she knew).  Cashiers had been given fliers and brochures that first day but they had not been replenished after they ran out.  Is PayPal not providing and requesting Best Buy to share this material or is Best Buy refusing to do so?

PayPal's current strength is on P2P transactions because it allows consumers (as well as small- and medium-size retailers) to accept cards with minimal hassle.  How is Visa's plan to bring P2P payments to U.S. account holders going to affect PayPal?

Will startups like WePay, with increased ease of integration and reduced merchant fees, gain enough momentum to affect PayPal's (or Google Checkout, for that matter) business model?

The PayPal Wallet in Action

This are the steps I followed to pay at the self checkout at a Santa Clara Home Depot.

This is what I 'saw' happening in my PayPal App.