Digital River is a company that offers:
- Payment processing. For (very) small software vendors such as myself, Digital River competes with Paypal (owned by Ebay), Google Checkout (now Google Commerce), and others.
- E-commerce / online store. This relates to automatically letting the user download the product once payment is received, product updates, etc. etc. I use E-Junkie for this service.
Digital River has a lot of unhappy customers because it was upselling its customers’ customers. The software vendors are unhappy since they can’t opt out of the upselling (nor do they profit from it) and some of their customers are turned off by the upselling practices. Digital River doesn’t seem to understand its software vendors and has a terrible reputation among them (Google around… here is one example). I will never do business with Digital River as a software vendor. And I wouldn’t go long the stock.
As far as Paypal and Google Checkout goes, I would have used Google Checkout over Paypal if it were available in Canada. Google Checkout is able to accurately track the results of ad campaigns with Google’s advertising products. The tracking with Paypal is unreliable and basically doesn’t work the last time I tried it. Also, Paypal tries to trick buyers into signing up for a Paypal account and linking the Paypal account to the buyer’s bank account. This lowers Paypal’s costs as it can avoid credit card processing fees and has more defence against fraud. In other areas of business (i.e. not in selling software online), Paypal has had somewhat of a checkered past. Some users have accused Paypal of freezing their account and in some instances basically taking (stealing) their account balance.
Part of the reason why Paypal has problems is that its system is vulnerable to fraud. Systems where money is being transferred from one party to another tend to be targeted by fraudsters. Paypal could implement security measures to screen its users but this would make its service less convenient to users. There are tradeoffs between convenience and security. According to an interview with Paypal’s founder max Levchin in the book Founders at Work, Paypal outlived its online payment competitors because it was able to figure out ways to mitigate the fraud problem. It has computer algorithms that estimate the riskiness of a transaction.
*Fraud is not that big a deal when it comes to selling software online. Because users can steal software anyways via software piracy, it doesn’t make sense for vendors to worry too much about fraudulent payments.
How fraud works in general- fraud by buyers
A buyer purchases an item from the vendor.
The vendor receives notification of payment and ships the product.
The buyer then reverses the payment, files a chargeback on their credit card (they almost always win these), or the nature of a fraudulent payment is revealed. The payment does not clear or the payment is reversed.
So, the buyer ends up receiving the product without paying for it. They may consume it themselves or try to resell the product for a profit. The latter is a much bigger issue as the fraudster will repeatedly re-run their scam whereas there is a limit to personal consumption.
Fraud by sellers
A seller receives payment for products that the seller does not intend on shipping. The seller drains their financial accounts.
The buyers, who have not received their products, may initiate chargebacks on their credit card.
The payment processor eats the loss if they allowed the seller to withdraw money from their account and the buyers reverse their payments before it has fully cleared.
The future of online payment processing
As Max Levchin (Paypal founder) points out, online payments is an industry where virtually all of Paypal’s earliest competitors were wiped out by fraud.
In the future, it is theoretically possible that payment processing begins to move away from the credit card companies such as Visa (V) and Mastercard (MA). When buyers fund their Paypal purchases from their bank accounts (or Paypal balances), the credit card companies do not get a cut. I believe that this happens mostly only on eBay. Outside of eBay, there is little incentive for users to pay with Paypal (it costs the same unless the buyer is avoiding a currency conversion). There is little incentive for vendors to offer Paypal as a payment option (high fees/it costs the same). Amazon for example does not offer Paypal as a payment option. It is currently pushing its own credit card. The current credit card business model based on debt addiction and fees may be a competitive advantage over Paypal, which hasn’t mastered that business model (despite trying to).
Shorting Digital River?
They are profitable so it doesn’t look like a great short. I am not smart enough to spot imminent doom that may be about to crush their business and the stock.
*Disclosure: I do not currently own or short any of the stocks mentioned except for 1 share of Google I am long into another account. Despite my distrust of Paypal, I use it to buy and sell things.