3 Factors Driving Growth for PayPal

PayPal (NASDAQ: PYPL) continued to add new users to its platform in the second quarter, topping 244 million account holders. In fact, customer growth is accelerating, with net new active accounts increasing 18% year over year last quarter. What's more, PayPal users are using its services more often, with the average user making 35.7 transactions in the last 12 months, up 9%. And that number is accelerating, too.

It's no accident that PayPal is seeing accelerating user growth and engagement. The company has focused on improving its product significantly since it became an independent company again in 2015. It's done so with three big initiatives: improving customer choice, partnering with banks, and fostering customer loyalty.

Give customers a choice

Just a couple of years ago, PayPal used to force its users to spend down their account balance before letting them use any other payment options. It also made users set their bank accounts as their default payment accounts. These measures were taken to reduce the costs associated with processing payments. It's a lot cheaper to move numbers on a digital ledger (account balances) or make an ACH transaction (from a bank account) than it is to process a credit card.

A couple of years ago, PayPal started striking deals with payments networks like Visa (NYSE: V) and Mastercard (NYSE: MA). PayPal agreed to allow users to set their default payments to a credit card in exchange for a break on processing fees. There was also the potential for PayPal to increase its in-store presence, but that never really materialized.

The move has paid off handsomely for PayPal. By allowing users to sign up for PayPal using whatever payment method they like, it was able to get a lot more people on board. It's also spurred greater engagement, since users can easily use their preferred payment method through PayPal. The outcomes of both of those changes are reflected in PayPal's results.

Opening the door for partnerships

As a side effect of striking deals with payments processors, PayPal opened the door to partner with banks. Credit-card issuers naturally want to win that default spot in users' PayPal wallets, so they've provided incentives for people to use PayPal with their bank cards.

That's allowed PayPal to increase its presence in certain countries like the U.K. and India by partnering with banks that incentivize signing up for PayPal. This is a key strategy PayPal has extended to even more countries in order to drive adoption. Management points to its recent partnership with Korean credit card issuer ShinhanCard, which enables PayPal registration through its own app.

PayPal has also partnered with credit card issuers to allow users to redeem their rewards points through PayPal, providing yet another incentive to use that credit card in PayPal. Since PayPal is accepted by over 19 million merchants, that can make rewards points very valuable to some shoppers.

Keeping customers loyal

PayPal benefits from a big network effect. As mentioned, it has 19 million active merchants that accept PayPal, and that number is growing quickly. It behooves customers to sign up for PayPal, so they can enter their payment information once and be able to shop all over the web. In fact, some customers won't complete a purchase if PayPal isn't a payments option. One-third of all PayPal mobile customers will abandon a purchase if PayPal isn't a checkout option, according to a survey from ComScore.

That kind of customer loyalty encourages merchants to add PayPal as a payments option, particularly on mobile. And as more and more merchants add PayPal, it creates more incentive for shoppers to sign up for PayPal. The network effect in action.

Of course, PayPal has to continue to "champion its customers," as management says. That means making checkout as simple as possible. It's hit a home run with its One Touch checkout, which allows users to pay from their mobile device without having to log in every time. Typing in usernames and passwords can be tedious, especially on mobile.

To that end, PayPal has a boatload of cash that it's going to prioritize making tuck-in acquisitions with as well as buying back stock. PayPal should also continue to strike partnerships with banks to promote more users signing up as it benefits from opening up customer choice in payment options. Those three factors give PayPal a lot of room to keep growing.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Mastercard and PayPal Holdings. The Motley Fool owns shares of Visa. The Motley Fool has a disclosure policy.