Don't give up on eBay yet

July 23, 2009: 10:13 PM ET

Don't give up on eBay yet. Despite posting a second quarter drop in earnings for the second quarter, the company beat analyst estimates.  Merrill Lynch and Bank of America upgraded it to neutral on the news, while Goldman Sachs and Credit Suisse raised their earnings targets. Since the announcement yesterday evening, eBay's stock has jumped over 10% to $21.52.

eBay (EBAY) CEO John Donahoe helped explain that show of faith today at Fortune's Brainstorm Tech conference.

But to do so required clarifying an important point: eBay is no longer just an online auctioneer. In fact auctions are only a quarter of its revenue today. Instead eBay has shifted its focus to broader ecommerce and most important, to growing PayPal, the leading online payment provider.

PayPal now accounts for 35% of revenue, but Donahoe predicts that in four to six years, it will eclipse the entire eBay business. The nascent ecommerce industry is still only 5% of offline retail. Donahoe believes the sector could grow as large as 20%, and the opportunity for processing those payments is enormous.

"Payments is a winner take all business," he said.

Today eBay announced that it's opening PayPal up to third-party developers, enabling them to more easily build the payment service into their applications. For example, Twitter users can now use the service to transfer money between PayPal accounts using a third-party application called TwitPay.

Donahoe believes PayPal is well positioned to defend its leadership in payments since it already has assets like foreign banking licenses and risk detection programs. "Evidence would say that you have to be part financial services company and part Internet company -- you need both," he said. Anyone seeking that evidence need look only as far as Google's failure to gain traction with Google Checkout.

Still Donahoe acknowledged there is work to be done in the marketplace business, the unit responsible for eBay's fixed-price and auction sales.

"We're still the most trafficked Web site with most active users in the world," but he said the company is going through a "growth inflection point." Reinvention will be required to get "marketplace back to the growth rates we'd like to see."

How did eBay get here? While it succeeded in scaling around the world, Donahoe explained that "you can get so focused on expanding current business models that innovation slows down." As a result the user experience didn't keep pace.

"We thought fun could overcome less than optimal user experience," Donahoe admitted. "Now we're restoring trust and layering fun on top." This includes hiring more senior software architects and including them in product design.

The evolution also includes transitioning away from auctions toward ecommerce. Over half of  what's sold on eBay now is brand new, but not the latest generation. "We're focused on a wider selection of inventory than anyone else can offer," said Donahoe.

As for Skype, the Internet telephony service eBay acquired in 2006 and intends to sell, Donahoe resisted calling it a fumble. Rather, he emphasized that it was growing but simply "doesn't have synergies with the other businesses."

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