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These days, if you go up and down the elevator at PayPal’s headquarters, get out on each floor and look around. You’ll see the perfect metaphor for PayPal’s past, present, and future.

On the third floor, PayPal President David Marcus shows me a sea of high-walled beige and grey hexagonal cubicles. The kind you stared at for 16 hours a day if you worked at a Peninsula-based, late-1990s tech company. They look identical to Yahoo’s except no purple and yellow. The walls block out most of the natural light in the room and any sign of coworkers. Even “Cubicle Guy” would have to stretch to prairie dog over them. Marcus can’t hide his contempt looking at them.

On the fourth floor, you could hold a middle school prom. It’s just a huge, flat empty space. Those same cubicles are there, only they’ve been dismantled and leaning against walls. It’s so flooded with the July San Jose sun, it’s almost blinding. “The carpets are next,” Marcus says, of the ugly beige floors with darker beige squiggles on them.

On the fifth floor, though, I see David Marcus’ vision of the future, what working at PayPal could be like. It’s an open environment with modern white and chrome desks, no walls between them. Along the walls are open collaboration seating areas meant to deemphasize conference rooms. There are still a few conference rooms that you can reserve for meetings, though very few. In their place are several small “focus” rooms that don’t operate on a schedule.

The message? If you can actually see your coworkers, you don’t need more meetings, because you are always working together. Marcus mutters something about PayPal’s “meeting disease,” as we walk past.

The entire company is going to look like this soon. Nearly 3,000 cubes are getting thrown out. Marcus is going to force people to work together via every means necessary, even furniture. Force the company to operate in small teams. Force them to collaborate on everything. Force them to be — groan with me, if you’ve heard every other guy at a has-been large tech company say it — more startup-like.

As he’s stripped away worker comforts, many have balked at these changes and others he’s instituted over the the year and five months he’s been in charge. Those people, Marcus says, need to go.

“There are plenty of companies in Silicon Valley that have cubicles,” he says. “They are welcome to go find them. It’s harsh but you have to let people know it’s happened. This is how it is.” He stops just short of saying, If they don’t like it, they can leave. But it’s clearly the message. “You can’t change the culture nice and slow and gently,” he says. “You need a series of electric shocks. The more violent the better.”

An unlikely turnaround

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Marcus has inherited a turnaround story unlike almost any other playing out in the tech rustbelt today. PayPal is still the market leader in its category. Not just by market cap and number of employees but by transactions, too. PayPal isn’t a fading legacy brand like Yahoo–  it’s still growing. PayPal is heralded as one of the best acquisitions in Silicon Valley history. It’s one of the key things that has been pushing eBay forward: Payments have increased from 24 percent of eBay’s revenue in 2006 to 43 percent last year. Its CEOs have repeatedly said that one day PayPal will be bigger than eBay.

While PayPal has more formidable challengers than ever in Braintree, Square, and Stripe, the market is still PayPal’s to lose.

And all of that is precisely the problem.

Silicon Valley is obsessed with network effects, or when the benefit of others being on a site makes the experience that much better for everyone – and more valuable to the company. Network effects give you an unfair advantage over newcomers; even a challenger that’s technically better will struggle to pose a threat. (Witness PayPal’s parent company eBay.) Forget building a $1 billion company. Network effects are how you get a $10 billion company.

But PayPal is the cautionary tale of what happens when a network effect works too well. It turns out that solving the many security, fraud, trust, marketing, and chicken-and-egg challenges of building a new system for buying and selling goods around the world creates a moat so wide and deep it can actually be a problem.

Simply put: PayPal got soft. It stopped innovating, because it didn’t have to. PayPal was one of the most ambitious startups of the late 1990s, co-founded by the holy trinity of intense over-performers Max Levchin, Peter Thiel, and Elon Musk. As that talent migrated, however, the new team realized no one was chasing PayPal any longer. Its sprint slowed to an amble. It still grew. PayPal took a break, got a snack, and took a nap. It still grew. Pretty soon PayPal’s technical muscles started to atrophy. Pre-Marcus, PayPal was still dominant and growing but was also fat, slow, and out-of-touch.

“I’ve never seen as many things broken, and a company still being successful. It was just kinda bizarre,” says Bill Scott previous director of ecommerce UI at Netflix and one of the key new hires Marcus has brought in to transform PayPal’s user experience and make it a more lean, iterative organization.

Under PayPal’s previous regime several sources have told me that the company actively tried not to hire the best engineering talent, because great developers are a headstrong, disruptive force. They just wanted competent coders who could get the job done.

The company was as slow as it was uninspired. It could take up to six weeks to get a single word changed on the Web site. The idea that it could even copy Square in short order? Laughable. It took two years after Square’s launch for PayPal to get a competing product on the market. A year ago, we asked Musk why he invested in challenger Stripe and he noted that PayPal’s product roadmap is actually less ambitious than the one he sketched out in 2000. “PayPal should be where all the money is… And it’s definitely not,” he said.

whitmanMeanwhile, its automated customer service was famous for “accidentally” shutting down campaigns, leading to lost revenue at pivotal sales times that could never be regained. That’s what gave Braintree an opening to steal customers by focusing heavily on human-powered, white-glove service.

The worst story about PayPal’s byzantine automated customer service was the case of the $2,500 violin. When a woman sold an antique violin online, the buyer disputed the purchase, expressing concerns that it was a fake. When he reached out to PayPal for a refund, the company demanded the buyer smash the violin first. It was a black eye for PayPal that the company responded to sounding like it was reading from a call center script:

While we cannot talk about this particular case due to PayPal’s privacy policy, we carefully review each case, and in general we may ask a buyer to destroy counterfeit goods if they supply signed evidence from a knowledgeable third party that the goods are indeed counterfeit. The reason why we reserve the option to ask the buyer to destroy the goods is that in many countries, including the US, it is a criminal offense to mail counterfeit goods back to a seller.

Let’s get this straight: PayPal had no common sense when it came to dealing with customers (or the press). It had no innovation strategy. It was actively avoiding hiring disruptive coders. It required dozens of tech support tickets to change a single word on the site. And it was as if PayPal worked so well as a network that no one at the company was encouraged or hired to think. Meg Whitman once said that eBay was such a great business, monkeys could run it. PayPal was apparently such a great business automatons were running it.

You think I’m being harsh? Who do you think PayPal’s biggest critics are? Not off the record whispers. Not disgruntled customers. Not some vague anonymous Internet haters. It’s the current management team:

Bill Scott, PayPal’s current senior director of user interface engineering, on the UI he inherited: “Wow, that’s pretty atrocious.”

Hill Ferguson, PayPal’s vice president of global product:  “The pendulum swung away from being a tech startup to being a financial organization. Now it needs to swing back.”

Adds Jeff Jordan, PayPal’s president from 2004-2006: “I think there was no innovation there for at least half a decade.”

This is the inside story of how an unlikely team of entrepreneurs are trying to change all that.

“You don’t start a company to work at PayPal…”

David Marcus and Hill Ferguson came into PayPal via the 2011 acquisition of Zong. The first time I met Marcus was at this year’s D conference. He came up and introduced himself to me, and I expected defensiveness and anger. I have not been too kind to PayPal in my reporting over the last year. Instead he thanked me, saying he’d used my articles in house to prove there was a problem.

As clear as it was to Marcus, Ferguson, Jordan, Scott, and others that there was a problem at PayPal, it hadn’t been clear to the previous regime at all. Indeed, PayPal was crediting with driving eBay’s turn-around. It was seen as the thing working. At the time of the Zong deal, it was radical to suggest things weren’t going extraordinarily well. It wasn’t until Stripe, Braintree, and Square started surging that there was anything the new regime could point to to show then PayPal CEO Scott Thompson that there was indeed a problem. “It gave credence to our story,” Ferguson says.

Indeed, all the executives I spoke with independently mentioned those three companies as threats to PayPal. They are threats that really shouldn’t exist, given the business’s strong barriers to entry. They could only exist if PayPal was epicly fucking up. “I love that those companies exist,” Scott says. “They lit a fire under us.”

Things got worse just after my first article when a small business owner named Elliot Jay Stocks wrote a post called “Good riddance, PayPal,” that was picked up on Hacker News and started a feeding frenzy of negative comments about the service. Stocks’ reason for switching was a mistake that caused funds in his account to be frozen — a common problem with PayPal’s automated fraud-detection system.

Marcus did something Thompson had never done. Something far different than the lame reaction to the violin case. He waded into the Hacker News comments to apologize, acknowledge a problem, and pledge to fix it.  Marcus was surprisingly frank in his comments, acknowledging how “hated” PayPal is in the developer ecosystem and pledging to “make this company GREAT again.” He said: “This WILL change, and we won’t rest until you all see it. The first installments are due very soon. So stay tuned…” The meme that something was wrong at PayPal wasn’t just for blogs and chat rooms anymore. The President of the company had actually acknowledged it. 

Just as it wasn’t clear to the pre-Marcus PayPal that something was wrong, it wasn’t clear that Marcus should be the guy to fix it. The $240 million Zong purchase was for all cash, all up front so there was nothing tying Marcus to the company. He wasn’t immediately sure how long he’d stay, but he also didn’t know what he’d do next. After all, as Ferguson says, it wasn’t exactly the ideal outcome when they started Zong.

“You don’t start a company to work at PayPal,” he says.

The morning the acquisition was announced, Marcus showed up for work to take on PayPal’s mobile division. It gave him his own sandbox in which to disrupt the company’s malaise. Because mobile was so ignored at that point in PayPal, he had plenty of room to do things his way.

When he heard Scott Thompson was leaving to become CEO of Yahoo, Marcus had no reason to think he’d become PayPal’s president. He had little in common with Thompson, and Thompson seemed to have done a great job with PayPal. Good enough he was taking a huge step up to go be CEO of Yahoo — or at least that was the view before Thompson’s fall from grace for falsifying his resume.

Zong wasn’t exactly a major acquisition, and Marcus wasn’t a Marissa Mayer-like household name. He wasn’t particularly qualified. The most people he’d ever managed before was about 200. PayPal had more than 13,000 employees. He was from Europe and things like that don’t happen there. You climb a ladder to become the boss. Marcus was an entrepreneur who was merely between things. He wasn’t a ladder climber.

But he started to think about what he wanted to do when Thompson quit, because he thought the odds were low they’d hire someone he wanted to work for. Three months later, when eBay CEO John Donahoe sat him down and said, “I’ve been thinking…” a job offer of this magnitude was the last thing Marcus thought was going to come out of his mouth next.

moneyMarcus asked Donahoe for 12 hours to make the decision. Marcus knew if he committed he’d have to stick around for a long time. But he didn’t know another place where he could create so much change in the payments world, where he’d spent the bulk of his career.

“In life, there are not that many opportunities to enhance the lives of hundreds of millions of people,” he says.

Marcus told Donahoe if he took the job he’d have to make radical changes. He’d need the freedom to change everything.

You do what you have to do, he says Donahoe told him.

When he started Marcus didn’t engage in any of this “first 100 days” bullshit. He’d been inside the company and knew what was wrong: It was no longer a technology company. He was going to have to change that. To do that he put products in two buckets: those that they needed to scrap, and those they needed to reinvent. He wanted to focus on the customer in a way the company never had. (Witness violin-gate.) Rather than buffering himself with ladder-climbers, he started to construct his management team in his own image. They are all entrepreneurs who’ve wound up inside of PayPal one way or another.

In addition to Ferguson, they include Don Kingsborough, the founder of Blackhawk Networks and World of Wonder, the company that made Teddy Ruxpin; Stan Chudnovsky, the founder of Iron Pearl; and Gary Marino and Mark Lavelle, the co-founders of Bill Me Later. [Disclosure: Chudnovsky's Ooga Labs is an investor in PandoDaily.]

“I’m not here to build a career,” Marcus says. “I don’t want a bigger CEO job. I’m not here for the money. Any salary wouldn’t be life changing. I only want to change the company.”

In a separate interviews, much of the rest of the management team echoes Marcus’s words verbatim: “We’re here to change the company.”

“Really, really ballsy”

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It’s impressive that Donahoe got the problem. I asked eBay CEO John Donahoe for an interview about the decision, but he offered me only this bland statement instead:

 “David’s experience as an entrepreneur and his passion for building great products and consumer experiences are driving a deep cultural change at PayPal. This has re-energized our employees and is stimulating greater levels of innovation.  I couldn’t be more thrilled with what he’s been able to accomplish in just over a year, but I know he and the PayPal team are just getting started.”

Jeff Jordan was the president of PayPal before Thompson and is a close friend of Donahoe’s. His partner Marc Andreessen is also on eBay’s board. [Disclosure: Both Jordan and Andreessen are investors in PandoDaily.] He puts it in more plain English: “The decision to put Marcus in the role was inspired and really ballsy by John. Really, really ballsy.”

Think about the other massive turnarounds going on the Valley: Tim Armstrong was ladder-climbing executive at Google. Mayer may have started small in Google’s early days, but her responsibilities and experience certainly grew along with the massive juggernaut. Even Donahoe was an executive before taking over eBay’s reigns, and he’s had the most success of the three. You’d be hard pressed to find another example of a little-known, middlingly-successful entrepreneur who’s been placed in charge of breaking, resetting, and fixing one of the Web’s largest and most profitable brands.

Jordan was as much in Donahoe’s ear about needing to fix PayPal as anyone. As a partner at Andreessen Horowitz, he heard the same things said in that Hacker News thread. Developers hated working with the company. He used to call Donahoe regularly and tell him things like, “We talked to three more companies today who said they hate PayPal.”

Donahoe has brought in other executives this way, even if they haven’t gotten so senior of a job. It’s his playbook when he does an acquisition, says Jordan. “I’ve heard him talk about how he needed entrepreneurs to help fix the company,” Jordan says.

A lot of his M&A strategy has been talent. The proportion of CEOs bought that remained at eBay is high. Donahoe can cite the number because he cares about it. He’s restocking a company with young innovative people with product sense because that’s the first thing to go in these big companies. eBay started to lose it before I left. You could see it calcifying.

The conversation he has in the deal is, ‘I want you. If you are not interested in that let me know now.’ He doesn’t let them get lost. What usually happens is the talent leaves and the company takes over the asset. The business is bought versus the founders are embraced. John doesn’t do that.

No one wants to mention it, because it’s not how the Valley works. But Marcus wasn’t just a tech entrepreneur: He was the anti-Thompson. Thompson was effective at scaling and de-risking PayPal as a global financial organization. But innovation, a customer focus, and any sense of speed or urgency were all collateral damage in the process. PayPal had more of the mindset of a bank than a technology company.

Scott sums it up well when he describes his experience as a contractor during the Thompson era. “They were treating customers like they were guilty when they are not,” he says. “PayPal was stuck in a culture where it took six weeks to make a word change on the site. The risk models were turned up so high, that there was no change happening.”

In technology, if you aren’t changing, you are dying. Even the strongest network effects can only delay and mask that.

Most shocking was the total lack of a coherent mobile strategy before the Zong acquisition. The first day Ferguson and Marcus showed up, Ferguson asked — among other questions — what the company was doing about Square. PayPal had thought about Square, sure. There were about seven PowerPoint decks on that topic but little in the way of a product. In seven months the upstart brought a product to market. It was brutal, but once people in Square proved they could do it, others in the company were encouraged.

PayPal could have led on this. It could have been Square. There was even a mobile effort underway as early as 2005, when Jordan was still there. “It sucked,” he admits. “It was just texting money. But at least it was out there. At least we were trying.” It all just stopped under Thompson.

Part of what PayPal has been doing for the last year is showing the organization there is another way. Everyone I interviewed insisted there was some lousy talent at PayPal, but  there was also some excellent talent trapped in a company where you needed 37 tickets just to fix a bug. The whole fail fast, iterate, lean startup movement had utterly passed PayPal by. That wasn’t the developers’ fault.

“They were stuck in a mindset of unlimited resources,” Scott says. “Scarcity breeds clarity. People have to go through the experience of seeing it done a different way before they ever believe.”

No sacred cows

“David only shows people this room when he really likes them,” a PR person tells me as we step into PayPal’s “war room.” It’s a conference room bordered by glass on one side, peering into a control room that looks like the brig of a Starship. In fact, some of the engineers got a Captain Kirk “authentic replica” chair and put it just under a 180 degree wall of IMAX-like screens. Marcus gets to sit in it from time to time.

On the screens are every payment flowing through PayPal — $8 million worth of them per day. It’s showing all the live connections with various banks around the world. And any problems can be flagged and brought up huge on center-screen. “This is the heartbeat of PayPal,” Marcus says staring at it, with a little awe. He’s never run anything close to this scale before.

cultureIt’s clear to him that he hasn’t inherited a media property like Yahoo or AOL, where people go to check celebrity news and sports scores. He’s inherited a trusted relationship with people’s money. That can’t be taken lightly.

As much as you can fault Scott Thompson for not being innovative or forward thinking or lean enough, you cannot fault him for scaling PayPal as a bullet proof, non-risky, trusted financial organization. Without that, there is no platform on which to innovate. Marcus gets that. But short of breaching that user trust, there is no sacred cow here, and his management team agrees that’s how it should be.

There was no quick fix to what was ailing PayPal. Nothing that can be boiled down to a press release. An acqui-hire wasn’t going to do it. A new product wouldn’t fix it. Nor would a splashy new ad campaign, free food, iPhones or UP bracelets for the team. He had to deeply change the culture. “It’s the hardest thing I’ve ever done in my career,” he says.

But once he did it, he saw that it could be done. And if they could change that, Jesus, the assets of PayPal were unlike anything anyone else possessed.

Nearly 18 months in, there are signs to Marcus that it’s working.

In terms of product, PayPal has launched PayPal Here for iPad, Chip & Pin, and tablet under his watch– the iPhone version in just thirty days and the iPad version because customers were asking for it. They overhauled the site and home page in six weeks versus the six months it would have taken before Marcus. They entered Costa Rica in three months — a process that has taken up to three years in the past. They piloted an “order ahead” feature with Jamba Juice to pre-order smoothies. They released a new SDK and APIs, too, in time for SXSW. He’s also acquired two small companies, card.io and Duff Research, to bring more mobile development talent into the company.

Marcus talks about a new product fair recently held in house, where almost every single product presented was a viable, new idea that you could build a startup around. The vibe was different — you could feel it. Most of the company showed up to see what developers were working on. He talks about a recent “Global Battle Hacks” hackathon to encourage developers to build on PayPal’s APIs in New York. It sold out in 15 minutes. “We wouldn’t have had two people show up a year ago,” he says. He talks about some employees who recently set up PayPal demos and sign up tables at their local farmers market on the weekend. “They did that all on their own,” he says. “No one asked them to.”

Perhaps, but another executive tells me that the quickest way to get on Marcus’s shit list is not to use the product. Everyone has to be a believer and a user and a brand ambassador, he’s argued before. Everyone. If someone has a problem with PayPal, reach out with a tweet and offer to help, he says. Marcus leads by example in being so out there the way he was with the Hacker News incident.

“The whole company should be doing that,” he says. “If every employee doesn’t own the brand, we don’t leverage our scale.”

There’s also direct uplift in the amount of payments processed, because false positives are no longer getting caught by overly sensitive risk modeling. Marcus can’t disclose how much, but he says its significant. “What we’ve done in the last nine months has impacted 40 million people,” he says. “That’s energizing to see.”

Everyone I spoke with has his or her anecdote that tells them things are changing. Ferguson notes that PayPal’s customer service is down 25,000 calls a month as its taking better care of people. There is a list of common pain points that are presented every year and not much was ever done about it. Marcus has been chipping away at it. They’re about 80 percent of the way through them.

Bill Scott has had two wins, one huge and one very small but symbolic. The big one: He’s revamped PayPals 2000-era underlying technology stack so that he can rapidly iterate and treat the site like an experimentation zone. The small one: He hired a guy who was actually able to push code on the first day thanks to the underlying changes in process. The development team has all been moved to Agile, and they’ve moved the codebase to GitHub as well. PayPal is operating like a modern technology company.

Scott used to consult for PayPal back in 2011, and was struck by a company full of “silos and problems.” He joined the company because we saw “flickers of new DNA starting to appear.” Literally and metaphorically, the walls around employees have been ripped out, and they’re talking to one another now.

That’s the tricky thing when you are transforming culture. It’s measured in flickers and anecdotes, not tangible things like dollars or uniques. You feel it working before you can see the quantifiable results of a change. And sometimes a culture feels different but results never follow.

Continuing to weed out the people who can’t change, transforming the views of the ones who can, and bringing in new talent will be key. The uncomfortable truth is this means more turnover. Not layoffs, but turnover. “Some people will never change,” Marcus says. “Some people you can’t carry with you.”

Everyone is diplomatic when they make this point, but they make it none the less. Scott’s version: “You can either fight people or route around them. The problem with routing around people is you don’t fix the problem.” Entrepreneurs always strive to hire slow and fire fast. And this is a company run by entrepreneurs now. If you aren’t on board for these changes, you are probably on the way out. Sorry.

As the many different executives I spoke with told me about the different innovative products PayPal had launched or was working on, it was dizzying. There are slick merchant tablet apps. There are mobile card readers. There are new ideas for making your phone a true digital wallet — no tapping a card or taking it out, just something the store can read if you have it in your pocket.

Marcus even says he’s speaking to local governments about making your Drivers License a part of PayPal’s digital offerings, making it the first true digital wallet, not just digital credit card. The picture Marcus paints is leagues beyond Google’s clumsy NFC efforts. It’s in line with intelligent devices just coming out of startups like August or Unikey — where you merely approach a smart device and it reads your mind and does your bidding. He’s dreaming, and few turn around executives do that. They’re too busy trying to please Wall Street. But eBay’s larger turn around — driven by Donahoe — has given him cover from that. It’s also given him a stock price that’s moving up — a boon in bringing in new talent that many turn arounds don’t have.

An explosion of product is what those close to the company, like Jordan, are looking for. “I’m waiting for product,” he says. “I hear it’s coming but I don’t know what ‘it’ is. I want the consistent drumbeat of ‘Oh, now, that’s cool.’ That’s when you know it’s back.”

This jibes with Scott’s nirvana of PayPal becoming a large company that feels like a smaller company because there are more and more “two pizza” teams building things and getting them out to users. But with so many irons in the fire and three competitors gunning after different parts of PayPal, distraction is a worry. This is not a company that feels focused. Then again, Google has never been particularly focused either. PayPal is similarly throwing a lot at the wall and seeing what sticks.

Was hiring Marcus too ballsy of a move? Friends of his have seen some of the emails he’s fired off, without going through the normal HR channels and gasped at his directness. He may be too different than Thompson for the organization to swallow. “I’m brutal at times,” he acknowledges. While I’ve only heard him spoken off positively by insiders, he’s aggressive. He rips out layers and formality and convention as aggressively as he’s ripped out thousands of cubicles.

Donahoe isn’t taking a gamble on a small part of eBay. PayPal has long been the crown jewel, intricately tied in with the company’s growth in the real world and mobile. But change is necessary for it to remain the crown jewel for decades to come.

With most tech turnarounds, the question investors ask is how the board and management allowed things to get so bad. Having painstakingly turned around eBay, Donahoe — via Marcus– is ensuring PayPal never gets to that point, one ripped out cubicle at a time.

[Feature image courtesy Kim White]