Micro-Problems

Micro-payments.  Cool huh?  The term was thrown around for awhile as the solution to content providers looking to find a revenue stream.    People could show up on a website and buy some content for a tiny amount - insignificant to them.  But the tiny amounts would add up and the content provider would make some real money.

Unfortunately this is a case where the brick and mortar world has held the web back.  There are fundamental issues with accepting micro-payments that can threaten the very business model of companies that have planned on charging, say, $1.00 per transaction.  The problem is the cost of the transaction itself.

Before we go any farther though, let's first define what we mean by micro-payments:

• $3 to $5 The Starbucks Range:  It's arguable whether this range is really micro-payments.  It's more like mini-payments.  Equivalent to an espresso bar drink in terms of cost, this range has a relatively low resistance to sales for items that are perceived to have value.  Movie rentals on iTunes are in this range.
• $1 to $2:  The iTunes Range: Long been considered the range of acceptable pricing for music and TV shows ($1 and $2) respectively.  This range seems to be low to no resistance for downloadable goods - at least for those who are willing to pay for digital media at all.
• Less than $1:The Mythical Range:  The realm of the original micro-payments range.  A price point considered to be so low that no one could possibly object to it.  Not much in the real world lives at this tier, for reasons we'll see in a minute.

From a marketing perspective, the original idea of micro-payments was to set the price for digital goods low enough that paying for them wasn't a big deal.  There would be no appreciable pain to the consumer, and volume would create a revenue stream for content providers.  The "true micro-payment" range (less than $1) was often cited in the context of this usage.

However there is a hard-to-solve problem lying in the heart of micro-payments - and that's  the cost of the transaction itself.  It costs money for a merchant to take a transaction.  This money is generally trivial in a "regular" size transaction, but it becomes an unreasonably large part of gross revenue when micro-payments are involved.

The problem is middlemen.  When one takes money on a website there are at least two other parties involved besides the merchant and the customer.  The first is the transaction gateway, such as Payflow Pro (owned by PayPal, which is in turn owned by Ebay) or Authorize.net.  These are the  people that connect the banking system to the Internet, allowing only credit card processing to be possible.

The second group is the merchant bank.  In order to receive credit card payments, a company must hold a merchant bank account and sign up for merchant services, usually provided by the same bank that issued the account.

Both of these two parties levy fees on each incoming transaction.  And fees are always structured as a few cents minimum, plus a percentage of the transaction.  It's the minimum fee that's deadly to micro-payments.

About a year ago I went shopping for a bank that could set me up with a micro-payment deal to accommodate purchases of $1.  The best I could come up with, after speaking with almost a dozen banks, was a deal that added up to about 37 cents of transaction fees on the dollar (that's the gateway cost, plus the bank charges).  That's 37% of the gross revenue going to bank charges.

One strategy to address this is transaction aggregation.  This is (probably) being used by iTunes.  How it works is that when you purchase the first micro-payment item, your credit card is authorized for an amount beyond what you actually purchased.  Subsequent purchases that take your total to an amount below the authorized amount cause no further activity with the gateway.

Then at the end a a certain time period, all the transactions that you did in that period that fall  under the original authorization are run as a credit card capture, all at the same time.  This will usually be less than the amount that was originally authorized.  In the end there is only one completed credit card transaction performed by the gateway and the bank, which hopefully contains several micro-payment purchases by you.

The first catch is that credit cards limit the amount of time a merchant can hold an authorization on a credit card without capturing it.  It looks like the most restrictive version of this is about a week, which is why if you buy stuff on iTunes you'll see a charge go through at the end of the week.

The second catch is that aggregation only works if the customer buys more stuff during the aggregation period.  So it means that iTunes only gets the advantage when you buy more than that first song during a one week period.  If your purchases are spaced out over a longer time - iTunes is out of luck, they need to run a new transaction.

The problems with the micro-payment structure may be one of the driving reasons behind the enthusiasm for subscription models with content.  The obvious advantage (besides the "reliable revenue stream" thing) is that the entire content income is balled into one big monthly transaction,  making the relevant transaction costs pretty insignificant by comparison.  Unfortunately the big transaction also has a big price tag, which brings with it increased buying resistance with consumers, also known as "sticker shock".

I don't have a great solution packaged up for you, unfortunately.  However I would urge caution when evaluating any business plan or idea that has micro-payments at the center of it.   Often thrown around as an idea, they have some real brick and mortar problems attached to them.