What we have here is...

PayPal is dealing with some unintended fallout regarding a smart policy decision.

The online money folks made a smart decision last week and put out a press release. The original news: PayPal to Block Users With Old Browsers. All well and good; PayPal is a regular phishing target.

But the news items and press around the announcement were not clear enough. From the article above: "PayPal said a 'significant' group of people still use Microsoft's Internet Explorer 3, released in 1996, and IE 4, which debuted in 1997. Those browsers lack a phishing filter, which can block users from accessing a reported phishing Web site." The article later notes that "Apple's browser -- Safari -- does not" have a phishing filter.

Cue melodrama, and the follow-up news this morning: PayPal Denies Plan to Block Safari. Which, of course, was not the original news item. But PayPal neither a) provided a list of blocked browsers nor b) listed modern browsers like Safari as safe for use, at least nowhere I've looked.

The lack of clarity created a situation that ran far afield of the original intent. Instead of being heralded as encouraging safe ecommerce, PayPal found itself dispelling rumors that angered the Macintosh audience. A little more communication and transparency would have ended the excitement before it began.

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.

Pricing right

A fascinating study was released last week that observed people find expensive items more desirable simply because they're more expensive. The same bottle of wine is more appealing to consumers who believe it's worth $90 than others who are told it's worth $10.

Pricing reactions also rely on contextual cues. Panasonic has found midprice items sell better when shown next to pricier models. The "reference prices" around a product significantly affect their perceived value.

These discoveries are not really new. Consider the make-up artist my wife hired for our wedding five years ago. After agreeing on a price, he forgot what they had decided, and quoted a second rate 80% higher. When my wife expressed shock, he quickly reverted to the original price. He explained that many of his clients were upper-class women who wouldn't think he was as good a stylist at the rate we were paying. Raising prices actually appeals to his audience, the cost verifying the talent on offer.

These theories are particularly interesting with regard to online merchants. As noted in the New Yorker article, websites create price transparency, which makes for savvier consumers both online and off, and forces retailers to compete in other ways.

The most intriguing question is raised by reading the two articles above as a single unit. In the first, The Economist argues that prices create emotional response, which could be used to sellers' advantage. In the second, James Surowiecki suggests almost the opposite: that the Internet has eliminated much pricing opacity, creating empowered consumers who understand right-priced items. Observing which one proves more accurate--or whether these theories work in parallel--will help define a generation of sales strategies.

Next-gen ecomm

From our flu-infested president (and reluctant blogger) Alex Schmelkin came this email last week:

I'm lying in bed with two horrendously uncomfortable pillows. Down feather nonsense. Popped onto amazon. Found the cheapest synthetic pillow. $9.99. Cart. x2. One step checkout.

The amazon ecommerce mobile site is phenom. It's fast. Super easy. Recognizes you're coming in on a mobile and serves the correct pages. Login in. Has all your addresses and credit card. Search. Checkout.

Alex sent this email to the team as both a cajoling boss and an impressed consumer. Lying in bed, playing with his BlackBerry, he went dit-dit-dit through the world's largest online store and completed a transaction as easily as he'd send an email.

This is the future of ecommerce. It's already happening in Asia, and it's a matter of time before it gets here, spurred on in part by the iPhone. Simple, clear mobile interfaces. Fast-loading pages. No-nonsense engines and processes. Nothing but goal-oriented transactional functionality.

Look for much more of this in 2008 and '09. And try it, too. Usage drives evolution.

WAX in the Wild: Ebay Desktop

The new Ebay Desktop is built with Adobe Air and presumably communicates with Ebay via web services or some similar mechanism.

Cross-Border Shopping

In Toronto for the long weekend (blogging in the strangely futuristic indoor patio of Richtree in BCE Place) and thinking about some of the lesser known reasons for the success or failure of e-commerce:

• Sales Tax: Often its cheaper to buy online, especially from companies that have no business presence where you live. In New York its a little over 8%, but in Canada there's usually provincial and federal sales tax, potentially adding up to 15% or so.
• Bank / ATM cards with credit card insignias: Any bank card issued in the states will almost always have a Visa or Mastercard label on it, and can be used as such. Canada bank cards have no equivalent label, and always require the entry of a PIN in order to operate. This means that if Canadians want to shop online they are obligated to use credit cards (not necessarily a financially wise move) or to use a solution like PayPal (requires a level of sophistication beyond some shoppers).
• Import / Export restrictions: You know, wine is an e-commerce tragedy. A closed bottle of wine is relatively non-perishable, has a range of pricing from discount to premium, has easy differentiation across the industry, is (with care) extremely shippable, and is primed for a great online service to offer a level of variety vastly beyond what a local provider could offer. Unfortunately its absolutely screwed by the law. Cross-border shipping restrictions, prohibition-era laws preventing the ordering of out-of-state liquor, import taxes - all combine to create a completely inviable (or at least inhospitable) environment for what would otherwise be a great e-commerce product. In Ontario its a complete non-starter: only the government can sell alcohol: its more or less illegal to run a private wine enterprise.

When I was running my little start-up in Toronto in the 90's, I always felt like a great opportunity was being missed by Canada. With its highly-educated population and its modern infrastructure (and, at the time, an exchange rate which made it extremely attractive to shop there from the States), it seemed like a short hop for it to become an e-commerce powerhouse. But the legal and financial support just never materialized, allowing other countries to pull ahead of it. I knew a couple of people from Toronto who were successful, but they became so by leaving.

I had dinner with (Torontonian) Jeff Skoll, co-founder of Ebay, a few years ago, and we puzzled over what was missing from the Canadian start-up landscape. He basically said that four things were required to form a great start-up environment:

1. Smart people with great ideas.
2. Angel investors willing to put up seed capital to fund it.
3. Venture capital funds willing to put up larger amounts of capital to allow a company to build up its business.
4. Larger underwriters willing to take the companies to IPO.

Canada is missing 2 and 3. I believe him, Jeff has always seemed to be right a lot.