Big Bucks In Micropayments
The E-commerce arm of Walt Disney Co.'s ABC network wanted to cash in on a hot new video game it was promoting called Alias Underground. After lining up an ad sponsor, it started offering the game on a promotional basis as a free download. It quickly became a hit, and ABC.com concluded it could generate cash by offering new versions of the game every few months, which users could download on a subscription basis.
There was just one hitch: The production, selling, and customer-support costs would have exceeded revenue generated by the subscriptions. But it would be profitable if Disney could get a service provider to process the sales of each monthly download, saving Disney from paying high fees on each small-value transaction.
The answer was Webpay International AG's Click&Buy software, which lets merchants sell low-priced merchandise online without the hassles of dealing with the high fees charged by credit-card companies. When consumers want to download a version of Alias Underground, they either log on to Click&Buy or, if they're not already signed up, fill out a quick registration form. Then, ABC.com gives them the choice of either buying the game or buying a subscription to have future versions of the game delivered on a regular basis. Click&Buy sends consumers a lump-sum invoice once a month for the subscription plus purchases made at other Click&Buy merchants.
Since ABC.com began offering the Click&Buy option about a year ago, revenue has more than offset production and customer-support costs, turning a potential money-losing venture into a winner. "ABC had transaction engines capable of processing online payments, but when we looked at the financials of charging users a few dollars per download, we realized the only way we could do it was through Click& Buy," ABC.com VP Harry Lin says.
Demand for so-called micropayment systems is growing quickly. Some 14 million Americans made digital-content purchases of $2 or less in 2004, up from 10 million in 2003, according to market-research firm Ipsos-Insight. That's prompting merchants to turn to micropayment-system providers such as BitPass, Peppercoin, and Webpay.
PayPal, the payments subsidiary of eBay Inc., has built a micropayment system for Apple Computer's iTunes that allows customers to download and start listening to music while they're still browsing for other songs. "With digital music, customers want to consume the product while they're shopping," says Peter Ashley, director of merchant services at PayPal.
One approach to micropayments is the pay-as-you-go model, in which customers are charged each time they make a purchase. However, to get around high card-transaction fees, some micropayment service providers aggregate small payments from a single customer into one bulk payment in order to save on transaction fees. "For orders from the same customer, we can turn three or four $1.95 orders into one order," says Bob Nix, Peppercoin's VP of engineering.
Peppercoin's software approves and processes card transactions right at the merchant's site, avoiding the need to send each transaction through the card network. "Our algorithms allow us to provide the bank with the same assurance without moving the transaction back and forth," Nix says.
Peppercoin allows merchants to set parameters such as the amount of time to wait before aggregating transactions. For example, a merchant might choose to wait a week before submitting a customer's transaction.
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Visa and MasterCard take too much of transactions, Mashboxx CEO Wayne Rosso says. | |
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However, aggregation makes sense only if a merchant has repeat business from a single customer. "You need to have that customer come back regularly," says Jeff Fogel, VP of sales at Moneris Solutions, a joint venture of Royal Bank of Canada and Bank of Montreal serving 350,000 merchants.
Moneris and other providers of merchant payment services such as Chase Merchant Services and SunTrust Banks have inked co-marketing deals with Peppercoin. "They're providing a micropayment gateway, and we're providing the banking relationship," Fogel says.
Banks are lining up behind Peppercoin because it provides a complete micropayment business model, including pay-as-you-go, prepay, and postpay for digital content, in-store purchases, and payments made via mobile phone, Peppercoin president Mark Friedman says.
In the postpay model, such as Webpay's, customers make payments after they've made purchases. In the prepay model, customers first deposit money into an account; purchases are then deducted from that account.
BitPass, for example, provides a virtual prepaid debit card that consumers fund through their American Express, Discover, MasterCard, PayPal, or Visa accounts. The card is accepted by 300 to 400 sites selling digital content such as music, video, photos, and news, marketing VP Duane Kuroda says.
PayPal's deal with iTunes works on the postpay model. Instead of paying every time they download a song, customers download as many songs as they want up to a set limit; iTunes charges their PayPal accounts for the songs they've downloaded.
The deal lets iTunes process payments at a fraction of the cost of a typical credit-card transaction, Ashley says. The reason is the $750 million that flows through the PayPal system every two weeks, much of it funded through low-cost bank accounts and prepaid accounts, rather than credit cards. "The different funding mixes give us the ability to process payments at a lower cost," he says.
For major credit-card companies, the micropayment explosion is an opportunity to boost transaction volume. Visa estimates that online micropayments totaled $3 billion in 2004, about half of it for music, says Billy Knupp, VP of product innovation at Visa USA.
Visa's systems have plenty of capacity to soak up those transactions: VisaNet, its core transaction system, achieved a peak-processing rate of 5,546 transaction messages per second on Dec. 24, up 8.3% over the previous year's peak, also on Dec. 24.
Visa views micropayments as "another touch point" for using credit and debit cards, Knupp says. The challenge "is making sure all these models work to provide a consistent buying experience."
Merchants are depending on micropayment system providers to expand their customer base. It costs merchants $25 on average to attract each new customer through advertising and marketing; customers need to make 20 or so purchases of small-ticket items in order to be profitable. "A payment solution for small-ticket items not only processes payments more cheaply but enables merchants to create deeper relationships," Friedman says.
But micropayment systems aren't just limited to digital content; they're starting to make inroads in the real world as well, as replacements for cash. The potential is staggering: In the United States alone, some 400 billion transactions of $5 or less are made each year, totaling $1.3 trillion.
Reino Parking Systems, a provider of payment systems for municipal parking lots, uses Peppercoin's system to give consumers the ability to receive text messages on their mobile phones alerting them that they've got five minutes left until expiration of their parking meters and allowing them to add time via their phones. With the soon-to-be-available version 3 of the Peppercoin system, Reino will offer motorists a prepay option, such as $20 with two free hours. The system has been in use in Australia for a year and a half and will soon be introduced in the United States, says Mark Ralston, chief operating officer at Reino.
Another Peppercoin customer, jukebox manufacturer Rowe International Corp., launched its first credit-card jukebox last year. "In our vision, credit cards will begin to replace coins and cash over the next five years," says John Margold, senior VP of sales and marketing.
Businesses such as bowling alleys, bars, and billiard parlors have switched from manual to computer-based jukeboxes, which retrieve songs from a file server over a high-speed connection. The systems have the capacity to monitor the number of songs downloaded; by installing Peppercoin technology, Rowe can aggregate these into a single bulk payment. "Peppercoin administers payments from thousands of jukeboxes on a given night," Margold says. Coin-operated machines are rapidly being augmented with credit-card readers, he adds.
Version 3 of Peppercoin will expand the payment options from the pay-as-you-go model to prepay, postpay, and loyalty programs. For example, instead of selling a single cup of coffee for $1.50, a retailer could offer a "bottomless" cup of coffee for $5 a month on a subscription basis.
This is the second go-round for micropayment technologies. The first wave took place in the 1990s, when the prospect of buying online content on demand, such as newspaper articles, gave rise to companies such as eCash Technologies Inc., which offered software for making electronic micropayments. It also gave rise to companies like Mondex, which developed a chip-based system that allowed consumers to make small-value purchases or person-to-person value transfers anonymously, exactly like cash. MasterCard bought a 51% stake in Mondex in 1996, but a trial of the system conducted in New York the following year was a notable flop, as merchants balked at the time it took to process transactions.
The early vision was that micropayments were an integral component of E-commerce, and demand for micropayment capabilities would grow exponentially. But micropayment pioneers failed when the dot-com bubble burst. Since then, changing technology, including peer-to-peer networks, radio-frequency identification, and cell phones, have helped bring micropayments into the mainstream. Visa and MasterCard, for example, have launched RFID cards that consumers can wave in front of readers for purchases of $25 or less. The cards are being test-marketed at outlets such as McDonald's and other purveyors of small-ticket purchases.
"The vision wasn't wrong, but the foundation wasn't there to generate the demand to justify deploying low-value payment services," says Ed Kountz, an analyst at TowerGroup, which provides research on payment technology for financial institutions. That foundation is now provided by iTunes and other sellers of digital content.
"Obviously, iTunes isn't a pure-play micropayments provider; they're selling both content and hardware," Kountz says. "But consumers are interested in downloadable music, and merchants need a way to offer that on either a pay-as-you-go or subscription basis."
For banks, micropayment "gateways" such as Peppercoin unlock a huge, untapped market. "It gives them something to offer to merchants who have lots of small transactions," Friedman says.
A new challenge is customer service. Handling customer-service calls costs money, which eats into profitability on small-ticket items. Peppercoin's suite includes a customer self-service feature for online merchants and content providers.
The aim is a scenario in which everybody wins: Online merchants can attract more customers and boost their profit margins, banks gain new classes of merchant customers, and the card associations gain a new source of fee revenue.