AGILEVC My idle thoughts on tech startups

May 28, 2009

Micropayments is a concept which has been like the proverbial pot of gold at the end of the rainbow… always just over the next hill, at least here in North America. Recently micropayments have received a lot of talk as a way to rejuvinate the newspaper industry or create massive revenue for companies like Facebook. It’s certainly possible that may happen, but I wouldn’t bet on it.

There’s no commonly accepted definition of a micropayment, but typically people use the term to mean purchases < $1.00 and certainly I'd would consider anything over $2.50-3.00 a normal transaction not a micropayment (i.e. a Starbucks drink isn’t a micropayment). Proponents of micropayments over the years have suggested that allowing consumers to buy in smaller increments might open up newer models for online content and services like pay-per-article, “tip” jars, or small virtual goods purchases. Supporters point to services like iTunes, where you can buy a song or some iPhone apps for $0.99, or virtual items which can be as small as a few cents.
But if you actually start to dig in to the “success” stories for micropayments, the data starts to look a little questionable. The average price of a ringtone in the U.S. is roughly $2.40… on the border of even my generous definition of a micropayment. Forrester did a study of iTunes a couple years ago and the purchasing behavior of consumers actually doesn’t look like micropayments and starts to look like “fractional CD” buying. The average transaction value (ATV) of an iTunes purchase was acually $6.34 and even the median was still about $3 bucks. Similarly if you start to dig in to virtual goods models at micropayment scale (some virtual goods are rather expensive), which today are still predominantly in Asian markets and not common in the US, you see a similar tale. When measured at purchasing power parity the $0.25 or $0.50 USD virtual good bought by a Chinese consumer starts to look like a “normal” sized purchase, i.e. equivalent to >$1 txn for US consumer.
I spent a lot of time, along with numerous colleagues, back in my PayPal days thinking about the micropayments space. It ultimately proved a nut we couldn’t figure out how to crack. This was a number of years ago now, but in looking at the challenges facing micropayments models I don’t see that a great deal has changed such that micropayments are now poised to grow dramatically.
Transaction Costs are the most cited hurdle for micropayments. It’s true that credit card processing costs can eat as much as 25-50% of the value of a < $1 payment. Well what about PayPal, you say? Services like PayPal haven't fundamentally altered this equation, since roughly half of the payments that flow thru their system are funded with a credit card. Batch billing, or aggregating a bunch of small purchases into one txn as iTunes does, can certainly help. And alternative payment schemes like cell phone billing theoretically could have lower txn costs, but in practice third parties still have to pay a lot to process small payments.
But believe it or not, transaction costs aren’t the largest barrier for micropayments. Yes it makes profitabiliy harder for Apple, given their cost of goods for a $0.99 iTunes song is $0.60-70 in record company royalties. Apple’s succeded because they sell hardware (iPods, iPhones, etc) at very high margins and can accept extremely low margins on the digital content. But for a virtual good with $0 marginal cost the high transaction processing costs associated with micropayments aren’t as big a deal.

Consumer’s Mental Accounting remains the greatest challenge for the widespread adoption of micropayments. Pyschologically, it’s not hard for us as humans to evaluate a $3 purchase from a $30 one or a $300 one. But it takes giant mental leaps for us to go from doing something totally for free to having to pay anything for it. Our brains go thru completely different calculus for paying $0.01 for something than simply doing something we know has zero direct cost. This is the true barrier to adoption for micropayments.
It’s for precisely because of this mental accounting that cell phone data plans had minimal adoption when priced as $0.xx / KB, but took off with flat rate monthly subscriptions. Similarly it’s why virtual goods based gaming has seen the proliferation of prepaid cards in $10, 20, and larger increments. Consumers in essence make a single “large” purchase decision, and simply consumer incrementally over time. It’s a workaround to make small purchases work, not the success of micropayments.
I don’t know if online subscriptions can save the newspaper business or what might drive a quantum shift in monetization of social platforms. But I’m highly skeptical that micropayments will do the trick.