Thursday
May282009
Why micropayments are (still) a terrible idea
Thursday, May 28, 2009 at 11:31AM 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.
tagged micropayments
micropayments
Reader Comments (7)
Interesting post. I'm a little torn here. You make a good point about the power of free and how uncomfortable consumers are at prescribing value to something under $2. I do buy into that.
But, at the same time, I would have never bought a bundle of apps on my iphone up front for $20. But that's essentially what I've done, purchasing apps one at a time for ~$1 each. Maybe because Apple already anchored me to think of digital entertainment products as being worth about $1.
I recently experimented with Swoopo that requires that I buy bids for $0.75 each, but forces me to buy bundles. I guess this is to minimize on transaction costs, but I definitely would have preferred a microtransaction vs. a bundle like that.
Anyway, I wouldn't say micropayments are a "terrible" idea - just that there are some real issues.
Rob - saying micropayments are a "terrible" idea works better as blog post headline than there are "some real issues" w/ it :)
Your points are all fair. To be clear, I'm not saying there are no use cases for micropayments. What I am saying is that they're not likely to become widespread because of the costs, both mental and hard dollar. And even purchases that are denominated in small amounts more often than not end up as larger transactions either thru bundling or because consumers tend to fill up a "cart" with multiple purchases (the iTunes ATV example).
If I were Swoopo, rather than forcing a new user to buy a bid "pack" or allowing a user to by a single $0.75 bid (don't think they do this) I'd use a try before you buy approach. If a user has given me all their registration info, why not give them one or two free bids to try the model? Then can sell bid packs from there.
Lee, I have my doubts about this statement: "It's for precisely because of this mental accounting that cell phone data plans had minimal adoption when priced as $0.xx / KB, but took off with flat rate monthly subscriptions."
Really? Seems to me that the problem with those data plans was that the user/payer did not know, not did he have any control, over just how much he was spending. Charging per minute would give him enough confidence to use that service. But who knows how many bytes will be downloaded when you read an e-mail or load a web page?
However, I don't disagree that micropayments are difficult for people to account for.
I know of one context in which micropayments *have* worked, for almost six years running now: Second Life. It's worked well enough that some people have been able to make a decent living from content sales -- fewer than the hype would have one believe, but still, some -- and many more have seen a nice significant supplemental income.
(I distinguish SL currency from WoW gold and other game currencies because SL funds are convertible to US$, and because there are no passive, inflationary 'farming' methods as in most games.)
I think this reinforces Josh's point about the lack of transparency being a problem for other micro schemes. The SL client makes it very clear how much one has, what one is paying, etc., at every step along the way.
Lee -
Really good post and obviously timely given that so many business models we see now are based around micropayments. Going along with the trendy jargon of today, some may say that "micropayments are the new advertising".
I think micropayments comes down to 3 things: scarcity, consumer mindset (as you mention) and ease of payment. The scarcity issue is the major reason (IMO) that web-based microtransactions have not taken off for newspapers. Why would I pay for an article from the NYTimes (even for $.10) that I could get from countless other, just as insightful, if not more knowledgeable, sources. For this reason, I think that newspapers will have a really hard time with significant monetization via microtransactions. The one exception to this is really well written editorial content (think Thomas Friedman), that you can't get elsewhere. I believe that these will be able to be monetized via microtransactions, but I doubt the scale is there to really make a difference for any newspaper. However, where there are areas of scarcity (i can't get a cool shirt for my avatar anywhere, so I may be willing to pay for it; I can't get the latest episode of The Daily Show anywhere outside of Hulu / Comedy Central, so I maybe willing to pay for that), I think microtransactions are a great model. The hard part is scaling your audience to a sizable enough amount that the 5% of people that buy via microtransactions make up for the other 95%.
Consumer mindset is the other major limiting factor - as Josh Kopelman pointed to in his post a long time ago "The Penny Gap". I think that is web-only phenomenon. Content publishers on the web have done a terrible job of prescribing any value to their content since they have given it away for so long. However on other platforms such as mobile, people are used to paying for things (such as the example you gave in ringtones). I would never pay for some of the things that I buy on my iPhone on the web (even with Apple's perfected payment system). As a result, I don't think microtransactions on other platforms will be nearly the hurdle that they are on the web. We will get a much clearer picture on if I am right once Apple releases their 3.0 software with the ability to do microtransactions (although all "microtransactions" will be a minimum of $0.99, not $.10 here and $.20 there).
On the ease of payment, Apple obviously nailed this, which is why iTunes has been such a hit. I have no problem buying something off of iTunes (whether it is a TV show, song, ringtone, etc). If I am ever presented with a Paypal checkout, I almost always drop off because the payment system is not nearly as fluid.
It will be interesting to see how the microtransactions business scales over the next 12 - 18 months. I think there will be some really big winners and a lot of companies that don't gain significant scale in terms of revenues.
Josh - the transparency point is a good one and because consumers' couldn't know their data usage up front... this could have been a barrier to adoption. It's hard to tease out the impact of the uncertainty and the micropayment issue. But my hunch is the micropayment challenges were the bigger one... even if people knew up front downloading one WAP page would cost them $0.20, I still think the txn processing and mental accounting costs would have been a bigger roadblock.
Kevin - SL has indeed been a success w/ virtual txns, which often have low nominal value. But Linden dollars are a virtual currency purchased w/ real money, and based on what I've heard the actual *purchase* of currency tends to be in the $20 range. The CFO of Second Life said as much in an interview awhile back (http://www.technologyreview.com/Biztech/19242/). So while the in-world virtual txns are small, the consumer decision (i.e. when they actually end up out of pocket the money) certainly doesn't count as a micropayment.
Dan - broadly agree w/ your points, esp the fact that scarcity drives value regardless of whether your talking about content, virtual items, whatever. Certainly willing to keep an open mind, but given the failure of micropayments on the web I guess I'm still a bit of a skeptic on other platforms as well. Guilty until proven innocent :)
It's all about context. If a company comes out with an ad vs. pay model and the pricepoint is low, a large portion of people will opt to pay to not be annoyed by ads. The killer app, is when the payment method is connected to an existing account such as an Amazon account. Now you have the person who is willing to pay hulu $0.25 a week to not show him ads, etc. It is coming, and it has to. Real money up front beats ad revenues anyday.