An Eye for A Lucrative Niche

  When it comes to the Web, credit cards were in the right place at the right time. Credit has been the perfect payment form for a merchant model that exists on a computer and demands a guaranteed payment from nearly anywhere on Earth.
  But a challenger to credit cards as the Web payment dominator may be gaining a foothold as both merchants and consumers seek cheaper and easier alternatives to plastic.
  Web merchants may also take a chance soon on a payment alternative for micropayments. Though the card industry has long contemplated serving this market, no solution for these under $5 payments has ever taken hold. With consumers buying music and games online, merchants and processors are rethinking this space.
  It would seem to be to online merchants' advantage to offer alternatives to cards. A survey last November of 147 large and medium-sized Web merchants by CyberSource Corp. found that the order-abandonment rate is lower when two or more payment methods are offered to consumers. Sales are completed in 71% of cases when three or more payment methods are offered compared with 60% when only one method is offered, CyberSource found. Reducing the abandonment rate could increase revenues by an average of 15% per merchant, according to Mountain View, Calif.-based CyberSource.
  I4 Commerce Inc.'s Bill Me Later payment system is a card alternative that is finding acceptance. For now, only about 20 merchants offer Bill Me Later, a deliberate limitation by management as it seeks out what it calls top-tier merchants for the service. Retailers include Buy.com and Hotels.com.
  When Bill Me Later is available, it matches the Discover card in market share, says Gary Marino, chief executive officer.
  Consumers select the Bill Me Later button on a merchant's payment page just as they would opt for a card. A user enters shipping information along with his birth date and the last four digits of his Social Security number. Bill Me Later uses the credit bureaus and other databases to check the consumer's credit quality to authorize the transaction. If approved, Bill Me Later vouches for the consumer to the merchant. The consumer receives a statement from Bill Me Later that month that can be paid in full or financed. Bill Me Later earns its revenues from the financing charges and its charges to merchants.
  To entice merchants into offering Bill Me Later, I4 Commerce charges them 30% to 40% less than the comparable costs of blended credit card fees, says Mark Lavelle, I4 Commerce's vice president of business development. According to I4 surveys, the average Bill Me Later order is 8% to 11% greater than a typical credit card order, and users return 26% to 46% more often to shop than credit card customers, says Lavelle. The company declines to share sales statistics. The loss rate is comparable to that seen by major card issuers, he says.
  Bill Me Later is designed for three consumer demographics: the cardless, consumers with a card who want to use an alternative financing source, and Web buyers who don't feel comfortable putting their card information online.
  Skeptics may assume that most users are cardless but the average Bill Me Later consumer has several credit cards and a FICO score over 700, says Lavelle.
  Timonium, Md.-based I4 Commerce has some of the major players in the card industry behind it. First Data Corp. and acquirer Paymentech are investors and Bill Me Later orders flow through their networks. Venture-capital firms Crosspoint Venture Partners, Azure Capital Partners, and GRP Partners have also bought in. In July, CyberSource, a provider of fraud-prevention tools and links to Web payment methods, added Bill Me Later to its offerings.
  Joining with giants like First Data is essential for any firm attempting to create something that will compete with an entrenched product like cards, says Marino. "This industry is an oligopoly controlled by major companies. Unless you have relationship with them it is difficult to build your business."
  Still, "we have to demonstrate it works. For consumers it resonates. It must be seamless, quick, and secure," says Marino.
  Gwenn Bezard, a senior analyst with Celent Communications who follows the online payments market, says Bill Me Later could add several percentage points in sales for many retailers. "For a big merchant, that's a lot."
  But I4's growth could be limited because cards are so dominant in the online arena. "Can they build a $200-million company in revenues? I don't think so. Maybe $30 million to $40 million," he says. That sounds respectable but could prove a letdown when your stakeholders are giants like First Data, notes Bezard.
  As I4 Commerce attempts to build its foundation, the Web continues to grow as a popular spot for shoppers. It's almost become a broken record to say that micropayments could prove the next big payments alternative. But records, or songs, could be the item that makes micropayments acceptable to merchants and consumers.
  According to international market research house Ipsos-Insight, 10 million Americans in 2003 paid $2 or less a song to download digital music from the Web, a nearly three-fold increase from 2002. Digital music is the most popular micropurchase, followed by articles, games and mobile-phone ring tones. Ipsos surveyed 1,112 Americans ages 12 and older in December.
  The Tower Group Inc. in July reported that digital micropayments, defined as those under $5, could a see a compound annual growth rate of 23% from 2003 through 2009.
  Tower breaks digital micropayments into two categories: mobile micropayments, which include ring tones and other services available over mobile phones, and Internet payments. Mobile payments will grow from $400 million this year to $4.8 billion in 2009, Tower predicts. The Internet payments side will grow from $2.8 billion in sales in 2004 to $6.7 billion in 2009. In all, digital micropayments could total $11.5 billion in 2009 (chart).
  Amortizing Fixed Costs
  One firm attempting to take advantage of this adoption is Peppercoin Inc. The Waltham, Mass.-based company this July rolled out version two of its software, receiving kudos from observers like Bezard for its merchant- and consumer-friendly design.
  Peppercoin's software accepts major payment cards and processes micropayments for both online and brick-and-mortar merchants. Merchants pay Peppercoin 7% to 10% of the transaction cost for purchases of 99 cents or less, says Perry S. Solomon, co-founder and vice president for strategy. Merchants earn volume discounts. There is no other fee to the merchant and Peppercoin is transparent to the consumer, says Solomon.
  The age-old complaint from merchants regarding micropayments is the impossibility of making a decent profit, or any profit, after paying interchange fees on a card transaction. Acquirers pay interchange to the card issuer and pass the expense on to the merchant.
  To solve that, Peppercoin's software aggregates transactions from merchants and sends them in one bunch to the payments processor, says Solomon. "We take lots of little payments from many sellers to many buyers, aggregate them as a larger payment, send them to the processor, and amortize the fixed costs per transaction," he says.
  Along with its new software, Peppercoin has changed its marketing focus from only Web merchants. In July, it said it would be meeting with merchant acquirers, issuers, and processors to convince them to offer its software. And Peppercoin began meeting with brick-and-mortar merchants to offer card acceptance for micropayments at the physical point of sale.
  Peppercoin will soon be available at bars and saloons, providing its software to Incredible Technologies Inc., maker of the Golden Tee Golf video game. Consumers will pay with their credit cards the average $3 it costs to play a game at 30,000 of the 100,000 Golden Tee machines, says Solomon. Peppercoin earns about 25 cents to 30 cents per game.
  Regarding another potential market, Peppercoin says vending machines represent a $30 billion a year business.
  Bezard believes the demand is certainly there for digital micropayments. The problem for vendors, he says, is that international giants like the EMI Group plc record label, and Sony Corp., with its music and games, could create their own payment system as micropayments gain traction.
  "The music industry is controlled by four or five major labels. They control (song) catalogs. Will they use a vendor to process? I doubt it," says Bezard.
  That could be a blessing in disguise for Peppercoin, says a spokesperson. Like many innovators, it could be acquired, or stay independent while licensing its software to a single major merchant.
  Clearly, growth in e-commerce offers opportunities for entrepreneurs seeking to find the right service for the right consumer and the right merchant.