Micropayments: Pennies from Heaven?

  Web-based micropayments, purchases many experts define as $10 or less, passed a milestone when Apple Inc. announced in January it had sold more than 2 billion songs for 99 cents a pop through its iTunes online music store. Apple says 1 billion of those sales occurred in 2006 alone and that, as of January, it also had sold 50 million television episodes and more than 1.3 million feature-length films through iTunes.
  Digital content, from newspaper articles to online gaming trinkets, represents about a $3 billion market in the United States, according to research firm Celent LLC. That is less than 2% of the $215 billion market for all U.S. e-commerce but is big enough to draw more attention from payments-industry players large and small.
  Payment providers enabling online micropayments say they believe it will pay off for their companies to be well-positioned in the small-payments market. But many also caution that the increasing flow of small online transactions does not necessarily equate to big profits.
  Indeed, buried in the e-commerce battlefield are the bones of upstarts that tried and failed to make online micropayments profitable. Rest in peace First Virtual, Cybercoin, Internet Dollar and BitPass.
  Peppercoin (see sidebar, page 32), which got its start as an online micropayments provider, found more success coupling payment aggregation with loyalty programs for such brick-and-mortar merchants as ice cream parlors and vending machines. Chockstone Inc., a Portland, Ore.-based loyalty, marketing and payment processing company, acquired Peppercoin in April.
  "It's still very hard for providers to make a living off of low-value payments in the digital world," says Celent analyst Dan Schatt. "Those that have been making it don't have business models that rely specifically on eking out a profit in this area."
  Apple's business model for iTunes is to sell iPods, Schatt says. Apple sold 10.55 million iPods in the first quarter of this year alone, 24% more than it sold in the first quarter last year. Schatt expects those song sales to help Apple invade the mobile-commerce world with iPhone, a device Apple released in June, that combines mobile-phone, iPod and Internet-accessible personal digital assistant capabilities.
  Rene Pelegero, PayPal senior director of industry relations, strategy and compliance, concurs that online micropayments are not big money compared with other PayPal operations, such as enabling higher-ticket eBay transactions. "There are low margins and not necessarily tremendous volumes," he says.
  PayPal ramped up its participation in the micropayments realm in September 2005 with cheaper merchant fees for transactions less than $12. The new fee, 5% of the sale plus a nickel per transaction, amounts to 10 cents per $1 transaction or 15 cents per $2 purchase.
  That would make a lot more sense for micropayments than did PayPal's standard pricing of 2.9% plus 30 cents, which amounts to 33 cents for a $1 transaction.
  PayPal's most-famous music merchant, iTunes, aggregates many song purchases by an individual user before sending to PayPal one transaction-say, $99 for 100 songs ordered over the course of an evening or a weekend-that is well above anyone's definition of micro.
  Pelegero does not disclose micropayment statistics for iTunes or its other merchants but says the segment has been "small but successful."
  "We've seen uptake," he says. "I wouldn't say it is phenomenal. It's not something that is driving the entire company strategy for us at this point."
  Whether or not online micropayments are directly profitable for payment providers, many industry experts say enabling micropayments can generate secondary benefits.
  For example, PayPal and Google, which began offering its Google Checkout service in 2006, are leveraging Internet payments, including small ones, to encroach on bank card turf, says TowerGroup analyst Dennis Moroney. "All these nontraditional payment providers, such as Google and PayPal, are looking toward the physical point of sale," he says.
  Moroney says the competition for handling small payments initiated online is important because when consumers become used to using a certain payment method for small Web payments, they are more likely to use that form of payment for larger online payments. And the battle between banks, nonbanks and dueling merchants to build certain payment habits spills out of the virtual world into the physical, he says.
  "The market value [of micropayments] is not the big deal," Moroney says. "The big deal is really the fact that your card is being used with greater frequency."
  Of course, card networks enable nonaggregated online micropayments, too. But given the higher interchange rates applied to credit and signature-debit cards, bank-payment vendors are seeking new micropayment offerings for merchants.
  STAR PILOT
  First Data's Star electronic funds transfer network in July plans to begin a four-month pilot switching PIN-less debit micropayments online.
  Internet and mobile-payments technology company Solana Corp. is serving as the pilot's first merchant. Solana will be allowed to aggregate transactions of its customers in batches up to $25 per consumer before sending them to Star for settlement.
  For now, only transactions initiated with personal computers or laptops qualify, but Star hopes eventually to add mobile phone-initiated transactions, according to Nancy Loomis, Star director of new product development and management.
  Star will require merchants to register and authenticate consumers for the payments and to bear the risks of disputed transactions.
  In return, PIN-less debit will provide merchants with interchange that is cheaper than credit cards and settlement that is faster than routing purchases as automated clearinghouse transactions, which can take a couple of days to settle. Star's PIN-less debit system will settle the next day transactions approved by financial institutions, Loomis says.
  She declines to disclose exactly what fees Star might charge for the service but says "appropriate pricing and rules that make sense are two lessons Star hopes to learn from the pilot. ... We want to make sure this is equitable for all parties."
  Star already enables PIN-less debit transactions for bill payments, with interchange on those transactions capped at 35 cents.
  Micropayments are an easier step into the riskier space of online shopping than are larger online transactions, Loomis says. "Because these transactions are PIN-less, we don't want to open [transactions] up to e-commerce in general," she says.
  Schatt says the Star pilot is interesting, but it will be a challenge to get cardholders to opt for PIN-less debit transactions over signature debits that rack up rewards points.
  "And the EFT networks (including Star) are kind of caught in the middle between the large banks that they service who also are large card issuers and fear some kind of cannibalization if transactions go through these networks," Schatt says.
  Struggling to find that balance online is worth the effort for bank and nonbank payment providers and third-party vendors, TowerGroup's Moroney argues.
  Even if they do not bring easy profits, he says, online micropayments can help consumers build payment habits that can transfer to larger payments, both in the virtual and brick-and-mortar worlds.
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