Making Small Payments Practical for Small E-Tailers

By James Maguire | Posted March 30, 2004

In a perfect world, all of your customers would be able to pay for their purchases with credit cards, but if you sell small-ticket items such music downloads, newspaper articles, trading cards, fonts and so on, that isn't feasible. The good news is that there is an alternative to credit cards, enabling e-retailers to make a profit even on small-ticket items: micropayments.

Micropayment technology is especially popular among sites selling music downloads or single newspaper articles. Because these items sell for just a few dollars (or less), merchants can't afford to allow consumers to buy them with credit cards — the per-transaction fees would gobble up any profit from the tiny purchases.

"If you're selling something under $10, you pay the credit card companies more than your profit," said Gartner analyst Avivah Litan.

Micropayment vendors let consumers make tiny purchases by deducting from a pre-paid balance. So a consumer with a $10 or $20 balance can make $0.25 and $1.50 purchases at all her favorite sites, while those sites get a transaction rate that allows them to make a profit on those items.

Despite its benefits, the technology is only now coming into vogue in earnest. At one time, Internet futurists predicted that micropayments would take over the Web, with content providers getting a nickel or a few pennies from every surfer. As it's turned out, using advertising to create revenue has proven to be more user-friendly. And a string of failures by micropayment vendors made the technology look like a passing fad. (The names Flooz and Beenz may come to mind.)

These earlier vendors "were a solution looking for a problem," said JupiterResearch analyst Bruce Cundiff, explaining that not enough consumers or content providers were interested in micropayment to support these early pioneers.

Now, however, as e-commerce continues to surge, micropayment service providers are growing with it. Cundiff points to two factors fueling micropayment use: broadband adoption and shifts in consumer behavior as surfers start to pay for music downloads. The efforts of the Recording Association of America (RIAA) to drive surfers toward legal downloads are working, he said.

Based on a survey by Gartner's Litan conducted in 2002, 44 percent of retailers said they had goods and services they would sell if a micropayment system existed.

"We get enough clients looking for micropayment systems to know there's a market — even big merchants with little things to sell want an alternative," she said.

Starting Micropayments: What To Look For
Micropayments are ideally suited for "small businesses that have no other way to take electronic payment, and for merchants who can't get a good rate on a credit card account," Litan said. So micropayment is not for everybody, and by the same token, micropayment vendors don't offer a "one-size-fits-all" solution, Cundiff said. Merchants need to consider the following as they weigh micropayment solutions:

  • Cost of the transaction: Not surprisingly, this is always the first issue to consider, Cundiff said. He suggests e-tailers ask, "Is this micropayment provider giving me a discount rate that I can survive at if I'm selling in $0.25 increments?" It's not unusual for a micropayment vendor to charge 15 percent of every transaction, from a penny to $5. That may seem steep, but it allows merchants to be "hands off." In other words, sellers won't need to pay a monthly payment service provider or handle headaches like credit card fraud.

  • Viability: When shopping for a micropayment solution, you should ask yourself: How big do I expect to grow, and will this solution grow with me? Additionally, you should ask enough questions to feel confident that a given vendor will be in business three years from now. Finally, you should determine whether the vendor has an installed user base among consumers that will bring you customers. Those questions favor the market's dominant player — which is expected to be PayPal, once it launches micropayment later this spring — but experts still recommend considering offers from smaller competitors.

  • Level of integration: Different micropayment vendors offer services that can become a part of an e-tailer's content. Some, for example, provide a DRM (define) system to protect content from being freely traded once it's bought. Merchants should ask solution providers: How long does set-up take? Is there a one-time set-up fee? Particularly important is whether the solution can be combined with Visa and MasterCard.

The Players
If you are ready to at least contemplate a micropayment approach, here are four vendors that are considered the top micropayment solution providers:

  • BitPass: Catering to smaller, independent content providers, BitPass charges no sign-up or monthly fees and is easy to set up. The company offers a "stored value" solution in which users deposit funds in an account; users can make purchases as low as a penny. The BitPass solution integrates so closely with a content provider's Web site that the transaction is nearly seamless, analysts report.

    The system's downside is that it has a small user base, which creates a hurdle: Potential buyers might be reluctant to sign up for a new service. BitPass is working to overcome this by streamlining its sign-up. "They have it down to a science," Cundiff said, noting that it takes only about a minute to activate an account.



  • PayPal: Clearly the 500-pound gorilla of online auction payments with 40 million users, PayPal enables merchants to benefit from its well-established brand name. Users know and trust it, Cundiff said. While it's owned by eBay, PayPal's 2004 strategy is based on building business in areas other than online auctions, he said. "They're working to have the PayPal logo next to Visa and MasterCard on regular retailers' site."

    PayPal benefits by allowing its consumer users to load their accounts using ACH (automated clearinghouse), the payment networks that banks use to route money through checking accounts. Processing is much cheaper than with using credit cards to load accounts, which enables PayPal to offer lower rates to merchants.

    PayPal is scheduled to launch a micropayment product offering this spring, and Cundiff expects them to quickly become the dominant player. "PayPal is positioned really well to win in the music download market," he said.



  • Yaga: A vendor that seeks to work with newspapers and magazines selling online content, Yaga's goal is to be a full-service payment solution: The company's technology supports both subscription and micropayment models. Additionally, "they can either maintain the content or just be the back-office payment network," Cundiff said.

    The company touts its capability to scale large enough to handle major archives, and they have a client list to prove it, including Time Inc., Ziff-Davis and Tribune Media.



  • Peppercoin: Instead of the usual stored value method, Peppercoin aggregates many small transactions into one large transaction. This means users' credit cards are charged only once for many transactions. So a series of $2 and $3 dollar purchases is charged as if it were one larger purchase, meaning content providers get a lower discount rate.

    Content providers encrypt their material using "Peppermill" encryption technology. While this provides protection, it also causes problems: "Peppercoin requires users to initiate a download to activate and use accounts, creating confusion at registration and point-of-purchase," Cundiff said. This will likely hinder growth in Peppercoin's user base, he said. Additionally, the company is still new, with only a few dozen merchants enrolled, and an undetermined number of account holders.

Surviving Models
Micropayments will continue to gain traction, analysts predict. A chief growth area is selling piecemeal access to large archives, which some content providers might combine with a subscription. For instance, "a user subscribes to the Wall Street Journal, but pays $0.20 more for an article from five years ago," Cundiff said.

On the other hand, he said he thinks the years-old dream among Internet publishers — in which surfers pay for all content — remains only a pipe dream. "The idea that someone's going to pay $0.15 for every article — I don't see that happening," Cundiff said.

Advertising, rather than paying per article, continues to be a highly viable publishers model. But the advertising and micropayment models might merge into a hybrid. "Someone like a comics seller isn't going to survive on the advertising model," Cundiff said. He added, however, that comics sellers could offer paid products beyond what they're giving away for free, combining modest advertising revenue with income from micropayments.

Gartner's Litan noted that the business growth of micropayment vendors like PayPal, BitPass, Peppercoin and Yaga will continue, "as long as the credit card companies don't want the business." The credit card companies are still uninterested in underwriting the legion of small auctioneers that powers eBay, she said.

"The credit card companies have first dibs, and if they don't want it or it's not enough volume, then there's room for these other players," Litan said, adding that there will always be some sort of transactions that credit card companies don't want. Given this fact of Internet life, micropayments seem likely to play an important role in e-commerce's foreseeable future.

Adapted from ECommerce-Guide.com, part of internet.com's Small Business Channel.

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