With PayPal Backing, Will Micropayments Work This Time?

By Evan Schuman  |  Posted 09-12-2005

With PayPal Backing, Will Micropayments Work This Time?

The concept of e-commerce micropayments—small Web purchases typically less than $2—is nothing new, but it has never gained widespread acceptance among e-retailers because credit card fees took too much of a bite out of a micropayment to make the exchange profitable.

eBay's PayPal payment service, on the other hand, is restructing its fee structure to encourage micropayments.

Although specifics vary depending on the retailer's sales volume and other negotiated details, retailers selling online end up paying credit-card processors, gateway providers or other middlemen about 35 cents for every sale—and that doesn't include the percentage of the sale that Visa, MasterCard and AmericanExpress typically also take.

That percentage cost does take a bite out of a micropayment, but the fixed charges are a much more serious concern.

Paying a 5 percent fee for a 99-cent song will trim the margin for a site selling music, for example, but adding a 35-cent exchange fee on top can sour the whole deal.

"That really erodes a lot of the profit motivation to sell," said Peter Ashley, PayPal's director of digital content and micropayments.

eBay has introduced a new pricing package, seeking 5 percent of the total sale (that's more than 2.5 times eBay's current high-volume commission of 1.9 percent) plus five cents per transaction.

With a fixed cost of only five cents, PayPal is hoping to make micropayments worthwhile for retailers, Ashley said.

Rather than force buyers to register for every purchase, PayPal's approach is to require only a PayPal number.

"These are small payments, often quick impulse buys. It needs to have a very convenient payment system," Ashley said.

Given the credit card costs, many companies have toyed with selling low-priced content using a subscription model under which consumers pay a fixed amount, say, $10 a month for unlimited access to stories, images or songs.

But few have found that approach viable. CNN.com, for example, recently gave up trying to charge for access to "premium" content on its site.

Ashley said the subscription approach has failed because it's not what consumers want. "You're trying to force a consumer into a scenario where, if they want access to this premium content, they have to pay $10 a month," Ashley said. "It's a not a consumer-oriented solution."

PayPal concluded that the early Web micropayment attempts didn't fail because of the Web's immaturity, but because the people who worked them out didn't understand how consumers want to buy.

"What didn't work in '95 still won't work in '05," Ashley said.

Click here to read about how PayPal and iTunes are making sweet music together.

Analysts applauded the move and said PayPal is one of the few vendors positioned to make a micropayment difference.

"I think it's going to make a significant difference," said IDC Analyst Aaron McPherson. "I know in the Web comics community, there's a lot of excitement about this. They lacked a good subscription model for online payments. There was a lack of good options, not just with the music downloads but also with the Web comics. "They've been accepting higher (credit card processing) fees in order to get money. This is a positive development that allows people to use a payment method they're already familiar with."

At Gartner, analyst Avivah Litan also saw the move as a good strategic move for PayPal.

"PayPal's move into the micropayment market was a sound business decision and one that is likely to lead to market domination," Litan wrote in a report on the topic.

"PayPal can beat credit card pricing because it blends credit card, bank account transfer and stored PayPal account value funding on the payer side, lowering PayPal's overall cost of funding any payment.

"PayPal encourages repeat payer customers to keep money in their PayPal accounts (the company's lowest-cost funding method) and to use credit cards (the most expensive funding option) as a last-option funding method."

PayPal, in theory, could have offered this package quite some time ago, but Litan said PayPal wanted to wait until it had accumulated enough customers—it claims 78 million accounts—to make it profitable at even a low margin.

"PayPal's expansion is bad news for countless startups around the world that have tried to enter the micropayment market," Litan said.

"Although credit/debit card companies could enter this market simply by lowering merchant transaction fees, these companies don't have the PayPal advantage of funding payments from PayPal stored accounts, as well as traditional bank accounts."

Next Page: Micropayments are big business.

Micropayments Are Big Business

A micropayment may be a small individual purchase, but it is also big business. Estimates vary, but most industry experts estimate the potential for online micropayment-based purchases at about $5 billion a year and growing.

But micropayments are not necessarily limited to online. As retailers start looking at almost all small cash purchases as potential micropayments, the effort to create transaction fees that work for small purchases could impact online as well as offline.

The market for all micropayment transactions is in excess of $1 trillion a year, Ashley and others said.

Those non-Web microtransactions include tolls, snack machines and fast-food. Quick-service restaurants like McDonalds have already started pushing credit cards aggressively.

Contactless payments may accelerate some of those physical world micropayment options, assuming the back-end transaction fees can be worked.

A key (although much smaller) eBay rival, Peppercoin, Inc. of Waltham, Mass., is experimenting with a wide range of non-traditional micropayment options, including allowing people in Las Vegas to pay for their parking meters with their cell phones rather than with their quarters.

To read about how "fixed" isn't good enough for payment protection, click here.

"The micropayment market has clearly emerged," said Peppercoin CEO Mark Friedman.

In the online world, though, pricing expectations are being set by a handful of e-commerce micropayment pioneers.

"iTunes has done a great job of setting the consumer price expectation of 99-cents" for a song download, Ashley said.

There is also disagreement within the industry of whether credit card companies will see these moves by executives at companies like PayPal and Peppercoin as competitors trying to horn in on traditional credit card turf or as helpful partners trying to increase overall marketsize for micropayments.

At PayPal, for example, "a little more than 50 percent" are ultimately funded with credit cards, Ashley said, with the rest typically paid for with bank account debits.

One e-commerce segment that has often been seen as an ideal micropayment segment is adult-oriented images and videos, but PayPal has stopped supporting that segment because fraud attempts and credit card chargebacks were too high, Ashley said.

Retail Center Editor Evan Schuman can be reached at Evan_Schuman@ziffdavis.com.