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The Siren Song of Internet
Micropayments
by:
Steve Crocker, Founder of CyberCash
Article orginally posted on iMP:
The Magazine on Information Impacts
The Vast (?)
Market for Micropayments
Would you enjoy
making small payments across the Internet?
Imagine paying a nickel for a stock quote, a
quarter for a news article, a dollar for a
picture or a song. Over the past several years, a
number of Internet micropayment schemes have been
invented, and some of these have been put into
service. Instead of revolutionizing commerce on
the Internet, the total impact has been
negligible. What happened? Is the concept flawed,
or were the specific efforts just not right? Is
it an idea whose time has not yet come, or is it
forever doomed?
I was one of the
founders of CyberCash and a co-inventor of
CyberCash's CyberCoin service. We had great hopes
for this service. We imagined a vast market in
which sellers would provide a wide array of
digital goods -- music, information, pictures,
games -- and customers would make small purchases
over the Internet -- a page of a book, a single
song, or the cost of sending in a membership.
Costs over the net could be disaggregated into
small components rather than bundled into larger
prices. The implications for defining transaction
costs and for establishing a low threshold of
entry for small and low-budget vendors (like
libraries, for example) were and remain
potentially provocative. The approach, however,
required creating new third party service to
handle the financial transactions on behalf of
both buyer and seller.
At CyberCash, we
targeted the purchase prices to be in the range
of $0.25 to $5.00. We built the system and began
service in 1996 in the U.S., and later in the UK,
Germany and Japan. The volume of transactions has
been very low. CycberCash is suspending its
CyberCoin operation in the U.S. but may revive it
when there's a stronger market for it.
CyberCash was
not alone in this vision of a market, and its
experience is not unique. First Virtual Holdings
brought out a system for small payments in 1995.
That business is now gone and First Virtual has
transformed itself into an entirely different
business. Carnegie-Mellon University created
Netbill, whose commercial rights were acquired by
CyberCash. Digicash in the Netherlands pioneered
a method to make payments anonymously, and put it
into service in Germany and the U.S. Digicash
filed for bankruptcy and has ceased operation.
Digital Equipment Corporation developed its
Millicent system, ran some trials and never came
to market. It is possible that Compaq is
reconsidering it after its acquisition of
Digital, but no announcements to this effect have
been made. IBM developed a system in its labs but
has not brought it to market. Mastercard invested
in Mondex and worked on bringing Mondex payments
to the Internet. That effort stalled and has
dissipated. Visa built and tested an Internet
micropayment system but has also not yet brought
it to market. Many more schemes have been
invented and some of these have been tested in
the marketplace, but none has gained a secure
foothold.
How could so
many of us have gone astray? I'll draw primarily
from the experience at CyberCash, but many of the
issues are the same for other systems.
Why
Micropayments? Why Not Just Use Credit Cards?
Credit card
payments rule the Internet today. An obvious
question, then, is why try to invent something
new. The short answer is credit cards are
unprofitable for the seller at purchases
below $5.00.
In the U.S. last
year, there were more than $900B worth of credit
card transactions including face-to-face, mail
order, telephone order, and Internet purchases.
The average transaction was around $80. The
merchant pays a fee on each transaction. This fee
is divided among the merchant's bank, the
cardholder's bank, the card association (Visa,
Mastercard, etc.), and the various companies
operating behind the scenes to process the
transaction and move the data. The aggregate fee
is usually between 1.5% and 3.5%, depending on
the risks and costs involved. The average is
about 2.2%, but Internet companies usually pay
more. Merchants with large volumes of high value
transactions with no complaints or chargebacks
enjoy a low discount. Merchants who present a lot
of risk, incur a high rate of chargebacks or
whose average transaction size is low generally
pay a high discount. Thus, risk itself -- always
an issue in a new venture like net commerce --
increases the threshold cost. Which is precisely
the problem in small payments.
Although the
discount rate is usually referred to as a
percentage of the transaction, often with a few
cents added on as well, there's an underlying
factor that is slightly less visible. From the
banks' point of view, part of the cost of
processing a transaction is the same for small
transactions as for large transactions. The
system as a whole needs to charge an average of a
dollar or more for each transaction, irrespective
of whether it's presented to the merchant as a
percentage of the amount or a fixed amount per
transaction. A large portion of this base cost
covers the cardholder's bank's cost of operation
-- issuing cards, setting up accounts, billing
etc.
A merchant who
creates a large number of very small transactions
discovers his bank will raise his discount rate
in order to recover its baseline costs. Hence, it
is not uncommon for a merchant to refuse to
accept a credit card for transactions below
$5.00, $10.00, or sometimes $15.00.
The implications
are clear. The transaction costs implied in the
credit card financial structure mean they cannot
be used directly for very small purchases. If
each transaction costs the merchant a dollar just
to process the credit card payment, he can hardly
afford to sell anything for a quarter!
A related but no
less important "cost" is the time it
takes to authorize a credit card transaction. In
the U.S., credit card authorizations take between
6 seconds and 90 seconds. Outside the U.S., the
authorization time is often longer. A customer
who makes an $80 purchase waits patiently and
usually makes only a few purchases in a single
day. In contrast, a customer who makes small
purchases may make several in a single day and
will not want to wait more than a second or two
for each one. Imagine waiting 6 to 90 seconds 10
times a day in an environment that seems to
promise real-time interactivity. Then, imagine
waiting during periods of peak use -- at 6 p.m.
the week before Christmas.
Designing a
Micropayment System: Aggregation Is the Key
Thus,
micropayment systems posed several kinds of
technical requirements. The ventures mentioned
above all use some form of aggregation that
reduces both the cost and the time delay for any
single transaction. In CyberCash's CyberCoin
system, the user created an account, loaded it
with funds -- usually $5.00 to $20.00 -- from his
checking account or credit card, and then spent
against the funded amount. Each transaction
involved an interaction among the user, the
merchant, and the CyberCoin system, but
individual transactions did not require any
interaction with the banks or the credit card
system.
The CyberCoin
system was designed to make the purchase
transaction very fast and efficient. Of
particular concern was the number of messages
sent between the user, merchant and CyberCoin
system, the number of cryptographic operations
needed to assure authenticity of the transaction,
and the number of database operations needed for
each transaction. We chose each of these to match
what we perceived the need to be. We chose
cryptographic algorithms which were strong enough
to protect small value transactions but which
could be carried out reasonably quickly on our
computers. We reduced the number of messages sent
among all the parties, and we chose a database
design that allowed us to respond very quickly
when a merchant forwarded an authorization from a
user.
From a technical
perspective, these strategies appear to have been
effective. When the system operates at high
volumes, the cost of an individual transaction is
low, perhaps a fraction of a cent. Further, the
system adds only about a second to the total
transaction time.
Assured
Delivery Reduces Customer Service Cost
Another source
of expense in any payment system is the cost of
handling complaints and questions from the
consumers. A customer service operation requires
many people, telephones, and computers. Customers
are usually confused or irritated, so the
interactions are far from efficient. Each
customer service call costs a few dollars,
sometimes more. If there is no way to resolve a
dispute amicably and quickly, there might be
several calls associated with the same
transaction.
Customer service
becomes a serious burden in the micropayment
world. Even if the nominal profit margin is high
on individual micropayment, the absolute margins
are rather thin. A single customer service call
can easily wipe out an entire year's profit on
that customer account. And an unhappy customer
can put a dent in company's profitability.
Therefore, one of the design goals in each of the
micropayment systems was a reduction in the
number of customer service calls.
One potential
source of dispute in online transactions is that
the customer may claim he did not receive the
digital goods he paid for. Several micropayment
systems included some form of "assured
delivery," approximately equivalent to the
U.S. Postal Service's certified delivery service.
To assure delivery, the payment process is
intertwined with the delivery of the digital
goods. For example in the CyberCoin and Netbill
systems, encryption is used to assure delivery.
When the user
requests the information, perhaps a page from
Gray's Anatomy for a medical student who needs it
for a paper, the "goods" are sent back
to the user's system in an encrypted form before
the user pays. This puts the information on the
user's computer but does so in a form the user
cannot read.
Once the
encrypted information is on the user's computer,
the user's system sends back an authorization for
payment, and the merchant's system forwards this
authorization to the clearing center. The
merchant's system also includes the key necessary
for decrypting the digital goods. The clearing
center debits the user's account and credits the
merchant's account. When the merchant's system
receives acknowledgement from the clearing center
that payment is complete, the merchant's system
forwards the key to the user. The user's system
then decrypts the digital goods and displays or
stores the result.
If the
merchant's system fails to deliver the decryption
key to the user's system, the user can contact
the clearing center to obtain the key. The user's
system maintains a copy of recent transactions,
so it can prove that it received the encrypted
information and that it authorized payment. This
information is sufficient to show that the user
paid for the goods and is entitled to decrypt
them, thus providing protection from failures in
the merchant's system or potential fraud by the
merchant.
How well does
this scheme work to reduce customer service
costs? No one knows. There has not been enough
volume in any of the micropayment systems to
gauge how large customer service costs are or
whether assured delivery is an important way to
reduce those costs.
What Went
Wrong?
As noted in the
introduction, neither the CyberCoin system nor
any of its competitors has made much progress in
the market. What went wrong? We know some of the
reasons, which I list below. But far more
important is what we do not know. I am convinced
that it is not sufficient to simply fix the
problems we know about.
Too much
authentication
The early
micropayment systems were clumsy to use, mostly
because the designs erred on the side of caution.
In the early implementations of CyberCash's
CyberCoin system, the user was presented with
multiple screens for each transaction. This level
of caution is appropriate for higher value
purchases, but it slowed down the interaction.
The user did not find it a compelling or
gratifying experience.
A more onerous
hurdle was the loading of the user's account. In
the CyberCoin system, we experimented with two
forms of payment, checking accounts and credit
cards. The credit card payment was fairly easy,
but many users were, nonetheless, reluctant to
pre-pay $20.00 to load their CyberCoin accounts.
Payment from a checking account was significantly
worse. Before we could give users access to their
checking account online, we required a canceled
check and other proof of identity by mail. Very
few people went to the trouble of setting up a
CyberCoin account tied to their checking account.
Later, these
barriers were lowered. The payment process was
streamlined. In other systems, a user was
permitted to accumulate charges first and then
have them charged against his credit card. These
were a big improvement, but they didn't prove
sufficient.
Too few
merchants
As with all
network systems, a critical mass of users,
sellers as well as buyers, is required. Bob
Metcalfe suggested the value of a network grows
as the square of the number of users. All of the
early micropayment systems failed to gain a
critical mass of merchants and a critical mass of
consumers. These two groups reinforce each other,
of course. In all of the early ventures into
micropayments, there was neither a single
compelling digital good available only through
the micropayment system nor an overwhelmingly
attractive variety of digital goods.
An Internet
micropayment system might yet come into
widespread use if pushed by a large marketing
power. We can imagine that AOL, Visa, Mastercard,
or a collection of large banks might have
sufficient marketing power to entice a
substantial number of merchants to come into the
market and make their digital goods available in
small transactions. On the other hand, this may
be exactly backwards. The banks or other
financial services companies are more likely to
provide a successful micropayment system when the
merchants demand it. Perhaps the critical mass
needs to come from a collection of large
publishers who view micropayments as essential
for their growth and health.
Subscriptions
and Advertising -- Alternatives to Micropayments
Once upon a time
we thought micropayments were the only way
merchants would deliver small quantities of
digital goods. However, two very important
alternatives emerged: subscriptions and
advertising. Both of these have substantial
advantages from a merchant's point of view.
Subscriptions
provide guaranteed income. If a merchant were to
choose between selling digital goods on a one
shot basis and selling on a subscription basis,
the merchant will choose subscriptions. Although
the higher price for a subscription will mean
that some of the potential buyers will be lost,
it also means that a higher price will be
extracted from a number of buyers. Moreover, the
guaranteed income gives the merchant much greater
ability to plan, provision and grow.
Subscriptions
have another and perhaps even more important
quality. They provide considerable information
about the consumer and establish a relationship
between the consumer and the merchant. Consumer
information is extremely valuable in its own
right, as it enables to the merchant to target
further sales pitches more accurately --
"up-selling" and
"cross-selling" -- or to sell this
demographic information to others for similar
purposes. The relationship also generates
renewals, thereby continuing the income stream in
future years.
Compared to
subscriptions, selling individual items on a
one-shot basis is a secondary concern.
Micropayments are useful as a way to draw in new
customers and to serve casual customers who will
not pay for subscriptions, but it's unlikely to
be preferable to subscriptions.
Advertising,
too, has been an extremely successful alternative
for funding the delivery of small digital goods.
Stock quotes and news stories, in particular, are
easily available on the web free of direct
charge. Web searches are also free, though they
cost the search companies quite a lot of money to
provide. Instead of a few cents for each
transaction, the users pay attention. That
attention may be far more valuable to the
merchant and his advertisers than the few cents
the merchant might collect. In this respect, the
web is similar to broadcast television.
Reverse
Micropayments, The Internet Surprise
All of the early
micropayment systems were aimed at collecting
small amounts of money from large numbers of
consumers in exchange for digital goods of
(presumably) real value from a relatively fewer
number of merchants. As described, none of these
has achieved any large volume.
An interesting
reversal seems to have occurred, however. Several
companies, Cybergold, Netcentives and
ClickRewards among them, have been making small
payments to consumers instead of collecting small
payments from them. These payments are either for
attention to ads (Cybergold) or rewards for
patronage (Netcentives and ClickRewards).
Compared to the several micropayment systems,
each of these "reverse micropayment"
systems is overwhelmingly successful.
Cybergold is a
particularly interesting case study. It offers
users anywhere from fifty cents to five dollars
to read an ad. Users have to register and
describe themselves. The payment varies according
to the material and the demographics of the user.
An ad for a Cadillac will be worth far less to a
college student than to a middle-aged, high
income executive. Cybergold reports that it has
hundreds of thousands of users and has
accumulated around a million dollars in payments,
most of which is sitting in its accounts waiting
to be disbursed to the users or consumed in some
fashion. In an effort to provide additional
outlets for its users to use the funds they have
accumulated, Cybergold is now entering the
classical micropayment business. It remains be to
seen whether it reaches critical mass and creates
a sustainable system.
That reverse
payments may prove the first commercial success
of the micropayment model should not surprise me.
The trajectory of the Internet has surprised us
all, even those of us who worked on it when it
was an experimental system among a relatively
small group of researchers. That it may transform
the way we work and our economic structures is
likely. What we have learned from micropayments
is that new technologies do not change people and
organizations overnight, that change is hard, and
that the future holds many surprises.
--------------------------
Steve Crocker was one of the founders of
CyberCash and a co-inventor of CyberCash's
CyberCoin service. In the late 1960's and early
1970's, Dr. Crocker was part of the team which
developed the protocols for the Arpanet and laid
the foundation for today's Internet. In addition
to his technical work, he organized the Network
Working Group, the forerunner of the modern
Internet Engineering Task Force, and initiated
the Request for Comment (RFC) series of notes
through which protocol designs are documented and
shared. Steve Crocker Associates, LLC is a
consulting and R&D company specializing in
current Internet and electronic commerce
technologies.
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