Maximum Effort in Micropayments
Jim Daly
Once
almost synonymous with online music downloads, micropayments are moving
quickly into the physical world. But, with transaction pricing still
problematic, will micro-transactions lead to maxi-profits?
More and more consumers today are using cards for so-called micropayments, loosely defined in the payments industry as transactions under $5. While cash dominates these pint-size purchases, electronic processing is making steady gains both on the Web and in physical locations.
Members of the generation that grew up in a plastic society are leading this trend. First they downloaded songs for 99 cents from Apple Computer Inc.00 hugely popular iTunes site and other Internet music sites. Now they use cards for minipurchases when they venture into stores. 00ids today, young adults, they don00 have any qualms about doing $1.50 credit card transactions,00says Russ Jones, a partner at Menlo Park, Calif.-based payments consulting firm Glenbrook Partners LLC.
Visa USA recently reported that its volume of small-ticket purchases0025 or less00otaled $49.1 billion in 2005, up 25% from 2004. Micropayments, which Visa defines as $2 or less, were a good though unspecified share of that. According to Niki Manby, senior vice president of product and innovation, a Visa-sponsored survey in July of 1,154 U.S. general-purpose cardholders showed 70% of consumers between 18 and 25 years old are willing to use credit or debit cards for purchases under $2, compared with only 26% of respondents ages 45 years and older.
00 see micropayments as part of another opportunity to develop relationships with the customer, access to cash, access to a younger generation,00 says Dennis Moroney, senior analyst at Needham, Mass.-based TowerGroup Inc., an editorially independent subsidiary of MasterCard Worldwide.
The potential market is huge: $160 billion in point-of-sale purchases in cash-dominated merchant categories such as vending machines, public transit, parking meters, pay phones, and coin-operated laundries, according to a June report about micropayments from the Federal Reserve Bank of Philadelphia.
00he trend does point one way, and I think that lots of people in the payments space see these small transactions more or less as the final frontier,00 says the report00 author, James C. McGrath, an industry specialist in the Philly Fed00 Payment Cards Center.
Outer Limits
Yet, this shift to micropayments is putting card issuers, merchant acquirers, payment networks, processors, and other industry players in a bind. They welcome the new volume, but confront technology, operational, and pricing problems in accommodating it. They00e all trying to fit micropayments into a system originally designed for much larger, and slower, transactions.
While not the only force for change, micropayments are a big factor spurring development of some of the electronic payment industry00 newest products and services, including contactless cards, Internet payment systems, and payment-enabled cell phones. MasterCard reports almost half the transactions on its PayPass contactless card total less than $10.
Yet, despite the buzz about micropayments in the wake of recent reports and network initiatives, many merchant acquirers and processors nonetheless are approaching the market cautiously.
00here is a pretty good-sized technology build to play in this space, and then a marketing and sales effort,00says Gregory C. Cohen, the new president of Moneris Solutions Inc., the U.S. arm of Canada00 largest acquirer, Moneris Solutions Corp., itself a joint venture of the companies that own Royal Bank of Canada and Bank of Montreal.
The micropayments market indeed has its pitfalls, but many payments players are charging ahead to these outer limits. While online payments, the ancestral home of micropayments, remain a vibrant sector with e-commerce consistently posting 20%-plus annual growth rates, much of the recent action is going on at the physical checkout counter.
00e don00 have any precise statistics, but generally our sense is that most of these small tickets have come in from the physical world,00 says Carl Stefanelli, senior business leader for e-commerce at MasterCard.
Not only have the card networks tinkered with pricing to make tiny payments palatable for merchants, but Visa and MasterCard also have eliminated traditional point-of-sale signature requirements in more than a dozen low-risk merchant categories for small purchases to make transactions go fast, just as small cash sales do. 00hat we00e found is an increasing number of merchants are interested in speeding payments at the point of sale,00says Visa00 Manby.
Transactions that use radio-frequency identification (RFID) technology to transmit data between specially equipped POS terminals and contactless smart cards such as PayPass, American Express Co.00 ExpressPay card, and the Visa Contactless card typically take a few seconds less than ones involving the usual swipe of a magnetic-stripe card through a traditional terminal. That was one reason San Francisco-based Wells Fargo & Co. started issuing Visa Contactless credit cards this year. Wells had 125,000 contactless cards out by late summer, and expects to have 400,000 in issue by year00 end. Pulling in more small transactions normally done with cash is a big reason for the initiative.
00ontactless has offered us an opportunity to capture more micropayments,00says Peter Ho, product manager of Wells Fargo Contactless. 00e saw an opportunity to make our card top of wallet.00/font>
Ho didn00 have specific data on the micropayments volumes Wells is getting with the new cards, but says that overall 0000 very happy with what I00 seeing00considering the limited merchant acceptance of contactless cards. 00e are seeing that people are spending more money and more often.00/font>
No Breakdowns
MasterCard reports that it had nearly 10 million PayPass cards in issue in the second quarter, cards accepted at 32,000 locations worldwide. Big acceptors include 7-Eleven Inc., which has 5,800 convenience stores in the U.S. and Canada, CVS Corp. pharmacies, New York City-area drug-store chain Duane Reade Inc., and some McDonald00 Corp. locations. About 4 million Visa contactless cards were in circulation early this year, according to the Philly Fed report.
Tests of contactless chip card technology in new merchant sectors abound. Some of the more notable are in transit, including related categories such as tolls and parking. MasterCard is in the midst of a six-month PayPass pilot with issuer Citigroup Inc.00 Citibank and the New York City area00 Metropolitan Transit Authority. And this month, the Salt Lake City-based Utah Transit Authority is expected to start the nation00 first test of contactless technology on buses. The buses will accept PayPass, ExpressPay, and Visa Contactless as well as passes from area ski resorts.
In New York, approximately 7,000 subway riders are using Citibank PayPass contactless credit and debit cards or special tags at 79 00ap-and-go00 turnstiles in 30 stations along the Lexington Avenue subway line, the MTA00 busiest. Cardholders can prepay transit fares to get bonus rides, or simply pay at the turnstile for a single ride, which costs $2.
The sponsors won00 release much data until after the trial closes at the end of this year, but a MasterCard spokesperson says cardholders have made 00ens of thousands of transactions. We have been thrilled.00 The equipment has apparently stood up to rush-hour deluges pretty well. 00e haven00 had any breakdowns of the hardware,00the spokesperson says. MasterCard and Citi are footing the test00 costs. The payment tags use technology from Israel-based microprocessor systems provider On Track Innovations Ltd.
Vending machines, which absorbed an estimated $24 billion in currency and coins in 2004, according to the Philly Fed, are another fertile micropayments field. In late June, MasterCard, The Philadelphia Coca-Cola Bottling Co., and USA Technologies Inc., a Malvern, Pa.-based wireless-payment technology provider, started testing tap-and-go payments at 1,000 vending machines. Before the pilot started, only a handful, perhaps as few as 1,000, machines accepted contactless cards. According the Worldwide Vending Association, the nation has 6.6 million vending machines. About 3% accept magnetic-stripe credit cards, according to Automatic Merchandiser magazine. That works out to 198,000 machines.
Users at the Philadelphia machines can make selections for up to $10 in a single transaction. The machines are equipped with USA Technologies00 e-Port device, which reads radio waves and costs about $400.
00ecessary Evil00/i>
As more physical locations begin to accommodate micropayments, some processors that made their names in small-ticket Internet payments are moving to the brick-and-mortar world. One is Waltham, Mass.-based Peppercoin Inc., an early leader in so-called aggregation technology that in June launched a loyalty module within its Small Payments Suite, a hosted payments service.
A key selling point for merchants and consumers who don00 want to carry another card is that the new module uses a customer00 existing payment card as the account for merchant-designed rewards programs. 00t00 a huge advantage to the merchant and a huge advantage to the customer,00 claims Mark Friedman, Peppercoin00 president and chief executive officer.
At the three locations of the module00 first announced user, Toscanini00, an ice cream and coffee shop based in Cambridge, Mass., card payments zoomed from 0% to 17% of revenues, according to Friedman. Card sales are 43% higher than cash purchases, he adds. Customers can enroll with the swipe of a card, and track their loyalty points and purchases online. Toscanini00 offers prepaid and non-prepaid versions of the loyalty program. Peppercoin has two more booked merchants for the system that it hasn00 announced yet.
Peppercoin00 business model is based on changing a common mindset among small businesses, one Friedman describes as, 000Card acceptance, be it credit card or debit card, it00 kind of a necessary evil.00But people want to use cards.00Instead, he00 trying to convince merchants that cards can grow revenues and deepen customer relationships.
Peppercoin uses what it calls 00ntelligent aggregation00technology that lets its merchant clients submit tiny transactions from the same customer in batches rather than individually. In that way, the merchants save on interchange costs, notably the fixed part of Visa and MasterCard acceptance pricing, which also includes a percent of the sale.
Peppercoin00 technology submits transactions into the payment networks based on predictive modeling that factors in, for instance, how often a customer shops at the merchant. Transactions from a frequent customer using the same card could be held for a certain time and then batched, while one from a new customer would be routed for immediate authorization.
00urdle Rate00/i>
Pricing and related operational issues are probably the biggest drags on micropayments growth. The card networks have taken steps to address these issues, though some experts say more remains to be done.
Besides permitting aggregation under controlled circumstances, both Visa and MasterCard have expanded the number of merchants not subject to the signature requirement to expedite checkout. Visa no longer requires signatures on sales of under $25 in 17 merchant categories that include fast-food restaurants, pharmacies, parking lots, and movie theaters. Up to 27% of Visa transactions may be eligible for no signatures by year00 end, the association says.
Also, under Visa00 Small Ticket Payment Service program announced last spring, merchant acquirers can qualify for reduced interchange on consumer credit and check (signature-based debit) card transactions of $15 or less. A total of 14 merchant categories are eligible. Visa00 Manby wouldn00 disclose the amount of the reduction, but the Philly Fed report says it00 20%.
Both Visa and MasterCard normally charge 1.55% plus 4 cents under their current small-ticket interchange price lists for signature-based debit. That works out to 11.75 cents on a $5 sale. Visa00 small-ticket credit rate is 1.65% plus 4 cents, or 12.25 cents per $5. MasterCard00 equivalent rate could not be immediately determined. Acquirers pass these costs on to their merchant clients.
The key issue is that ordinary interchange eats up a disproportionate share of a small purchase, leaving less margin for the seller. Technologies like aggregation, and specific price breaks like those introduced by Visa, can help, but what could really supercharge growth in small payments is a more generalized and permanent move downward in interchange rates, driven perhaps by economies of scale from other volume. With MasterCard freed of direct ownership by interchange-earning banks00nd Visa now headed in the same direction00ome observers say the probability of such a pricing move could be much higher than before.
Obviously, the recent high growth rates in small card transactions indicate the market can bear current pricing, but could volumes go even higher? Nobody00 crystal ball is giving a very clear answer to that question because of the complicated interaction of pricing, technology and operations, and the needs of merchants generating micro transactions. Many such merchants are small and hence present more underwriting risks than larger, more established merchants that generate larger tickets.
Acquirers such as Moneris, which has worked with Peppercoin and is piloting micropayments, are certainly interested in small payments, but Cohen notes that other systems such as the automated clearing house network also have their pluses in addressing micropayments. Given all that00 needed to accommodate card-based micropayments, including the right pricing and special technology, Cohen believes many acquirers will leave the market to a select few that can get satisfactory returns on their investments. 00veryone00 got an internal hurdle rate,00he says. 00 don00 think there00 room for a lot of players here.00/font>
One tough challenge for micropayments advocates has been the cell phone, a seemingly natural component for generating small-ticket payments. A nine-month test of Nokia cell phones as payment devices at Atlanta00 Philips Arena that involved Visa and JPMorgan Chase & Co. ended in September with generally positive reviews, as this magazine00 sister publication Digital Transactions News reported Sept. 8.
Consumers used their handsets equipped with near-field communication (NFC) technology to make contactless purchases of food and other concessions, as well as to download digital content. But mobile payments in this country aren00 nearly as advanced as they are in some other countries, in part because America lacks a single cell-phone technology platform and because of the multiplicity of carriers.
00he cell-phone companies, communications companies, have been really sleepy,00 says TowerGroup00 Moroney. 00hey haven00 really pushed aggressively to cross-sell into credit markets, to sell other products other than communications. They want to stick to their knitting.00/font>
00eturn on Content00/i>
Meanwhile, some of the Internet-based specialty micropayments processors and technology vendors see little need to follow the herd into stores. PayPal, the online alternative payment system owned by eBay Inc., launched a micropayments initiative a year ago with significantly lower prices for under-$2 tickets compared with its standard merchant pricing.
And this September, San Mateo, Calif.-based Bitpass Inc. unveiled its iMedia Commerce Engine, a hosted, software-as-a-service platform that helps content sellers gain more control over subscription sales and gather more information about their customers00purchases to fine-tune their product offerings. IMedia also is adaptable to cell phones.
While Bitpass doesn00 profess to be interested in the physical point of sale, it is very interested in helping merchants learn more about their customers00preferences and then offering them packages aimed at getting them to buy more, says Preston Roper, vice president of marketing. 00he micropayments are a piece of it as a solution,00he says. 00he content is going to drive it. We want to optimize people00 return on content.00/font>
With the new iMedia account, consumers can store downloads along with any access privileges attached by the seller. The downloads reside on consumers00 machines. Users can also access transaction histories, including data on refunds and disputes, through their accounts.
Bitpass00 4,000 merchant clients include television network ABC Inc., Walt Disney Co.00 Disney Online, and The E. W. Scripps Co.00 United Media, a comics syndicator. For ABC, Bitpass has sold access to peripheral materials such as 99-cent game episodes for enthusiasts of the TV show Alias. 00here00 so much going on in the world of digital content,00says Roper.
True, and there00 also a whole lot going on in stores and unattended physical locations when it comes to turning cash transactions into electronic ones. The momentum behind micropayments has started to build, but keeping it going will depend on finding a pricing model merchants can live with when electronic transactions are still dominated by bank-association interchange rates.
