Virtual pennies may be back from premature death
(IDG) -- Micropayments are one of the Internet's great failures. In the mid-1990s a handful of eager start-ups with expertise in encryption technology recognized the obvious: There will be an online economy and a lot of virtual money will be spent in small amounts. Creating a micropayment system is one thing. Getting financial institutions, consumers, and merchants to use it is an evolutionary process far beyond the scope of current Internet software development.
Yet micropayments are steadily creeping into the market again, and within the span of a five-year business plan, many companies will wake up and realize that micropayments have become a major part of the Internet-commerce infrastructure. And for many content providers, such as record companies, that wake-up call could come sooner rather than later.
The date of micropayments' general acceptance, the industries that will be able to take advantage of them, and even which technologies will deliver them -- smart cards, software, or both -- are open questions. But it is clear that micropayments will ride on the coattails of the I-commerce boom led by traditional models of buying and selling, and that boom is just getting under way. Gauging the boom are three major companies -- IBM, Compaq's Digital division, and British Telecom (BT) -- that are poised to release micropayment systems.
The number of North American residents who have made purchases over the Internet has doubled in nine months from 10 million in October 1997 to 20 million in June 1998, according to a CommerceNet/Nielsen survey. At the same time, Internet commerce bellwether Amazon.com's revenues shot from $37.9 million in the third quarter of 1997 to $153.7 million in the third quarter of 1998. It now boasts 4.5 million customers.
The rapid growth of I-commerce is projected to continue, partly because the Internet itself is still growing quickly. According to Dataquest, a market analysis company in San Jose, Calif., more than 43 million households in North America have Internet access this year. That number will more than double to nearly 95 million households by 2001. Forrester Research, in Cambridge, Mass., projects that online retail revenues will reach $17 billion by 2001.
Micropayments haven't been swept up in the I-commerce tornado yet because members of the immature industry are still trying to figure out how to make money online.
For example, online advertising has been a successful revenue model only for Web sites with very high volumes of repeat traffic. Even the larger media companies are looking to supplement advertising revenue with online retail shops and other forms of sales.
Still, the industry is busy adapting existing business models to the online economy.
"[The lack of micropayment systems] is not currently holding back commerce on the Internet," says David Weisman, a group director at Forrester. "It's not a roadblock, and therefore it's not going to get a lot of attention, given all the other priorities that people have to deal with right now."
The slow growth can be attributed to bottlenecks in both the software and smart card industries.
"In the software world it's a matter of convenience, or lack thereof, and in the smart card world it's a lack of smart card infrastructure," says Sharon Osberg, senior vice president of the Wells Fargo bank headquarters in San Francisco. In September, Wells Fargo began a trial of supporting purchases over the Internet using the Mondex smart card.
But these are temporary conditions. Software makers are refining their products after several years of somewhat limited experience, and the financial services industry is cautiously introducing smart cards into the U.S. market. Several standards initiatives are under way, including the Online Trading Protocol, which aims to bring consistency to electronic payments; the Common Electronic Purse Specification, which is fostering interoperability among smart cards; and the Micropayments Transfer Protocol, which defines a software-based micropayment system.
"I don't see any major roadblocks [to micropayments]. But there has to be volume, volume, and more volume [of] merchants, buyers and goods," says Karsten Revsbech Andersen, chief of projects for Tele Denmark, the Danish telecommunications company. Tele Denmark, a participant in IBM's micropayment trial, plans to operate a micropayment system, serving as a broker between merchants and consumers, she says.
Most analysts and observers agree that micropayments are inevitable, but estimates about when they will become established in the market vary from 18 months to 10 years.
A cheaper way to pay
One of the more enticing opportunities afforded by micropayment systems, particularly for merchants, is reduced transaction costs. Merchants pay between 2 percent and 2.5 percent in credit card transaction fees, and those fees usually have a minimum of about 26 cents. These fees can easily wipe out profit margins on low-cost items.
"It doesn't make a lot of sense to have to process something that costs $2 the same way you process something that costs $50," says Heather Ashton, a senior analyst at the Hurwitz Group, in Framingham, Mass.
The cost of processing credit card transactions is high because the merchant has to ask the credit card issuer to verify the card holder's ability to pay for each transaction. Micropayment schemes eliminate this costly step. The micropayment system broker -- typically a bank -- usually simply verifies that the encrypted serial number on an electronic token or purchase order is valid.
Systems such as MilliCent use electronic currency, also called tokens or scrip, which, like real world currency, have inherent value. Systems such as IBM Micro Payment and CyberCoin perform electronic fund transfers from a customer's bank account. And systems such as BT Array simply record each transaction on a server and periodically bill the user's credit card for the total owed.
Because communications with third-party brokers are simpler, they can give the illusion of a direct transaction between the customer and merchant.
"The only thing [consumers] have to do is click on `OK' when the wallet asks if they want to spend a penny," says Russ Jones, director of microcommerce business development at Compaq, in Palo Alto, Calif.
The low transaction costs allow for very small payments. MilliCent supports charges as low as 1/10th of a cent; IBM Micro Payment: 1 cent; BT Array: 10 pence; and CyberCoin: 25 cents.
The various micropayment companies take different approaches to client-side software. MilliCent uses a wallet that supports multiple users and exports transaction information to personal finance programs such as Quicken. IBM's wallet is a thin browser plug-in. Wallet applications can potentially include more sophisticated functions such as allowing parents to control where children spend money. Eventually, wallet software is likely to become more integrated into browsers.
Today, however, multiple immature wallet applications, along with few participating merchants, make it difficult to attract users. Several companies are opting for a different approach. CyberCash is moving away from the client side with a cookie-based system, dubbed Agile Wallet. BT Array has no client-side software.
Companies are also positioning these products as "universal wallets" that will accept and facilitate multiple payment options, including competitors' micropayment schemes, smart cards, and standard credit card payments. CyberCash's Agile Wallet currently accepts credit cards and will add support for its CyberCoin cash in one year to 18 months, according to Russell Stevenson, senior vice president of the Reston, Va.-based company.
Smart cards support micropayments because they hold electronic funds, and they have the advantage of working in both the physical and online worlds. Several hardware makers, including Hewlett-Packard, have begun adding smart card readers to some PC models, and Intelidata Technologies in Herndon, Va., is marketing a smart card reader that fits in a PC floppy drive.
Smart cards are well-established in Europe and they are moving onto the Internet. In October, Giesecke & Devrient in Munich announced a system that will allow Germany's 45 million Geldkarte smart card users to make payments over the Internet. In that same month, Proton World International announced that its 30 million smart card users in Europe are now able to reload their smart cards over the Internet as well as make purchases. Given the global appeal of content such as popular music, these announcements give some companies an immediate business case to support micropayments.
Smart cards are emerging more slowly in the United States, partly because credit and debit cards are firmly established.
"We're probably not going to see an extraordinary infiltration of smart card technologies through the vast majority of the public for another 10 years," says Laura Starita, a research analyst at the Gartner Group, in Stamford, Conn.
Penny for your thoughts
Although you can't buy a sandwich or a cup of coffee online, clearly there's more potential for I-commerce than selling 15-song CDs, year-long subscriptions, and big software downloads.
"In the physical world things are often artificially aggregated to cover the costs of distribution and sales," says Compaq's Jones. "So you see music aggregated into CDs; you see articles aggregated into magazines. But on the Internet you tend to do things in smaller chunks. You download a song; you don't download the CD."
Some analysts cite per-play online games as a potential micropayment killer application. Others say the electronic delivery of music, particularly as prices for CD recorders continue to fall, will give small payment systems the boost they need to go mainstream.
There is also a lot of room for selling services in smaller increments. A language translation business, for example, could benefit by offering its services on an ad hoc basis to one-time users who would otherwise have no incentive to subscribe, says Jeff Sumner, manager of emerging payment products for IBM's software division, in Hawthorne, N.Y.
On the information side, micropayments will allow for deep searches and expand other existing information distribution models. Some worry that micropayment systems will encourage content providers to charge for material that is free today. But the market has already drawn a distinction between free content, which providers use to support products and garner advertising revenue, and premium content. Micropayments simply provide another mechanism for charging for premium content.
San Diego-based Web-Vantage online software magazine charges $49 for annual subscriptions but, with the MilliCent trial, was able to add anonymous 5-minute, one-day, one-week, and one-month subscriptions for 25 cents, 50 cents, $1.50, and $5, respectively.
Oxford University Press, which had a 5 cent-per-lookup dictionary in the MilliCent trial, is exploring micropayments "because there will be a market that we can reach that we can't reach [using] the subscription model or the print model. And we'll actually end up using all of these avenues," says Andrew Peerless, group Internet coordinator at Oxford University Press, in Oxford, England. "With the right kind of product, [micropayments] would be a phenomenally successful revenue earner."
In addition to giving larger companies another online revenue mechanism, micropayments open the door for a host of smaller players. The Guitar Heroes Web site, based in St. Paul, Minn., offered songs that customers could play along with for 25 cents in the MilliCent trial and made the $75 in test money in one month. Each day of the month Magic had 120 downloads at $2 to $5 each, earning about $450 in test money.
The Internet's many-to-many communication has created a new playing field, and the rules of I-commerce are still taking shape.
"The traditional means of buying have started to be challenged," says Stacey Bressler, vice president of marketing and business development at Palo Alto, Calif.-based CommerceNet, a nonprofit consortium of U.S. companies pushing I-commerce. "For instance, the auction model, or more importantly, the reverse auction model [in which buyers post prices for sellers to bid on], are new ways of purchasing for consumers."
The heavyweights of the high-tech industry are not alone in preparing for micropayments.
"In the financial services industry, most companies are already looking at this or are actively involved in some kind of [electronic] cash pilot," says Wells Fargo's Osberg.
So what is an IT manager to do? At the very least, keep micropayments in peripheral vision.
"The main thing is to remain very fleet of foot because the Internet is empowering the consumer and we have to be able to react to rapidly changing delivery mechanisms," Peerless says. "There's no use committing a lot of resources to developing one channel for delivery and being surprised when that isn't what your market wants."
Ignoring micropayments could be as hazardous to a business' health as it was to assume in 1995 that micropayments would be ubiquitous today.
"It's like year 2000; you can't plan for it in December 1999," says Don Sussis, an I-commerce specialist at Interested Inc., a New York consulting company.
Kimberly Patch and Eric Smalley are free-lance writers in Boston. They can be reached at email@example.com and firstname.lastname@example.org.
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