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In a recent discussion paper “Micropayments: The Final Frontier for Electronic Consumer Payments?,” Industry Specialist James McGrath examines the potential for electronic payments to replace small-dollar transactions in the U.S. Despite the growth of credit and debit card transactions, these “micropayments” have stubbornly remained the domain of cash and coin. In 2004, credit and debit networks processed a mere $13.5 billion of the $1 trillion worth of such point-of-sale transactions, leaving the bulk of transactions outside the electronic payments network. This suggests that the further electronification of micropayments could increase the efficiency of the payments system. At the same time, extending the electronic acceptance of payments may facilitate the creation of new markets in low-cost goods and services (particularly digital goods). Seeing this opportunity, payment card associations, banks, technology firms, and entrepreneurs are working to develop innovative solutions to spur the further adoption of electronic micropayments.
McGrath conducts a broad survey of micropayment innovations past and present from both the U.S. and around the world. By examining the business case for each of a variety of micropayment solutions, he identifies specific contributors to success. Interestingly, besides banks, many of the players that have driven innovations in micropayments are firms whose central business is not payments, including telecommunications, technology, and transportation firms. Despite much divergence in markets around the world, McGrath applies economic intuition to draw four central insights about how products are developed, marketed, and provided and by whom.
First, differences between laws and regulations across countries and industries matter greatly in explaining patterns in payments innovation. Worldwide, cellphones, smart cards, and credit card networks have all been vehicles for delivering micropayment solutions. The different regulatory environments faced by telecommunication firms, banks, and other innovators affect whether and how firms from different industries enter the micropayments market.
Second, industry structure affects whether a firm from a certain industry has enough market power to push bold innovations. McGrath argues that successfully launching a micropayments system is easier when there is one party that can dictate technological standards and push adoption.
Third, McGrath notes that consumers tend to be initially hesitant about adopting new payment mechanisms and that it takes time and experience for consumers to trust and value new payment vehicles. Drawing from an analysis of other payment innovations, McGrath suggests that payment vehicles reward reputation and familiar brands. The most successful innovations benefited from strong reputations.
Finally, McGrath draws on the principles of network economics in his analysis of micropayments. Innovators face a “chicken and egg” problem: No merchants will invest in a technology that consumers do not use, and consumers do not want a payment device unless it is widely accepted by merchants. McGrath sees this as yet another reason that micropayments tend to piggyback on existing technologies, such as the payment cards network in the U.S.
However, McGrath argues that the chicken and egg problem may prove less important with micropayments than in other nascent two-sided markets. He argues that it is not necessarily current adoption levels that merchants and consumers care about but the levels that they expect in the near future. The growing interest in micropayments in the industry and among merchants and consumers suggests that in the U.S., we may be nearing a “tipping point,” where the requirements for development in these network businesses are coming together, suggesting more rapid innovation and consumer adoption in the future.
Overall, the paper concludes that the existing payment card infrastructure is likely to be the primary vehicle for electronifying micropayments in the U.S. for reasons similar to the ones that are likely to make smart cards and phone-based micropayments relatively more important in other global markets.