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The Case Against Micropayments

by Clay Shirky
12/19/2000

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Micropayments are back, at least in theory, thanks to P2P. Micropayments are an idea with a long history and a disputed definition - as the W3C micropayment working group puts it, " ... there is no clear definition of a 'Web micropayment' that encompasses all systems," but in its broadest definition, the word micropayment refers to "low-value electronic financial transactions."

P2P creates two problems that micropayments seem ideally suited to solve. The first is the need to reward creators of text, graphics, music or video without the overhead of publishing middlemen or the necessity to charge high prices. The success of music-sharing systems such as Napster and Audiogalaxy, and the growth of more general platforms for file sharing such as Gnutella, Freenet and AIMster, make this problem urgent.

The other, more general P2P problem micropayments seem to solve is the need for efficient markets. Proponents believe that micropayments are ideal not just for paying artists and musicians, but for providers of any resource - spare cycles, spare disk space, and so on. Accordingly, micropayments are a necessary precondition for the efficient use of distributed resources.

Jakob Nielsen, in his essay The Case for Micropayments writes, "I predict that most sites that are not financed through traditional product sales will move to micropayments in less than two years," and Nicholas Negroponte makes an even shorter-term prediction: "You're going to see within the next year an extraordinary movement on the Web of systems for micropayment ... ." He goes on to predict micropayment revenues in the tens or hundreds of billions of dollars.

Alas for micropayments, both of these predictions were made in 1998. (In 1999, Nielsen reiterated his position, saying, "I now finally believe that the first wave of micropayment services will hit in 2000.") And here it is, the end of 2000. Not only did we not get the flying cars, we didn't get micropayments either. What happened?

Micropayments: An Idea Whose Time Has Gone

Micropayment systems have not failed because of poor implementation; they have failed because they are a bad idea. Furthermore, since their weakness is systemic, they will continue to fail in the future.

Proponents of micropayments often argue that the real world demonstrates user acceptance: Micropayments are used in a number of household utilities such as electricity, gas, and most germanely telecom services like long distance.

These arguments run aground on the historical record. There have been a number of attempts to implement micropayments, and they have not caught on in even in a modest fashion - a partial list of floundering or failed systems includes FirstVirtual, Cybercoin, Millicent, Digicash, Internet Dollar, Pay2See, MicroMint and Cybercent. If there was going to be broad user support, we would have seen some glimmer of it by now.

Furthermore, businesses like the gas company and the phone company that use micropayments offline share one characteristic: They are all monopolies or cartels. In situations where there is real competition, providers are usually forced to drop "pay as you go" schemes in response to user preference, because if they don't, anyone who can offer flat-rate pricing becomes the market leader. (See sidebar: "Simplicity in pricing.")

Simplicity in pricing

The historical record for user preferences in telecom has been particularly clear. In Andrew Odlyzko's seminal work, The history of communications and its implications for the Internet, he puts it this way:

"There are repeating patterns in the histories of communication technologies, including ordinary mail, the telegraph, the telephone, and the Internet. In particular, the typical story for each service is that quality rises, prices decrease, and usage increases to produce increased total revenues. At the same time, prices become simpler.

"The historical analogies of this paper suggest that the Internet will evolve in a similar way, towards simplicity. The schemes that aim to provide differentiated service levels and sophisticated pricing schemes are unlikely to be widely adopted."

Why have micropayments failed? There's a short answer and a long one. The short answer captures micropayment's fatal weakness; the long one just provides additional detail.

The Short Answer for Why Micropayments Fail

Users hate them.

The Long Answer for Why Micropayments Fail

Why does it matter that users hate micropayments? Because users are the ones with the money, and micropayments do not take user preferences into account.

In particular, users want predictable and simple pricing. Micropayments, meanwhile, waste the users' mental effort in order to conserve cheap resources, by creating many tiny, unpredictable transactions. Micropayments thus create in the mind of the user both anxiety and confusion, characteristics that users have not heretofore been known to actively seek out.

Anxiety and the Double-Standard of Decision Making

Many people working on micropayments emphasize the need for simplicity in the implementation. Indeed, the W3C is working on a micropayment system embedded within a link itself, an attempt to make the decision to purchase almost literally a no-brainer.

Embedding the micropayment into the link would seem to take the intrusiveness of the micropayment to an absolute minimum, but in fact it creates a double-standard. A transaction can't be worth so much as to require a decision but worth so little that that decision is automatic. There is a certain amount of anxiety involved in any decision to buy, no matter how small, and it derives not from the interface used or the time required, but from the very act of deciding.

Micropayments, like all payments, require a comparison: "Is this much of X worth that much of Y?" There is a minimum mental transaction cost created by this fact that cannot be optimized away, because the only transaction a user will be willing to approve with no thought will be one that costs them nothing, which is no transaction at all.

Thus the anxiety of buying is a permanent feature of micropayment systems, since economic decisions are made on the margin - not, "Is a drink worth a dollar?" but, "Is the next drink worth the next dollar?" Anything that requires the user to approve a transaction creates this anxiety, no matter what the mechanism for deciding or paying is.

The desired state for micropayments - "Get the user to authorize payment without creating any overhead" - can thus never be achieved, because the anxiety of decision making creates overhead. No matter how simple the interface is, there will always be transactions too small to be worth the hassle.

Confusion and the Double-Standard of Value

Even accepting the anxiety of deciding as a permanent feature of commerce, micropayments would still seem to have an advantage over larger payments, since the cost of the transaction is so low. Who could haggle over a penny's worth of content? After all, people routinely leave extra pennies in a jar by the cashier. Surely amounts this small makes valuing a micropayment transaction effortless?

Here again micropayments create a double-standard. One cannot tell users that they need to place a monetary value on something while also suggesting that the fee charged is functionally zero. This creates confusion - if the message to the user is that paying a penny for something makes it effectively free, then why isn't it actually free? Alternatively, if the user is being forced to assent to a debit, how can they behave as if they are not spending money?

Beneath a certain price, goods or services become harder to value, not easier, because the X for Y comparison becomes more confusing, not less. Users have no trouble deciding whether a $1 newspaper is worthwhile - did it interest you, did it keep you from getting bored, did reading it let you sound up to date - but how could you decide whether each part of the newspaper is worth a penny?

Was each of 100 individual stories in the newspaper worth a penny, even though you didn't read all of them? Was each of the 25 stories you read worth 4 cents apiece? If you read a story halfway through, was it worth half what a full story was worth? And so on.

When you disaggregate a newspaper, it becomes harder to value, not easier. By accepting that different people will find different things interesting, and by rolling all of those things together, a newspaper achieves what micropayments cannot: clarity in pricing.

The very micro-ness of micropayments makes them confusing. At the very least, users will be persistently puzzled over the conflicting messages of "This is worth so much you have to decide whether to buy it or not" and "This is worth so little that it has virtually no cost to you."

User Preferences

Micropayment advocates mistakenly believe that efficient allocation of resources is the purpose of markets. Efficiency is a byproduct of market systems, not their goal. The reasons markets work are not because users have embraced efficiency but because markets are the best place to allow users to maximize their preferences, and very often their preferences are not for conservation of cheap resources.

Imagine you are moving and need to buy cardboard boxes. Now you could go and measure the height, width, and depth of every object in your house - every book, every fork, every shoe - and then create 3D models of how these objects could be most densely packed into cardboard boxes, and only then buy the actual boxes. This would allow you to use the minimum number of boxes.

But you don't care about cardboard boxes, you care about moving, so spending time and effort to calculate the exact number of boxes conserves boxes but wastes time. Furthermore, you know that having one box too many is not nearly as bad as having one box too few, so you will be willing to guess how many boxes you will need, and then pad the number.

For low-cost items, in other words, you are willing to overpay for cheap resources, in order to have a system that maximizes other, more important, preferences. Micropayment systems, by contrast, typically treat cheap resources (content, cycles, disk) as precious commodities, while treating the user's time as if were so abundant as to be free.

Micropayments Are Just Payments

Neither the difficulties posed by mental transaction costs nor the the historical record of user demand for simple, predictable pricing offers much hope for micropayments. In fact, as happened with earlier experiments attempting to replace cash with "smart cards," a new form of financial infrastructure turned out to be unnecessary when the existing infrastructure proved flexible enough to be modified. Smart cards as cash replacements failed because the existing credit card infrastructure was extended to include both debit cards and ubiquitous card-reading terminals.

So it is with micropayments. The closest thing we have to functioning micropayment systems, Qpass and Paypal, are simply new interfaces to the existing credit card infrastructure. These services do not lower mental transaction costs nor do they make it any easier for a user to value a penny's worth of anything - they simply make it possible for users to spend their money once they've decided to.

Micropayment systems are simply payment systems, and the size and frequency of the average purchase will be set by the user's willingness to spend, not by special infrastructure or interfaces. There is no magic bullet - only payment systems that work within user expectations can succeed, and users will not tolerate many tiny payments.

Old Solutions

This still leaves the problems that micropayments were meant to solve. How to balance users' strong preference for simple pricing with the enormous number of cheap, but not free, things available on the Net?

Micropayment advocates often act as if this is a problem particular to the Internet, but the real world abounds with items of vanishingly small value: a single stick of gum, a single newspaper article, a single day's rent. There are three principal solutions to this problem offline - aggregation, subscription, and subsidy - that are used individually or in combination. It is these same solutions - and not micropayments - that are likely to prevail online as well.

Aggregation

Aggregation follows the newspaper example earlier - gather together a large number of low-value things, and bundle them into a single higher-value transaction.

Call this the "Disneyland" pricing model - entrance to the park costs money, and all the rides are free. Likewise, the newspaper has a single cost, that, once paid, gives the user free access to all the stories.

Aggregation also smoothes out the differences in preferences. Imagine a newspaper sold in three separate sections - news, business, and sports. Now imagine that Curly would pay a nickel to get the news section, a dime for business, and a dime for sports; Moe would pay a dime each for news and business but only a nickel for sports; and Larry would pay a dime, a nickel, and a dime.

If the newspaper charges a nickel a section, each man will buy all three sections, for 15 cents. If it prices each section at a dime, each man will opt out of one section, paying a total of 20 cents. If the newspaper aggregates all three sections together, however, Curly, Moe and Larry will all agree to pay 25 cents for the whole, even though they value the parts differently.

Aggregation thus not only lowers the mental transaction costs associated with micropayments by bundling several purchase decisions together, it creates economic efficiencies unavailable in a world where each resource is priced separately.

Subscription

A subscription is a way of bundling diverse materials together over a set period, in return for a set fee from the user. As the newspaper example demonstrates, aggregation and subscription can work together for the same bundle of assets.

Subscription is more than just aggregation in time. Money's value is variable - $100 today is better than $100 a month from now. Furthermore, producers value predictability no less than consumers, so producers are often willing to trade lower subscription prices in return for lump sum payments and more predictable revenue stream.

Long-term incentives

Game theory fans will recognize subscription arrangements as an Iterated Prisoner's Dilemma, where the producer's incentive to ship substandard product or the consumer's to take resources without paying is dampened by the repetition of delivery and payment.

Subscription also serves as a reputation management system. Because producer and consumer are more known to one another in a subscription arrangement than in one-off purchases, and because the consumer expects steady production from the producer, while the producer hopes for renewed subscriptions from the consumer, both sides have an incentive to live up to their part of the bargain, as a way of creating long-term value. (See sidebar: "Long-term incentives".)

Subsidy

Subsidy is by far the most common form of pricing for the resources micropayments were meant to target. Subsidy is simply getting someone other than the audience to offset costs. Again, the newspaper example shows that subsidy can exist alongside aggregation and subscription, since the advertisers subsidize most, and in some cases all, of a newspaper's costs. Advertising subsidy is the normal form of revenue for most Web sites offering content.

The biggest source of subsidy on the Net overall, however, is from the the users themselves. The weblog movement, where users generate daily logs of their thoughts and interests, is typically user subsidized - both the time and the resources needed to generate and distribute the content are donated by the user as a labor of love.

Indeed, even as the micropayment movement imagines a world where charging for resources becomes easy enough to spawn a new class of professionals, what seems to be happening is that the resources are becoming cheap enough to allow amateurs to easily subsidize their own work.

Against users' distaste for micropayments, the tools of aggregation, subscription and subsidy will be the principle tools for bridging the gap between atomized resources and demand for simple, predictable pricing.

Playing by the Users' Rules

Micropayment proponents have long suggested that micropayments will work because it would be great if they did. A functioning micropayment system would solve several thorny financial problems all at once. Unfortunately, the barriers to micropayments are not problems of technology and interface, but user approval. The advantage of micropayment systems to people receiving micropayments is clear, but the value to users whose money and time is involved isn't.

Because of transactional inefficiencies, user resistance, and the increasing flexibility of the existing financial framework, micropayments will never become a general class of network application. Anyone setting out to build systems that reward resource providers will have to create payment systems that provides users the kind of financial experience they demand - simple, predictable and easily valued. Only solutions that play by these rules will succeed.


Clay Shirky writes about the Internet and teaches at NYU's Interactive Telecommunications Program. He publishes a mailing list on Networks, Economics, and Culture at shirky.com/nec.html.


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