Friday, October 17, 2008

Using Credit Cards for Micropayments

Here's the situation: you swing by a convenience store looking to buy a pack of gum or similarly inexpensive item, but when you reach the counter to pay, you realize you have no cash in your wallet. Lucky for you, you have your credit card. But there's a problem – the guy at the counter says they won't accept credit cards for any purchase under $5. Muttering under your breath, you quickly grab a couple additional items that you don't really need just to push your grand total high enough to be able to pay with plastic. As you walk out with more merchandise than you planned to buy, you vow to be sure to always carry a little cash from now on.

Such interactions between consumers and retailers, along with a rapacious appetite for new avenues of charge volume growth, have motivated the credit card companies to help facilitate micropayments, or small-change transactions of $5 or less. By encouraging the use of credit cards for small purchases, lenders hope to cash in on the additional transaction volume that would inevitably occur. In the U.S. alone, around 400 billion transactions of $5 or less occur every year, totaling $1.3 trillion in 2004. Visa estimates that online micropayments totaled $3 billion in 2004, with about half of that for music. And it seems credit cards are steadily replacing cash, even for small payments. In 2005, Visa cardholders spent over $17 billion at fast-food restaurants, an almost 63% increase from the prior year. Research firm TowerGroup predicts that by 2009 the volume of micropayments will reach $11.5 billion domestically and $40 billion worldwide.

For merchants, one problem involved with micropayments is the extra cost. Retailers must pay fees for card-based transactions, which can wipe out their profit on the smallest transactions. Another concern is associated with providing customer service, the cost of which eats into profitability on small-ticket items.

In the pay-as-you go model approach to micropayments, customers are charged each time they make a purchase. But in order to avoid high card-transaction fees, some micropayment service providers aggregate small payments from an individual customer into one bulk payment in order to save on transaction fees. However, aggregation only works if a merchant has repeat business from a single customer.

Although the first round for micropayments that occurred in the 1990s was stymied by the dot-com bubble bursting, it seems the tiny money generators now could be getting a second wind. Chains such as McDonald's and 7-Eleven are already accepting plastic for small transactions. Additionally, changing technology, including peer-to-peer networks, radio-frequency identification (RFID technology used in toll tags), and cell phones, have helped bring micropayments into the mainstream.

With consumers evidently increasingly willing to use credit or debit cards to make small payment purchases on a variety of low-priced goods and services, the indication is that merchants, retailers and card issuers could all benefit from greater consumer access to micropayments. Small-change transactions via credit card, if done correctly, provide a winning situation for everyone involved: Online merchants can draw more customers and increase their profit margins, banks gain new classes of merchant customers, consumers can leverage small expenditures to earn more rewards, and the credit card associations get a new source of fee revenue.

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