Micropayments Revisited -- via Apple

[JT]

http://rentzsch.com/notes/creditCardMicropayments

Credit Card Micropayments

So Apple's new music store sells songs for 99¢ per track. That sounds suspiciously like a micropayment (or at least a "minipayment") system to me. Somehow, Apple is pulling it off using the traditional credit card system. Everyone knows your profit margin is eaten alive in transaction fees for multiple small credit card purchases. So how is Apple doing it? I think I know.

A typical credit card transaction charge is between 12¢ and 50¢. That's on top of the 2% to 9% credit card sale discount rate. I know of no way to lessen the discount rate, but it should be possible to significantly reduce the transaction charges by batching multiple purchases into one transaction.

Credit card companies don't directly support this, but with some server-side software smarts, you can emulate it. The trick relies on the fact that there are two distinct phases to each credit card purchase. The first phase, the "authorization", tells the credit card company to reduce the purchaser's credit limit by a certain amount, earmarked for the merchant. At this stage, the merchant doesn't actually have the purchaser's money yet, but the purchasers can't go and spend it elsewhere, either.

The second phase is the "capture" phase, which actually moves the money from the purchaser's account to the merchant's account.

When you place an order online (or over the phone) for delivery, the merchant is supposed to authorize the transaction immediately, before the purchase is even accepted. However, the merchant is contractually bound to only capture the transaction upon order shipment. Sadly, many merchants will play fast-and-loose this last rule, as it's a bear to automate when dealing with things like third-party fulfillers.

The key insight here is that both the authorization and capture requests specify an amount. That means the merchant can earmark your account for one figure, and then request payment for another figure. For example, a merchant's website could say they'd charge you $15 for a widget+shipping, only to discover at shipment time that shipping price is lower than average by a buck. They could thus capture only $14.

So this is what I think Apple is doing. Upon the first purchase, they authorize your account for some higher figure. Let's say $9.90, enough for ten songs. Even though Apple delivers ("ships") the music right away, they don't immediately capture the transaction. Instead, they hold it for a certain number of days. The number of days is based on two things: how many days the credit card company will hold an authorized-only transaction before automatically voiding it (35 days is typical), and Apple's business decision of the tradeoffs involved (cash-flow versus transaction fee reduction).

If you purchase more music in within the authorization window, Apple simply updates their internal records without engaging in another credit card transaction. But eventually the authorization window must be closed, which leads to three scenarios:

You don't purchase another song within the authorization window. Apple takes the large transaction fee hit and hopes these types of single-purchases are made up by multiple-purchases.
You purchase more music within the authorization window, but it stays within the original authorization's amount. When the authorization window closes, and the capture time has come, Apple merely specifies a capture amount less than or equal to the original authorization amount.
You purchase more music within the authorization window, and it goes over the original authorization's amount. This is interesting. Apple has two choices here. They can either create a new authorization transaction (and start the next authorization window, which invokes the transaction fee), or they can fulfill the order (and gamble that a capture amount greater than the original cleared authorization amount will pass).

[Sparky]

http://www.phobe.com/scott_n_bot.jpg

[Ben Sones]

Interesting business model, and probably accurate. I'd say that it's probably a good idea, assuming that Apple can hold off capturing a sale for at least a week or two. At $.99 a pop (great impulse-buy pricing), most people will probably purchase more than one song in that amount of time. I guess it all depends on what kind of overhead they are dealing with, but I'd imagine their margins on selling music electronically must be pretty big.

[chet]

ummm... but it is not a micropayment, or even near what is normally defined as a micropayment in price, how it collected(interaction with the user) and product. This is someone wanting to push micropayments and desperatly trying to find something to use to support his point.

Also as he defines it - is illegal. So I hardly think apple is doing it this way. Unless the user agreement agrees to the higher price, the hold or charge cannot be placed on a card. Traditionally, a lower amount than the purchase can be done to validate the card and amount on a check card. The authorization puts a hold on your account for that amount - so they would be blocking that much out of your limit - which is against every visa/mc rule and also against almost every state law.

But the article does a great job of demonstrating the problem when the masses are used and believed as a news source.
Chet

[Bub, Andrew]

Good show Sparky. I think whenever we talk about micropayments, or anything else that has anything to do with Scott McCloud, it should be done entirely with pictures.

[Ben Sones]

It's less a micropayment and more just the sale of an inexpensive commodity. If I buy something cheap at Amazon, is that a micropayment? When people talk about micropayments, aren't they really talking about per-use payment plans for services (visiting a website, for instance)?

Re: the Apple thing: It's also possible that they aren't capturing the sales ahead of time at all. Perhaps they just hold off on running your card altogether until either you have accumulated X amount of music purchases, or until a certain time period has elapsed. They might require some sort of up-front deposit for using the service, or they might figure that any money that they lose when people spend more than they have free on their credit cards will be offset by reduced fees on credit transactions.

[Supertanker]

I'd love to give their music store a whirl, but it requires a Mac? http://www.apple.com/music/store/launch/message.html

[Ben Sones]

Ah, there's the part where Apple stops being smart. I'd probably give this service a whirl, too, if I could. Limited to Mac users, I can see it becoming as widespread as Firewire did... n't.

[Tim]

I read about a new micropayment scheme in the works (or maybe already available). I think it was in Dr Dobb's Journal, and the guy behind it is I believe a respected pioneer in encryption. I don't remember his name, but it was someone I recognized.

Anyway, it sounded like a doomed idea to me. The plan tries to surmount the otherwise insurmountable problem of transaction 'shipping and handling' costs that make micropayments unworkable with this simple trick: 99 out of 100 transactions are discarded. So instead of actually paying a penny a page to access 100 web pages, you on average get 99 for free and pay $1.00 for one of them. Merchants, likewise, on average give away 99 pages for free, and get $1.00 for one of their transactions.

The blurb mentioned that because of the guy's stature in cryptography, he might be able to get enough trust on both sides to get it off the ground.

But I don't think so. He'll get complaints of unfairness from both directions. And in order to truly eliminate the pesky per transaction costs for most transactions, you literally have to throw away all record of the 99 'free' transactions. So, assuming you could actually build enough volume where individual consumers and merchants really do tend strongly toward the averages, you won't have any audit trail to dispute claims by those who perceive that they get billed for at least half of their purchases (or merchants who only get paid for 1 out of 1000 transactions). I suppose you could document that you're not skimming any more than you promise, but that will still leave many objectively getting shortchanged or overbilled and many more who think they have been based on a recent aberration or faulty recollection. Let alone the false claims of unfairness.

[chet]

I am guessing, that is it apple only to avoid some fraud, fraud on a non-shipped good is insane.

Also the original story had other things wrong, on one of our merchant accounts, you could batch all of the transaction and pay a flat fee instead of per-transaction. Plus the percentage of course.

I am sure apple has enough clout to work something like this out on a larger scale. That side, the fees are not as regulated and they have flexibility.

Chet

[Tim]

I also used to manage a small credit card merchant account provider.

Overauthorizing the dollar amount is actually standard practice in the restaurant industry, and completely kosher with the card issuers. Depending on the restaurant, they typically authorize your bill amount plus 15% or 20% so that they won't have problems for customers who tip beyond their credit limit. A pretty rare problem, I'm sure, but it's a safe bet anywhere your credit card receipt has a TIP line that this is being done. But part of the reason it's not a problem is that the restaurant must 'capture' the final transaction amount within a couple of days, at which point the originally authorized amount is released.

However, the time an authorization is held is not standardized across Visa and Mastercard issuers. There is a minimum, but I believe it's 3 days. Many issuers do hold them much longer - they want to give a merchant every opportunity to submit a charge, it's how they make money. But you can't count on it.

Further, aggregating transactions would probably get major objections from the card issuers for some good reasons. Basically, it would confuse customers. "Hmm. I didn't buy 10 songs from apple last monday. In fact, I was in a coma that day so I'm positive I didn't buy anything at all from them that day. I think I bought a few songs, but that was last month and should have been on my last statement." As soon as this cardholder picks up the phone, presses 1 to use a touchtone phone, presses 1 to use English, enters his 16 digit account number, presses 0 to speak to an operator, then repeats his 16 digit account number and reports his mother's maiden name, the card issuer is unhappy. Even if they're able to jog his memory and nip the confusion in the bud, they've just lost a bunch of money because a merchant is trying to bend the system. It gets much more expensive if the customer requires research to explain the transaction - most issuers will just write off a $10 question like that.

If Apple wants to aggregate transactions, I'm positive they'd need to make that as clear as possible to customers with explicit upfront notice and then emails or other contact. I think ebay does this - they don't bill me $.35 immediately for listing an auction, they wait a month, gather transactions, and then send me an invoice detailing the charges & the total amount & date it'll be billed.

Also, discount rates can go well below 2% for a big business and 9% is ridiculous. My company used to set up tiny BBSs and shareware authors at about 2.5% plus $.25. And if you can get the card issuers onboard to try to expand their market, you can get it all for free for a while. Most supermarkets got their credit card processing done at NO cost for their first year back in the early 90s, and they've given away millions of dollars in smart cards & merchant setups for pilot projects like the Atlanta olympics and another in Manhattan a few years ago. (All huge failures - more credits were thrown away than spent).

[Sparky]

I'd love to give their music store a whirl, but it requires a Mac?
Heh...I use a Mac, but not OSX. Guess I can't use it either. Not that I would -- I'll be driving a Zamboni in hell before I give Steve Jobs another penny.

[Jason McCullough]

$1 isn't micropayments. 1 or 2 cents is.

[Squirrel Killer]

1) Maybe Apple is aggregating totally on their end, and once the customer reaches a certain limit (i.e. at the end of every day, every 15 minutes, or after the customer spends a certain), they run the authorization and capture at the same time. Giving away the music gambling that the transaction will be good, eating the loss if the transaction goes awry. But really, how bad is their loss if a transaction bombs out? Bandwidth, server capacity, and licensing are their main costs. Since they're a computer company, you can bet they've got bandwidth and servers at a rock-bottom cost.

I'd bet that either Apple has an agreement with:

A) the credit companies to i) reduce their transaction costs (to let them run the authorization/capture when the customer click "Buy Now") or ii) let them run the authorization for more than what the customer actually purchased at that one time (formalizing the practice the resturants use when they authorize for amount + expected tip.)

or

B) has an agreement with the music companies (to reduce/eliminate charges for transactions that don't go through.)

2) It won't be a Mac OS X exclusive forever. Apple's already announced a port of iTunes to Windows.

3) I usually think of 1 or 2 cents as a minipayment, something that I'd still use, but would be careful with. Micropayments are intended to inspire a "electricity" style usage, use it whenever you want without thinking to much. But then the Apple Music Store isn't intended to be a micropayment system, it's intended to be a way to buy music cheaply and conveniently.

[Met_K]

Considering the average Mac user's taste in music is Hootie and the Blowfish, Counting Crows, DMB, and other shithead frat-fucks, then I hope to God that they pull off this brain-dead idea they have going so that the band's really don't turn a profit.

Thank you, Apple, you might just be the saviour of music by killing what the industry really doesn't need.

[voltaic]

Also as he defines it - is illegal. So I hardly think apple is doing it this way. Unless the user agreement agrees to the higher price, the hold or charge cannot be placed on a card. Traditionally, a lower amount than the purchase can be done to validate the card and amount on a check card. The authorization puts a hold on your account for that amount - so they would be blocking that much out of your limit - which is against every visa/mc rule and also against almost every state law.
Go buy gas on your credit card. They'll authorize about $75.00 in response to "fill 'er up!"

[wumpus]

$1 isn't micropayments.
It is when you're Scrooge McDuck. Now, according to the Salary Calculator, I'll resume swimming in my gigantic money bin.

[westyx2]

Apple has currently at least one position they're actively hiring for a windows developer to port it to windows, and they're talking with music companies right now about royalties due from a windows version. expect apple to try and get this up and running as soon as possible to avoid microsoft stealing their music now that they've proved it's possible to do music cheaply and easily.

[Met_K]

Proved? Cheaply? Easily?

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