A Penny for Your Thoughts?

A Penny for Your Thoughts?

A Penny for Your Thoughts?

Feb. 14 1997 3:30 AM

A Penny for Your Thoughts?

Charging a little on the Internet is even harder than charging a lot.

Transactions involving money--say, the purchase of something at a store--cost money. The cashier must be paid, the cash register bought, the bookkeeper hired, etc. Honest mistakes and dishonesty also take a toll. These expenses can be expressed as a cost per transaction. The higher that cost, the larger the transaction has to be in order for it to make financial sense.

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Computers are very good at counting money and keeping records, so they have been used for decades to manage transactions. Today, when your credit card is run through the little machine at the checkout counter, computers handle the entire transaction. Nobody is going to look at that little slip you sign unless a problem develops.

What is the cost of a transaction done purely by computer? A recent estimate put the cost at less than one-millionth of one cent per transaction--i.e., 100,000,000 transactions can be done for $1. Digital cash--where the value is stored on the card you carry and there's no need to check your credit against a faraway database--may be even cheaper.

Regardless of how it's done, transaction costs will continue to plummet as computers get more powerful. Low transaction costs are a wonderful thing if you're in the transaction business. They're wonderful for consumers too, making it cheaper and easier to buy things and creating new things to buy. All this is especially true now that the Internet provides a direct connection between sellers and millions of consumers.

In a normal situation, you could end there. But this isn't a normal situation. This is the Internet, where any legitimate idea is immediately taken to ridiculous limits. That's because there are plenty of would-be Internet visionaries competing to outdo each other, both in philosophizing and in trying to sell shares in their start-up companies to the public. The magic words "on the Internet," if inserted into nearly any sentence, seem to protect it from normal critical scrutiny.

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So it is with cheap transactions, which tend to go by the sexier name of "micropayment systems." Press reports about micropayment schemes extol their virtues in breathless wonder. Micropayments, it is said, will revolutionize the economics of journalism on the Net (a topic I've opined on before). People will pay some small fee--like 10 cents--to read an article, rather than buy a whole magazine for $2.95. Or, what the hell, they can pay by the paragraph, sentence, word, or--why not push it to the extreme--the bit. Wouldn't that be wonderful?

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N o, actually, it wouldn't. Micropayments might be important in some limited areas, but most of the hoopla is very poorly thought out. To see why, consider Slate, which recently decided to remain free to users for now. But imagine that, several years hence, Slate is trying to decide among micropayments, subscriptions, and remaining free. Let's consider what effect these choices will have on a couple of typical users (or "readers," as they used to be called--tellingly, the computer industry shares with the drug industry the habit of referring to its customers as "users").

Joe Avid is what we in the computer industry would call a "heavy user." Joe reads every bit of every issue of Slate. Jeff Accidental rarely reads Slate on purpose--but every now and then, he follows a link from another site into Slate. Somewhere in the middle is Tom Average, who reads Slate just as much as the average user does.

What price should we set for the micropayment? If we set the price so that it will yield the same total revenue as a subscription, then Tom Average will pay the same amount either way. Jeff Accidental will save a bundle by buying occasional articles instead of having to buy a subscription. But it's tough luck for Joe Avid. He--and everybody else who reads more of Slate than its average reader--will pay more than a normal subscription would cost. In customer-service circles, this is known as "screwing your best customer." That's OK in the sex industry, but not so great in others, because it tends to alienate the loyal supporters who form the core of the business. (It is, though, standard practice in the print-magazine industry, which gives new subscribers a bargain rate and rewards steady renewal by raising the price.)

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The problem, for Slate and other Internet sites, comes from having to charge for usage, when what they're selling is intellectual property with a flat production cost. Slate doesn't get "used up" by being used. It costs virtually the same amount to produce, no matter how many people use it, and no matter how heavy the use.

The Random House Unabridged Dictionary is priced at $100 and has 315,000 entries. Of these, I have looked up maybe 20 of them since I bought a copy a couple of years ago. If I could pay based on usage, Random House would have to charge me $5 for each word I looked up to bring in the same revenue. Hardly a micropayment. Five bucks per look up would bankrupt frequent users--Scrabble players or copy editors, for example.

But I didn't really pay $100 to "use" 20 entries. It's much more accurate to say that I paid for the option to use any of the 315,000 entries that I might need. Similarly, I subscribe to magazines to get an option just in case I want to read any of the articles. The editors, for their part, arrange to have them all written just in case I do.

You could argue that Joe Avid is so hooked on Slate that we can afford to put him over a barrel at the micropayment rate, even though it means that he will pay a lot more. Similarly, when dictionaries are all online, Random House could hold up the world's Scrabble players and copy editors. Unless, that is, there is competition that offers an exotic billing option known as the subscription or flat-price deal. It won't take a genius competitor to come up with this plan. Charging a usage-based fee for content sounds fair--but it is artificial, because your costs are fixed. A flat-rate competitor would present an attractive proposition to Joe Avid and anybody else with heavier-than-average usage.

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So what about a hybrid plan--subscriptions for heavy users, and micropayments for the rest? This is another way to say "drop prices," because heavier-than-average users will buy a subscription, while lighter-than-average users will choose the a la carte plan. Dropping prices can sometimes make sense--especially when, as here, you can drop them for only your least eager customers. (The airlines are specialists in maximizing revenue and filling seats by charging different amounts to different people.)

But this raises another question. If lowering the price gets you more customers, why not lower it all the way to zero and get the greatest number? That is, why not rely on advertising? Advertising is, in effect, a funny kind of micropayment system. Advertisers pay on the basis of how many people see their ad. For most media, this is measured statistically, via surveys, because statistical estimates are an even cheaper way to record tiny transactions. They're not exact, but the overestimates and underestimates average out over time. Besides, if the transactions are really small, who cares if you miss a few? Ad rates amount to a few cents per customer impression, which is in the same range as micropayments. And of course the customer ends up paying, indirectly. But it feels different to users. If imposing micropayments or other explicit user fees loses you many users, you'll decide to stay free and collect your micropayments through ads.

Micropayments are great if you use them for a product or service with certain properties. It must be one where you can get away with usage-based pricing, and where there is a strong rationale for making it cheap, yet not free. Put another way--micropayments make sense only when they match the fundamental economics of the product or service better than other ways of charging. Products that get used up as they are used naturally have this property. If the basic economics are usage-based, then the payment can be too. This class does not include journalism or, indeed, most intellectual property. Yet, this is where micropayments are most often suggested.

That isn't quite the end of the story. One situation where micropayments will work is where there are no heavy users or repeat customers--or where you don't mind screwing your best customers. Films are a good example. The movie industry always starts a film with a high, usage-based pricing model--$7.50 or so per ticket. This price is high enough to discourage many people from seeing the film. That doesn't matter, because after a run in the theaters, the film will be released to home-video rental and pay per view, where it costs $3 to $5 and nobody counts how many people are in the room. There it picks up a few repeat customers, but mostly new ones. The price is brought lower on premium cable (like HBO), which is a flat-rate cost to the user, and it eventually hits zero when the movie appears on broadcast television, where ads support it.

Technically speaking, this is a repeated auction. We're more familiar with what economists call an English auction--prices start low and rise as people bid. However, there is also the Dutch auction, where prices start high and go lower until somebody bites. Movies are sold to the audience via a very slow Dutch auction, where each phase between price drops can last weeks or months. Book publishers do the same thing, with two stages--hardcover and paperback.

Movies get away with this because they don't generally have "heavy users" or repeat customers. Most people see a film once, or at least don't see it again for many months. Some films inspire hard-core fanatics who see them repeatedly, but these viewers are so few in number that movie theaters do not cut them a special deal. The real savior is the repeated Dutch auction, which lets theaters be cavalier about pricing the movie beyond the reach of a large set of customers, because they'll get another crack at them later.

Most Internet content does not have these special properties. Sites need regular repeat visitors. Their costs, for the most part, are not usage-based. So micropayments will play a very small role in selling Internet content. Most sites probably will wind up being free, supported by ads. User fees will also exist, but for any content conducive to repeat use, they will be based on a flat rate--either a subscription to a site or a membership that lets you get to a set of sites. A penny won't buy much, even on the Web.