The Case Against Micropayments

The Case Against Micropayments
Andrew Odlyzko
Digital Technology Center, University of Minnesota,
499 Walter Library, 117 Pleasant St. SE,
Minneapolis, MN 55455, USA
odlyzko@umn.edu
http://www.dtc.umn.edu/∼odlyzko
Abstract. Micropayments are likely to continue disappointing their ad-
vocates. They are an interesting technology. However, there are many
non-technological reasons why they will take far longer than is generally
expected to be widely used, and most probably will play only a minor
role in the economy.
1
Introduction
This is an extended version of my remarks at the panel on “Does anyone really
need MicroPayments?” at the Financial Cryptography 2003 Conference. For a
report on the entire panel, see [20].
Micropayments are the technology of the future, and always will be. This
was said about gallium arsenide (GaAs) over a decade ago, and has proven to be
largely accurate. Although GaAs has found some niche applications (especially
in high frequency communications), silicon continues to dominate the semicon-
ductor industry.
The fate of micropayments is likely to be similar to that of gallium arsenide.
They may become widespread eventually, but only after a long incubation period.
They are also likely to play only a minor role in the economy. The reasons
diﬀer from the ones for the disappointments with GaAs. GaAs is playing a
minor role because of technology trends. Silicon has improved faster than had
been expected, and GaAs more slowly. On the other hand, the obstacles to
micropayment adoption have very little to do with technology, and are rooted
in economics, sociology, and psychology. Known micropayment schemes appear
more than adequate in terms of providing low cost operations and adequate
security. What is missing are convincing business cases.
This note is not a general survey of micropayments (see [1] for that, for
example). It does not even present full details of the arguments against mi-
cropayments. Instead, it summarizes what appear to be the main obstacles to
micropayment adoption. References are primarily to my own papers that are rel-
evant, and those papers contain more detailed arguments and references. (Many
of the arguments cited here have also been made by others, for example Clay
Shirky [18].)

2
Andrew Odlyzko
There have been and continue to be many proponents of micropayments.
For example, Bob Metcalfe was an ardent advocate for them while he was a
columnist for InfoWorld, arguing they were indispensable for a healthy Inter-
net, and continues to believe they are inevitable. More recently, Merrill Lynch’s
Technology Strategist, Steve Milunovich, has also endorsed micropayments as a
promising technology [8]. Many people have proposed to solve the spam problem
by requiring micropayments on email (to be paid to the service providers or to
recipients), to raise costs to spammers. The potential of micropayment appears
high enough that even though many micropayment startups have folded, new
ones keep springing up.
While I am pessimistic about micropayments, I am not opposed to them. The
standard arguments for micropayments do have some validity. I have worked on
several schemes, and together with S. Jarecki coinvented the probabilistic polling
scheme [7]. However, while that work was being done during the summer of 1996,
I was also involved in another study, of the economics of ecommerce. The re-
search of that study led to a paper that predicted explicitly that micropayments
were destined for only a marginal role in the economy [3]. Since that time, I
have accumulated a variety of additional arguments supporting the pessimistic
conclusion of [3].
As usual, micropayments in this note refer to systems where value changes
hands at the time of the transaction. Accounted systems, such as electricity me-
ters, which keep track of tiny transactions and bill for them at the end of a
period, are not micropayments in this sense. Thus the arguments against mi-
cropayments here do not rule out microtransactions such as purchases of ring
tones from cellular carriers or providers who bill through the cellular carriers.
(However, some of the arguments do suggest that even such accounted systems
are likely to be less important than various ﬁxed fee subscription options.)
The following sections outline the main barriers to micropayment adoption.
The ﬁnal section discusses the most promising avenues for micropayment diﬀu-
sion.
2
Competition From Other Payment Schemes
There is just one argument against micropayments that is based on technology.
The same advances in computing and communications that make implementa-
tions of micropayment schemes feasible are also enabling competing payment
systems (especially credit and debit cards) to economically handle decreasingly
small transactions. Hence the market for handling small transactions that only
micropayments can handle is shrinking rapidly. (Note that this is similar to what
happened in semiconductors. There improvements in silicon technologies have
limited the areas that seemed likely to be taken over by gallium arsenide.)
The slow pace of change in payment systems (discussed in the next section)
strengthens this argument signiﬁcantly.

Lecture Notes in Computer Science
3
3
Payment Evolution on Non-Internet Time
Probably the most damaging myth behind the high-tech bubble of the late 1990s
was that of ”Internet time,” that technology and the economy were changing far
faster than before. While there are a few small grains of truth to this, overall
the pace of change has not accelerated all that much. In particular, new tech-
nologies still take on the order of a decade to diﬀuse widely [11], [15]. Changes
in payment systems tend to be even slower [12]. (In fact, international compar-
isons of payment systems provide interesting examples for discussions of ”path
dependence,” ”lock-in,” and similar concepts.) As a simple example, consider
credit cards. They are ubiquitous in North America and many other industri-
alized countries. They are even spreading in countries like Germany, where it
had been claimed for a long time that there would be no room for them for
institutional and cultural factors. However, it took credit cards several decades
to achieve their high penetration [2].
As yet another example, debit cards (which were common in other countries
for a long time) have only recently achieved signiﬁcant penetration in the United
States. The reason for their adoption is largely the push by banks, which found
this to be a high-proﬁt opportunity. Thus banks played the roles of “forcing
agents” discussed in [11] that can sometimes propel faster adoption of new tech-
nologies than would have happened otherwise. Even so, the progress of debit
transactions in the United States has not been very rapid. When there are no
“forcing agents,” progress is often glacial, as in the lack of acceptance of the
Sacagawea dollar coin. It was introduced several years ago without the serious
design ﬂaws of the earlier Susan B. Anthony coin, but is practically never used
in early 2003. (By contrast, other countries, such as Britain, France, Germany,
or Japan, that did successfully introduce large denomination coins, did it by
government ﬁat, by withdrawing corresponding bills from circulation.)
The slow pace of adoption of new payment schemes does not doom micro-
payments. However, it does demolish the hopes of venture capitalists who invest
in micropayment startups, and certainly goes counter to the general expecta-
tions of micropayment proponents for rapid acceptance. (In particular, it does
decrease the “ﬁrst mover advantage” that many startups count on.) It also leaves
an opening for competing payment systems to take over much of those parts of
the economy that seemed natural preserves for micropayments, as is discussed
in the preceding section.
4
Bundling
Proponents of micropayments have claimed that they would open up new avenues
for commerce. They would enable microtransactions, such as newspapers selling
individual stories instead of entire issues, Web sites selling access to individual
pages, and even ISPs charging for each packet transmitted. We have seen very
little of that, and for good reasons. In general, it is to the sellers’ advantage
to sell bundles of goods, as that maximizes their proﬁts. As an example, the

4
Andrew Odlyzko
Microsoft Oﬃce bundle typically sells for about half of the sum of the prices of
components (Word, PowerPoint, ...). This is not done out of charitable impulses,
but to increase revenues and proﬁts. What Microsoft and other sellers are doing
is taking advantage of uneven preferences among their customers for diﬀerent
parts of the bundle.
The advantages of bundling in increasing revenues have been known in eco-
nomics for about four decades. There are various mathematical models that
demonstrate how useful bundling is, and how its advantages depend on number
of items in the bundle, distribution of customer preferences, marginal costs, and
other factors. (For some references, see [3].) The general conclusion is that ag-
gregation strategies tend to be more proﬁtable for sellers. This argument again
does not doom micropayments, since it is well known that mixed strategies (of-
fering both bundles and individual items, but with prices of separate items higher
than they would be if bundling were not feasible) are usually more proﬁtable
than pure bundling. (And indeed Microsoft does sell Word by itself.) However,
this again limits the range of transactions that seemed the natural domain for
micropayments.
5
Resistance to Anonymity
Micropayments have often been promoted as providing the anonymity of cash
transactions. However, while anonymity is often desired by consumers, it is re-
sisted by both governments and sellers. Government resistance is based on con-
cerns about money laundering, tax evasion, terrorism funding, and other illegal
activities, and is well understood. Commercial entities, on the other hand, might
be expected to be more receptive to their customers’ wishes. In practice, though,
they are the ones most responsible for the persistent privacy erosion we see. The
reason is that sellers have strong incentives to price discriminate, either explic-
itly or implicitly, through versioning and other techniques. Therefore they have
strong interests in avoiding anonymous transactions [10], [16]. Thus another fac-
tor that has been widely hailed as an advantage of micropayments works against
them.
6
Behavioral Economics
Behavioral economics, the study of what had for a long time been dismissed
as the economicly irrational behavior of people, is ﬁnally becoming respectable
within economics. In marketing, it has long been used in implicit ways. One
of the most relevant ﬁndings for micropayments is that consumers are willing
to pay more for ﬂat-rate plans than for metered ones. This appears to have
been discovered ﬁrst about a century ago, in pricing of local telephone calls [13],
but was then forgotten. It was rediscovered in the 1970s in some large scale
experiments done by the Bell System [3]. There is now far more evidence of
this, see references in [13], [14]. As one example of this phenomenon, in the fall

Lecture Notes in Computer Science
5
of 1996, AOL was forced to switch to ﬂat rate pricing for Internet access. The
reasons are described in [19]:
What was the biggest complaint of AOL users? Not the widely mocked
and irritating blue bar that appeared when members downloaded infor-
mation. Not the frequent unsolicited junk e-mail. Not dropped connec-
tions. Their overwhelming gripe: the ticking clock. Users didn’t want to
pay by the hour anymore. ... Case had heard from one AOL member
who insisted that she was being cheated by AOL’s hourly rate pricing.
When he checked her average monthly usage, he found that she would
be paying AOL more under the ﬂat-rate price of $19.95. When Case in-
formed the user of that fact, her reaction was immediate. ‘I don’t care,’
she told an incredulous Case. ’I am being cheated by you.’
The lesson of behavioral economics is thus that small payments are to be
avoided, since consumers are likely to pay more for ﬂat-rate plans. This again
argues against micropayments.
7
Incentives to Increase Usage
Both behavioral economics and conventional economic utility analysis argue that
in an environment of low marginal costs (which are increasingly prevalent in our
economy), sellers have a strong incentive to increase usage of their goods and
services. Although ”network eﬀects” were a much-overused mantra of the dot-
com bubble, they are real. As one example, Bill Gates said in 1998 [17]:
Although about three million computers get sold every year in China,
people don’t pay for the software. Someday they will, though. And as
long as they’re going to steal it, we want them to steal ours. They’ll
get sort of addicted, and then we’ll somehow ﬁgure out how to collect
sometime in the next decade.
Any kind of barrier to usage, such as explicit payment, serves to discourage
usage. (That was the basis for the prediction in [9] that pay-per-view was doomed
in scholarly publishing.) Even small barriers, such as having to pay for for indi-
vidual pages, act as a severe deterrent to usage. During the mid- to late-1990s,
several scholarly publishers experimented with a variety of payment schemes for
science, technology, and medical information through the PEAK system. The
conclusion that the main publisher in the experiment, Elsevier, drew, was very
clear [6]:
[Elsevier’s] goal is to give people access to as much information as pos-
sible on a ﬂat fee, unlimited use basis. [Elsevier’s] experience has been
that as soon as the usage is metered on a per-article basis, there is an
inhibition on use or a concern about exceeding some budget allocation.

6
Andrew Odlyzko
The same arguments will be increasingly persuasive as we become more of an
“attention economy” [5], in which the most scarce resource is human attention.
The incentives to increase usage argue for selling goods and services in ways that
maximize usage, and nothing does that as well as ﬂat-rate (or subscription) pric-
ing. A general rule of thumb is that switching from metered to ﬂat-rate pricing
increases usage by 50 to 200 percent [13], [14]. As one particularly noteworthy
example, when AOL switched to the unlimited usage plans in the fall of 1996,
the average time spent online per subscriber tripled over the next year. Hence
we should expect to see a continuing and even increasing dominance of ﬂat-rate
plans, and this again destroys much of the argument for micropayments.
As a ﬁnal example, a recent story about new communication, information,
and entertainment services stated that “[w]hat all these emerging services have
in common is a business model based on subscriptions that are billed monthly
or yearly” [4]. The sellers of these services are reacting to a variety of incentives
mentioned in this and previous sections. While one can argue that widespread
availability of micropayments might lead them to oﬀer diﬀerent payment options
(for example, to encourage people to try out a novelty), this is unlikely, since
accounted systems (with billing ultimately to a credit card, say) would be quite
adequate for most of these services, had the sellers had real incentives to use
them.
8
Conclusions
The general conclusion drawn from the discussion above is that there are many
factors working against the success of micropayments. Even some of the features
that seemed to be very attractive about micropayments, such as anonymity, work
against them. The technologists have produced many micropayment schemes
that are eﬃcient and secure enough to be used widely. However, economics,
sociology, and psychology place obstacles in the path of micropayments that are
likely to keep them restricted to a marginal role in the economy forever.
Still, micropayments may become widespread. There are needs that micro-
payments are uniquely suited to ﬁll. However, given all the obstacles that micro-
payments face, they are unlikely to succeed if oﬀered as a service that requires
special hardware or software. They are most likely to succeed if they piggyback
on top of something that is already widely used, such as cell phones, or (in
some places) mass-transit smart cards. When oﬀered as an additional feature
for something that is already carried by most of the population, micropayments
might be able to overcome the usual chicken and egg problem, and ﬁnd their
(very likely small) niche in the economy.
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