eeny tiny electronic payments, also known as micropayments, are traveling through POS systems at locations where once cash was king. People all over the country are swiping their plastic at quick service (QSR), or fast food, restaurants, coffee houses, convenience stores, movie theaters, Laundromats, vending machines, arcades, and even parking meters. There is also a quickly growing online segment for digital content, such as subscriptions and music downloads.

It's a burgeoning market for micropayments, and the question is, can (and how do) ISOs and merchant level salespeople (MLSs) make this a viable and profitable business model, not only for their merchants but also for themselves?

Although numerous definitions exist, we'll define micropayments as payments totaling less than $20; often they are less than $5 and sometimes only a few cents, but they are all made using a credit or debit card or an alternative payment solution.

In its latest research on the subject of micropayments, research and consulting firm TowerGroup, Inc. found that micropayments are indeed an emerging market.

"As technology has advanced so have customer expectations and networks, and these factors are setting the stage for expanded micropayments growth across the mobile, Internet and physical channels," said Edward Kountz, Senior Analyst in the Emerging Technology Solutions practice at TowerGroup, Inc.

In other words, consumers and businesses want more options for payments for a wider range of dollar amounts and not only for credit and debit cards, but beyond traditional payment types, too.

The TowerGroup issued two new research reports this month by Kountz: Electronic Micropayments: Market Development, Issues and the Potential Impact on FSIs and Making Sense from Cents: Trends in the Rebirth of Electronic Micropayments (both of these reports are available for purchase from TowerGroup).

The three main delivery channels for micropayments are via mobile, Internet and "physical world" point-of-sale transactions. The biggest market right now for electronic payments is digital content, according to TowerGroup (the firm estimates Internet and mobile micropayments will grow 23% to more than an $11 billion market by 2009), although plenty of opportunities exist for replacing cash with electronic payments at the POS.

According to TowerGroup numbers, last year, consumers spent more than $1.32 trillion on transactions totaling less than $5, with the average payment being $3.72.

Although cash still reigns for small payment amounts at the POS, consumers are becoming more accustomed to using plastic. A 2003/2004 study by the American Bankers Association and strategy-consulting firm Dove Consulting found that payments made with cash and checks have decreased since 1999.

These types of payments now account for 47% of consumers' in-store purchases, compared to 57% in 1999, and 51% in 2001, and this is largely attributed to the use of debit cards, the study found. In 1999, debit was used in 21% of in-store transactions; in 2003 consumers used debit about 30% of the time to make in-store purchases.

In 2002, research and consulting firm Collective Dynamics, LLC published the results of its own study on consumer attitudes regarding non-cash micropayment (less than $20) options.

"We wanted to understand what was driving consumers' behavior for the way they pay for small-dollar things, and what would be their propensity to switch to another payment type other than cash," said Stephen P. White, Partner and co-founder of Collective Dynamics.

White said, when consumers were asked: If you could pay any way you wanted, how would you pay? "the majority of the respondents answered that they wanted to switch from cash, and debit was preferred over credit, in all channels. QSR was the most preferred channel, followed by convenience stores and gas stations.

"I think going forward you're moving to more of a proliferation of the acceptance of credit and debit at all locations that have traditionally been cash only, because the customer wants it," White said.

For many customers, paying with credit or debit is a convenience if they are often short on cash, even change. And customers tend to spend more using plastic, which is good news for merchants and the ISOs/MLSs who sell them bankcard-processing services.

Paying With Plastic Most Anywhere

More and more, merchant venues, some rather unusual and some not so unusual, recognize the importance of this growing market and are beginning to accept electronic methods of payment for small transactions.

For example, PepsiCo Inc.'s Pepsi Cola partnered with U.S. Wireless Data (now owned by TNS, Inc.) to bring a cashless payment option to Pepsi's vending machines in the United States.

As part of a program called eSuds, IBM and USA Technologies are connecting washing machines and dryers to the Web at colleges and universities in Indiana, Kentucky, Michigan and Ohio. The Internet-enabled machines replace traditional coin-operated machines by allowing students to charge the cost of each cycle to a credit card.

Cities across the United States, including Austin, Texas; Boston; Frederick, Md.; Galveston, Texas; Miami; Newport, Ohio; New Orleans; Seattle; and Savannah, Ga. are testing and implementing parking meters that accept credit credit cards for payment.

Get Quickly to the QSR

The most significant market right now for ISOs/MLSs is QSR. All of the top fast food chains either currently accept credit cards or will do so before the end of 2004.

A recent USA Today article reported Burger King's 600 company-owned stores and about half of its 7,700 franchisees accept plastic; all 1,300 company-owned Taco Bells will accept credit cards by the end of the year, along with 2,000 franchisees; about 90% of both Jack in the Box and Wendy's locations accept credit cards; and McDonald's is moving to accept credit for payment at up to 8,000 of its 13,500 U.S. locations by the end of the year.

This is great news for POS terminal manufacturers and for the ISOs/MLSs that sell them. For instance, VeriFone, Inc. won a deal in July with Burger King, which will install VeriFone's Omni 3750 payment terminals in all company-owned restaurants, and is supporting a program that offers the same solution to its franchisees.

Micro Interchange?

The credit card associations recognize this growing payments segment, too. Visa and MasterCard have added new debit interchange categories in 2004 for micropayments, such as for QSR, although they categorize these types of payments as "small ticket" rather than "micropayment." Visa U.S.A.'s CPS/Small-Ticket and MasterCard International's Small Ticket rates are both 1.60% + 0.04.

"For ISOs and MLSs, it's a niche market opportunity," said Ed Freedman, President and CEO of Total Merchant Services. "The days of bundling one discount rate for every card type have really changed a lot. There's now a whole new way of pricing merchants that didn't exist before. MLSs are embracing it as an opportunity to be able to go out and differentiate themselves in the marketplace."

However, for "small ticket" purchases totaling less than the average QSR dollar transaction (which TowerGroup estimates to be $14 on average), the Visa/MasterCard interchange rate structure is currently not a viable option for most merchants.

"From a merchant perspective, to be willing to pay a discount rate on a credit card or some type of fee on a debit card given that the dollar amount is so low, and often the profit margin is already narrow, and to add more fees on that, accepting something other than cash becomes an economic issue," said Collective Dynamics' White.

"But I think Visa and MasterCard will have more new rules soon for small-dollar merchants, something other than their current interchange rate structure, because it's too big of a market for them to ignore. Why wouldn't they want to share in these small dollar payments that their current pricing model precludes them from participating in?"

Peppercoin is one software solutions provider offering a full solution to help make the acceptance of micropayments more profitable for both digital content and physical world goods providers. The product is called Peppercoin 2.0, and it is targeted to financial services and payments institutions.

The system enables card associations, banks and payment processors to offer larger merchants not only the ability to accept credit and debit for payment, but also the ability to handle and profit from low-value transaction processing.

"The pain that we solve is: relatively high transaction costs for low price point transactions," said Rob Carney, Vice President of Marketing for Peppercoin.

Peppercoin uses its own Universal Aggregation patented technology to aggregate multiple micropayments made by one consumer using a credit card into one larger lump sum payment for processing. The consumer is charged and billed the same amount, but the merchant only pays fees on one larger transaction.

Peppercoin has a direct sales force and does not currently work with any ISOs or MLSs, but the company is potentially looking to expand into that sales channel in the near future. "Our future business models have us licensing through multiple partners, so I think on a 'going forward' basis, it's appropriate," said Carney.

The micropayments, or small ticket, segment looks to be anything but a "micro" opportunity for ISOs/MLSs, but the challenge is finding viable ways for merchants of all types to profit from these types of payments, especially when dealing with transaction fees.

"I think interchange has been an addictive drug that [the card Associations] tried to make every type of payment device fit into an interchange type of model, but the world has changed," White said. "At some point, Visa and MasterCard will have to re-think the whole concept of interchange as an economic model for card acceptance at the point of sale."