Micropayments and Mental Transaction Costs | Satoshi Nakamoto Institute<br>PDFExternal link<br>We present intuitive arguments for why micropayments have not succeeded on the Internet. The “hassle factor” for customers asso ciated with such transactions is characterized. A framework of mental transaction costs and price granularity is then presented, and arguments ab out micropayments recast in its light. Finally, we make some suggestions for reducing the mental transaction costs of Internet commerce.

Introduction

Some Internet payment system pro jects promise dramatically lower transaction costs, so that we can achieve micropayments (e.g. [Be95], [GMAGS95], [RS96]). Other projects propose more sophisticated forms of microtransaction [MD88]. To what extent can transction costs be reduced in these ways? This paper will argue that mental transaction costs raise fundamental barriers to customer acceptance of fine grained bundling and pricing. We will explore the problems both informally and through a closer examination of three sources of customer cognitive expenditures.

These mental accounting costs, not the physical or computation or amortized R&D costs of a payment or billing method, set the main lower bound on price granularity. Judging from price granularity is far above suggested micropayment levels of a few cents or even fractions of a cent. The mental accounting costs for a typical on-line consumer seem to be somewhat higher than those in more familiar areas of commerce.

Customer mental transaction costs come from at least three sources: uncertain cashflors, incomplete and costly observation of product attributes, and incomplete and costly decision making.

Cognitive Versus Technological Transaction Costs

For electronic commerce economics, it’s important to distinguish between technological and mental transaction costs. When technologists talk about transaction costs, they are usually talking about computation and network costs. Thus the claim that micropayment technologies, which dramatically reduce these costs, will reduce “transaction costs.” The significance of such technological reductions depends on the accompanying cognitive costs already being very low, since these payments don’t address cognitive costs.

Economists (e.g. [Bz82], [W85], [H89]), on the other hand, usually, when using the term “transaction costs,” refer implicitly to cognitive costs. One goal of this paper is to make these assumptions explicit. Sometimes these mental transaction costs can be reduced with the aid of technology: whence the claim that tools like Internet search engines can reduce the transaction costs associated with comparing the attributes of goods and services.

In examining micropayments, this paper will assume that the technological costs of the payment system itself are zero, and will examine what limits are set by the mental transaction costs associated with the retail transactions targeted by micropayments. We will explore the possibilities of, and barriers to, automating, and thus potentially greatly reducing, the mental processes which impose mental transaction costs.

This paper examines decision processes which take place in the mind of the customer rather than on a computer, as well as the bottlenecks which are caused by the need to communicate between a computer and that mental process. Also, we discuss some related basic barriers to automated shopping.

This paper argues that customer mental transaction costs are significant and ubiquitous, so much so that in real world circumstance cognitive costs usually well outweight technological costs, and indeed technological resources are best applied towards the objective of reducing cognitive costs. Furthermore, technological costs will continue to fall while cognitive costs remain constant, and (more arguably) will fall faster than technological cost can be substituted for mental costs by discovering and automating the relevant mental processes. Customer mental transaction costs will soon dominate the technological transaction costs of the payment system used in the transaction (if they don’t already), and micropayment technology efforts which stress technological savings over cognitive savings will become irrelevant. This paper will suggest some ways to achieve cognitive savings.

Supplier Cost Structure

[BB97] and [FOS97] discuss bundling, and thus price granularity, from the supplier’s point of view. When marginal costs are small compared to amortization of fixed cost (e.g. a particular content work, much Internet infrastructure, etc.) it makes no sense, in the face of customer preference for flat pricing, to charge fine per unit costs to amortize a one-time investment, except in some exceptional cases, such as where congestion pricing provides major improvements in service quality. This paper provides explanations for a strong customer preference for flat pricing. These are so significant, we suggest that customer cognitive costs outweigh congestion...