Google has been offering free payment processing to Internet merchants since they launched Google Checkout almost two years ago. Merchants get free credit and debit card processing when they also use Google Adwords, a direct marketing service that displays paying advertiser’s names alongside search results. Could a marketing subsidized payment processing model work for physical face-to-face transactions as well? Could an acquirer offer free payment processing? Not just cheap and very low margin services (where they’re headed to already, due to pressure on acquirer fees and interchange litigation around the world) but free, gratis, without charge.
Wired Magazine’s cover story this month is titled Free! Why $0.00 is the future of business. “A decade and a half into the great online experiment, the last debates over free versus pay online are ending,” writes editor-in-chief Chris Anderson. “In 2007 The New York Times went free; this year, so will much of The Wall Street Journal. Once a marketing gimmick, free has emerged as a full-fledged economy. Offering free music proved successful for Radiohead, Trent Reznor of Nine Inch Nails, and a swarm of other bands on MySpace that grasped the audience-building merits of zero. The fastest-growing parts of the gaming industry are ad-supported casual games online and free-to-try massively multiplayer online games. Virtually everything Google does is free to consumers, from Gmail to Picasa to GOOG-411.”
The article has a good bit of the hyperbola typical of Wired, but it is nevertheless an interesting piece on how the practice of shifting the cost of one thing on to another (i.e. cross-subsidies) has matured at the same time that unit costs of technology continue dropping rapidly. It pretty much comes down to giving things away in exchange for advertising and marketing revenue. That’s echoed by Kevin Kelly, another Internet guru who has also written about the economics of free: “Ads are widely regarded as the solution, almost the ONLY solution, to the paradox of the free. Most of the suggested solutions I've seen for overcoming the free involve some measure of advertising.”
Readers of my blog have heard me rant ad nauseum about making payment more valuable for merchants so that we can slow down commoditization and protect payment fees, including interchange. Is my angle all wrong? I’m wondering now if there is not a more powerful way to accomplish the same thing, but from a very different angle. Instead of resisting downward pressure on payment fees, why not learn from Google and speed the process along? Why not eliminate the fees and make money instead through marketing and advertising services built into the payment transaction? At first glance, this may be impossible for many acquirers to imagine, but when you look a bit deeper at how Google does it, the idea is not so far fetched and the financials work out to the acquirer’s advantage. Which is of course why Google is doing this.
How does Google’s free payment processing model work? For every dollar merchants spend advertising on Google each month, they can process ten dollars in sales the following month for free. Merchants normally pay around twenty-five cents to process ten dollars of sales, so merchants are in effect getting a twenty-five cent discount on ever dollar spent on Google Adwords. Google hopes that by being a trusted intermediary, they can reduce the number of purchase transactions that are abandoned when customers are uncomfortable giving up their credit card information to a merchant. In turn, this would result in more shoppers buying from Google’s AdWords clients and more merchants spending marketing dollars on AdWords.
A Deloitte study shows how Google views the entire shopping experience as a continuum from the first search through to the final purchase, which enables Google to envelop the payment transaction within the shopping context. “Because search-to-purchase firms make their money primarily from merchant advertising fees, rather than on transactions, the potential profits are much greater. The profit margin for solving the merchants’ commerce problems and delivering new customers and/or closed sales is two to three times that of the payments transaction fee. Data shows merchants will pay between 7-9% for delivery of a sale vs. 2% for merely processing the payment.”
How would this look in the physical world? Imagine an acquirer offering merchants the following, “For every dollar you spend delivering targeted promotions when a credit or debit card is used in your stores, you can enjoy free processing on ten dollars in sales.” Let’s look at the impact on the acquirer’s margins. Take the same one-dollar paid by the merchant for targeted marketing services, and the same twenty-five cents of processing fees waived on a ten-dollar transaction. In this scenario, the acquirer earns seventy-five cents on that ten-dollar transaction instead of twenty-five. Three times more revenue. Since normal acquiring fees are primarily made up of interchange that goes to the issuing bank, the impact on net margins is much higher. Some of the numbers I’ve been playing with show that an acquirer’s net margins can be five to eight times greater with free payment processing. So this model is even more lucrative for a traditional acquirer working with mainstream physical merchants than it is for Google with Internet merchants.
Things are not all rosy for Google Checkout. Small merchants might not worry a whole lot about letting Google manage the relationship with their customers, but large Internet merchants like Amazon.com and eBay want to have a direct relationship with customers and don’t want Google in the middle (to complicate matters, eBay is a key Google advertising account, yet refuses to offer Google Checkout, preferring instead its own competing payment service, PayPal). Acquirer banks don’t face these challenges in the physical space, where merchants almost never know the customer anyway, unless a loyalty card is used. The whole disintermediation issue is avoided.
One big challenge that acquirers do face is the ability to think differently and to position themselves in the marketing world. Most acquirers are tired of playing in a low margin, commoditized market and many have successfully added new services that generate more profitable revenues from merchants. So they are already going in this direction. It could be a matter of time before an acquirer decides that it would be better to provide payment processing services for free and make money elsewhere, rather than competing with cheaper and cheaper providers.
“There is a huge difference between cheap and free,” Says Wired’s Chris Anderson. “Give a product away and it can go viral. Charge a single cent for it and you're in an entirely different business, one of clawing and scratching for every customer.”
Hmm. Clawing and scratching for every customer. Sounds like today’s payment processing world.
Google seems to want to move into the physical world too, starting with Google Maps on petrol pumps that provide drivers information on hotels, restaurants and other local merchants, plus coupons to get you to go to those merchants. Will Google want to close the loop with a free payment service for those physical merchants? (play scary movie music here)