why micropayments don’t work well and Amazon Prime does
Economists need to update our conceptual toolkit in order to catch up to the 21st century. One concept that I find myself frequently using is mental transaction costs. The expression was coined by Clay Shirky, and he used it as far back as 2000, to make a case against micro-payments as a tool for supporting content providers.
In theory, you could pay a penny or so to listen to a song one time on your phone. This would be inexpensive for the listener, andaggregated over many listeners it might provide decent incomes to artists. But Shirky identified the drawback.
Micropayments, like all payments, require a comparison: “Is this much of X worth that much of Y?” There is a minimum mental transaction cost created by this fact that cannot be optimized away, because the only transaction a user will be willing to approve with no thought will be one that costs them nothing, which is no transaction at all.
Thus the anxiety of buying is a permanent feature of micropayment systems, since economic decisions are made on the margin — not, “Is a drink worth a dollar?” but, “Is the next drink worth the next dollar?” Anything that requires the user to approve a transaction creates this anxiety, no matter what the mechanism for deciding or paying is.
The desired state for micropayments — “Get the user to authorize payment without creating any overhead” — can thus never be achieved, because the anxiety of decision making creates overhead. No matter how simple the interface is, there will always be transactions too small to be worth the hassle.
In short, charging you a penny to listen to a song forces you to stop and think whether listening to this song at this time is worth a penny to you or not. Your life would be much more pleasant without those mental transaction costs.
I subscribe to Spotify. My monthly subscription fee divided by the number of songs I listen to is more than a penny per song. But if a competitor were to offer me a music service that was one penny per song, I probably would stick with my Spotify subscription, in order to save mental transaction costs.
Another example of a service that attracts consumers by saving them mental transaction costs is Amazon Prime. Without Prime, each time you order you have to think about shipping. Do I want immediate delivery, or do I want free shipping? If I want free shipping, do I have to order more items to qualify? Having a Prime account means that you do not have to incur these mental transaction costs.
Health care and mental transaction costs
Economists and others who wish to reform health care often lament that patients with comprehensive health coverage are not concerned with the prices of medical services. Often, we are not even aware of what the health care provider is going to charge.
Perhaps consumers are ignorant about health care prices for a reason. When it comes to relieving pain and suffering, we do not want to take on the task of deciding between treatments based on price. Imagine having to ask yourself how much pain you would be willing to endure to save an addition $500. Or trying to choose between a high-cost treatment that is certain to work and a lower-cost treatment that has only a 75 percent chance of success.
Allowing our treatment choices to be made for us by doctors, with insurance companies in the background negotiating prices and determining what will be covered, saves us on mental transaction costs. We prefer to obtain health care without having to make cost trade-offs.
Having said this, I still believe that our health care system would work better if consumers were aware of prices and had the incentive to make cost-conscious decisions. My point is simply that health care reformers need to acknowledge the importance of mental transaction costs.
The Aggregator Model
Recently, Medium CEO Ev Williams made the case for what one might call the aggregator model. He called it the rationalization of publishing.
There’s a reason we don’t subscribe to TV shows or our favorite bands individually: 1) It would be a pain in the butt. 2) It would be a much worse deal. We pay for bundles, which give us access to lots of options. It’s great, and it will be great for published content, as well.
There won’t be a Spotify of publishing — with literally everything you want. But there will be a Netflix and Hulu and Amazon, etc. — each with a substantial amount of things you want. You might also have your superfan subscriptions (Patreon-based individuals), and your company-expensed subscriptions (The Information), but most consumers will have one or two of the big bundles.
This aggregator model saves on mental transaction costs. Subscribing to Hulu is an easier decision than subscribing individually to each program that you want to watch.
Traditional media outlets, such as TV channels, magazines, or newspapers, would prefer to remain independent, rather than have to rely on an aggregator to bring them users. But in many cases, consumers are not willing to incur the mental transaction costs that would be required to enable these content providers to obtain sufficient individual subscription revenue.
Summary
In many industries, we find that consumers want to avoid having to calculate the cost of making choices. In health care, many consumers prefer not to look at the price. When it comes to content on the Internet, they prefer subscription bundles to item-by-item pricing. And they are attracted to services such as Amazon Prime, which aggregate many services into a single price.
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Treat this as a problem in the elasticity of churn, find the boundary condition. Churn is well measured.
The churn rate for low cost subscription services is 5-6%/month, lower for business customers. And the rate is lower for the more expensive services. You we have the mental anxiety of churn, and we consider a free material to be a churn rate of 100% (with ad naturally). We have boundary conditions.
A single purchase does not work until the user is set up for penny clicks, a new tenchnology. But a monthly purchase set up can thus be made as cheaply using the technology. So we can ignore the churn costs of the seller, their end is automated. Note: I have included a large assumption here, some missing technology.
The evidence implies complete elasticity between the boundary conditions when I have my new technology. There is nothing in the model to make a zero crossings, every churn rate will have some positive market if churn costs are zero for the producer.
Sorry to go all 20th century on you (or even 18th century), but a more careful analysis would consider why pricing takes the form it does in different circumstances. All purchasing decisions involve some mental calculation costs, so why is it sometimes better to make one big decision rather than multiple smaller ones, or vice versa? Possibly there are sometimes “scale economies” to calculation, but it’s not at all clear that this is the case, or even that that phrase has meaning absent a more detailed discussion.
The (20th century) literature on long-term contracting has some relevance here. Long-term contracting economizes on contracting costs, but at the cost of poorer adaptability to changed circumstances. In different circumstances, the tradeoff favors longer or shorter duration. Simply identifying just one set of costs isn’t very illuminating if you’re genuinely interested in understanding the tradeoffs that shape consumer behavior.
If demand is reasonably foreseeable over some time horizon, a long-term contract, e.g. for a programming content bundle, may make sense. But then how to explain the popularity of pay-per-view? If a niche program, one not broadly popular enough to merit inclusion in the bundle, matches a particular consumer‘s tastes, a pay-per-view option fits the case. That’s why some prefer Prime to Netflix, although these services are more complements than substitutes. You may have noticed a major trend toward unbundling video content, driven by millenials. Do younger folk perhaps have lower calculation costs than older consumers? Ok, boomer.
There’s also state-contingent utility. All-inclusive resorts are popular in part because calculation is costlier during a putatively relaxing vacation than earlier, during the planning phase. Consumers are typically aware that they’re paying a premium to be relieved of calculation at the resort. For some, the mitigated calculation costs exceed the premium; for others, not.
Dr.Kling, I sympathize with your urge to be the bomb-throwing reformer. But I urge you to pause before tossing all second millennium economic ideas on the trash heap of history. First give a go to thinking through issues using tools that we’ve found useful for centuries. You may find that things have not really changed all that much since 2000. People must still contend with scarcity as they manage their desires, weighing the costs of the various alternatives available to them. Those alternatives may have undergone dramatic change, but human nature has not.
Pay per view is another. It has a typical penetration of 5%. Small. But what are the alternatives? Pay per season on foot ball, a very specialized channel. Pay per Netflix homegrown soap operas? I have seen that. The options grow because material transaction costs are dropping. Transaction costs have hit a barrier, though, the fear of online swindles, getting caught with payments streams not clear, identity theft and all that, the true mental anxiety.
The next technology solution is a handheld, secure process that can almost certainly manage the various contracts. It would be AppleID with programmable applications called contracts, contracts guaranteed to all parties to be obeyed properly by the process in charge. The hand held device counterfeit proofed, be it card or smartphone.
Mental transaction costs (whatever happened to Clay? He was soooo insightful). (Maybe at NYU… https://www.nyu.edu/about/leadership-university-administration/office-of-the-president/office-of-the-provost/academic-affairs/clay-shirky.html )
Yes, this is a problem for Libertarians and all Freedom lovers — most folk don’t want so many choices ALL the time. Habits hugely help to protect against that. There are many communists who don’t think we “need” 27 deodorants, or 200 types of jam.
On health care, many want their insurance company to take care of them, mostly. They would mostly be happy with a regular or premium model of insurance, and also of care. The publishing of costs would be most helpful for insurance companies to decide what to cover — most hospitals would rapidly converge to smaller ranges of similar care to avoid being too expensive.
How much were Ted Kennedy’s monthly care bills for the last 12 months, all very sick, of his life? The USA can’t afford that level of (super?) premium care for all sick people now. But it would be better to honest argue, in open public square, about the cost-benefits of almost each common medical hospital procedure, as well as the 1-yr and 5-yr survival rates.
On the aggregator model, it looks likely to be one possibility. Movies remain more a larger single cost for the whole movie, while CDs (vinyl sold more last year???) have to compete with single songs. Even on single songs it might be for unlimited or perhaps a limited number of times (1 or more but with a limit), or limited time, or both.
The market allows many possible alternatives for mental transactions.
It’s an important, useful, and relevant issue for day to day decisions; far more than many more studied issues in economics.