Credit Card Micropayments

A typical credit card transaction charge is between 12¢ and 50¢. That's on top of the 2% to 9% credit card sale discount rate. I know of no way to lessen the discount rate, but it should be possible to significantly reduce the transaction charges by batching multiple purchases into one transaction.

Credit card companies don't directly support this, but with some server-side software smarts, you can emulate it. The trick relies on the fact that there are two distinct phases to each credit card purchase. The first phase, the "authorization", tells the credit card company to reduce the purchaser's credit limit by a certain amount, earmarked for the merchant. At this stage, the merchant doesn't actually have the purchaser's money yet, but the purchasers can't go and spend it elsewhere, either.

The second phase is the "capture" phase, which actually moves the money from the purchaser's account to the merchant's account.

When you place an order online (or over the phone) for delivery, the merchant is supposed to authorize the transaction immediately, before the purchase is even accepted. However, the merchant is contractually bound to only capture the transaction upon order shipment. Sadly, many merchants will play fast-and-loose this last rule, as it's a bear to automate when dealing with things like third-party fulfillers.

The key insight here is that both the authorization and capture requests specify an amount. That means the merchant can earmark your account for one figure, and then request payment for another figure. For example, a merchant's website could say they'd charge you $15 for a widget+shipping, only to discover at shipment time that shipping price is lower than average by a buck. They could thus capture only $14.

So this is what I think Apple is doing. Upon the first purchase, they authorize your account for some higher figure. Let's say $9.90, enough for ten songs. Even though Apple delivers ("ships") the music right away, they don't immediately capture the transaction. Instead, they hold it for a certain number of days. The number of days is based on two things: how many days the credit card company will hold an authorized-only transaction before automatically voiding it (35 days is typical), and Apple's business decision of the tradeoffs involved (cash-flow versus transaction fee reduction).

If you purchase more music in within the authorization window, Apple simply updates their internal records without engaging in another credit card transaction. But eventually the authorization window must be closed, which leads to three scenarios:

• You don't purchase another song within the authorization window. Apple takes the large transaction fee hit and hopes these types of single-purchases are made up by multiple-purchases.
• You purchase more music within the authorization window, but it stays within the original authorization's amount. When the authorization window closes, and the capture time has come, Apple merely specifies a capture amount less than or equal to the original authorization amount.
• You purchase more music within the authorization window, and it goes over the original authorization's amount. This is interesting. Apple has two choices here. They can either create a new authorization transaction (and start the next authorization window, which invokes the transaction fee), or they can fulfill the order (and gamble that a capture amount greater than the original cleared authorization amount will pass).

Update: I've gotten feedback on my theory from Real Live Users. While the basics seem right, I got some of the details wrong. Specifically, Apple seems to be authorizing track sales individually. Ole Eichhorn, with his PayPal background, clued me in that an authorization alone doesn't always invoke a transaction fee (probably depending on your merchant contract). I suspect Apple doesn't pay for their authorizations, only their captures (which they batch).

Meanwhile, John Robinson deconstructs my theory and notes a small problem which may cause customer confusion, leading them to void the sale by calling their credit card company. Ouch! That's known as a chargeback, and it's expensive for the merchant. After too many chargebacks, merchant accounts can be revoked. Apple's use of multiple authorizations with batched captures nicely sidesteps the problem.

Finally, Apple is keeping the authorization window much shorter than I thought they would. Folks have been telling me numbers from two hours to two days. However, I have yet to hear anything longer than 48 hours. It could be Apple is just playing it safe for now, and will be extending the authorization window in the future -- they're potentially leaving money on the table. Either that, or there's a limiting factor of some sort that I don't see.

Wednesday, April 30, 2003
12:00 AM