Economics of Electronic Micro-Payment Systems

Despite the potential of micro-payment systems very few systems have been successful. Micro-payment markets exhibit twosided network externalities and the business models for these markets are not very well understood. By using a parsimonious game theoretic model, this paper studies factors affecting the existence of a market for micro-payment systems, how the users and merchants choose their acceptance levels, and how a profit maximizing system provider sets the prices under the presence of two-sided network effects. We find that there is a ‘survival mass’ of merchants and users for the market to exist and a ‘critical mass’ for the acceptance levels to take off and remain stable. There is also a lower bound for the user and merchant demands. The conditions for the existence of the market are derived. We find the non-intuitive result that lowering the user-side adoption cost will actually hurt the chances for the micro-payment market to exist. Anecdotal evidence supports this. We also find that to achieve full acceptance levels, the system provider needs to subsidize both users and merchants, which is not feasible in practice.