Despite the potential of micro-payment systems very few systems have been successful. Little is known about the reasons behind the successful few and the failures of the majority. Micro-payment markets exhibit two-sided network effects and the underlying dynamics of these markets are not very well understood. Based on a stylized model of a two-sided market, we find that a 'survival mass' of merchants and consumers is required for a micro-payment system to exist and a 'critical mass' for the acceptance levels to take off and remain stable. We also find the non-intuitive result that lowering the consumer-side adoption cost will actually reduce the chances for the micro-payment market to develop. Thus, subsidization alone cannot create a micro-payment market. Anecdotal evidence supports this finding. When subsidization is needed, the consumer side will normally be subsidized. The two-sided market structure makes comparative analysis complex and non-trivial, rendering the implementation of micro-payment systems very difficult as indicated by the mixed results of a number of initiatives worldwide.
Keywords: Network Effects, Two-sided Market, Micro-payment Systems, Smart Card Technology, Electronic Cash, Game Theory
(ProQuest-CSA LLC: ... denotes formulae omitted.)
The idea of having a cashless world has long been around. The costs of handling cash are high compared to that of electronic money. Printing, distributing and controlling cash are estimated to cost a developed economy 0.75% of annual GDP and an emerging economy 1% to 2% (Cobb, 2003). Social savings of using electronic micro-payment means over cash are substantial.
Given the huge potential savings electronic micro-payment can bring about, there is scope to increase profits. Electronic micro-payment is also important for a wide range of electronic and mobile commerce (Harris and Spence 2002, Papaefstathiou and Manifavas 2004), which further enhances the incentives for firms to enter this market (Baddeley 2004). Consequently, major credit card operators and financial institutions had been trying to capitalize on this business throughout the 90s. Initiatives like Mondex and Visa Cash (Westland, 1998; Westland et. al., 1997) have achieved little success. In an early pilot test (Van Hove, 2000), the acceptance levels of both Mondex and Visa Cash were disappointing.
An exception is the Octopus card in Hong Kong which ranks top worldwide in terms of circulation (Yoon, 2001). The Octopus card was originally a fare-payment smart card for the Hong Kong passenger transportation system. A joint venture firm called Creative Star Limited was formed by the five major public transportation operators to develop the system. It was introduced to the public in 1997, targeting a public transportation market with 10 million passenger journeys per day and total daily transactions valuing over 2.5 million dollars (Poon and Chau, 2001). A critical mass was quickly gained and the Octopus card system is now growing to support non-transportation micro-payment transactions too. With over 7 million cards issued, it is now the closest thing to an electronic-cash system anywhere in the world (Yoon, 2001).
The Octopus card has attracted significant attention (CPSS Survey, 2001) and its success is frequently contrasted with the failure of Visa Cash and Mondex which were launched contemporaneously in Hong Kong. The overwhelming success of the Octopus card is surprising. It does not have a gigantic client base compared with Visa Cash and Mondex, which are supported by Visa Card and Master Card respectively. Neither is the Octopus card more secured (Hong Kong Economic Times, 2000).
We believe the mixed outcomes of different micro-payment systems are attributed to the very basic market structure and the complex interdependent relationship between merchants and consumers that are not intuitive to a system provider. …