Chapter VIII
Introduction
The online payments1 sector in e-commerce has been analogized to the Chevrolet in the automobile industry: not terribly exciting, but big and capable of having a huge impact on the market (Burnham, 1999). Some researchers have argued that the success of e-commerce business models depends critically on firms’ ability to design and implement secure online payment systems in the marketplace (Aldridge, White & Forcht, 1997; O’Mahony, Peirce & Tewari, 2001). Key payment system considerations include (i) the timing of payment and consumption (that is, manipulating pricing schemes), and (ii) the character- istics of payment systems (for example, system usability, level of feedback consumers receive) (Dutta, Jarvenpaa, & Tomak, 2003). In this chapter we focus on the first feature — the timing of payments and consumption — and attempt to describe the impact that online pricing scheme variations may have on consumers’ preferences for payment systems.
In the traditional transaction model, the transfer of ownership of goods from seller to buyer occurs when the buyer provides payment to the seller. At the moment a seller receives payment, the buyer is free to consume his or her purchase. When consumers purchase their goods with cash, the moment of transfer from seller to buyer is relatively easy to pinpoint. In such transactions payment and the freedom to consume one’s purchase are simultaneous.
In the modern world, where cash purchases grow less common by the day, consumers often experience a separation between their consumption of their newly acquired goods and their payment for those goods. Most notably, with the advent of magnetic-stripped credit cards around 1970, consumers became accustomed to consuming some routine goods weeks and months before making payment. As online purchase options became available, the consump- tion-payment separation followed the familiar pattern in which consumption precedes payment. For example, when consumers download a song from a music provider or access a computer document through Wi-Fi connectivity, they may rely on a direct billing mobile payment solution. In such cases, aggregate payments are generally made to the mobile service provider at the end of a monthly billing cycle (for example, T-mobile data services at Starbucks).
We refer to pricing schemes in which payment follows consumption as “post- payment.”
Sometimes electronic pricing schemes are designed such that payment pre- cedes consumption. For example, consumers who purchase prepaid Internet
scratch cards or Millicent micro-payment systems pay in advance for antici- pated future consumption of digital products and services. We refer to pricing schemes in which consumption follows payment as “pre-payment.”
Finally, we note that the increased use of electronic payment plans does not always require separation between payment and consumption. Consumers who pay for goods using direct-debiting e-wallets are free to consume their goods at the moment they purchase them. We refer to pricing schemes in which payment and freedom to consume are simultaneous as “pay-as-you-go.”
In light of the increasingly common temporal separation between payment and consumption for consumer goods and services that the e-commerce revolution has promoted, it is important to ask how, if at all, such separation matters to consumers. From an economic standpoint, a rational consumer should be unconcerned with the temporal differences across various pricing schemes provided that the revenue streams are “properly” discounted. But, as recent research in behavioral economics documents, the tenets of economic theories of rationality and exponential discounting sometimes run afoul of the realities of consumer choice. The behavioral economics literature has identified descrip- tive models of economic decision-making by incorporating insights gleaned from decades of behavioral research (Kahneman & Tversky, 1979;
Loewenstein, 1987; Simon, 1957). Within the behavioral economics literature, research on “mental accounting” has shown that temporal separation of payment and consumption (that is, pre-payments and post-payments) impacts a consumer’s mental perception of a transaction and subsequently affects his or her preference for a given pricing scheme (Thaler, 1999). Specifically, experimental studies show that pre-payment pricing schemes offer greater hedonistic pleasure to consumers than other pricing schemes (Ariely & Silva, 2002; Prelec & Loewenstein, 1998). However the sheer popularity of credit cards and “pay-as-you-go” pricing schemes (for example, direct-debiting micro-payments) apparently run counter to these experimental findings. This chapter reviews the relevant behavioral economics literature and attempts to answer three research questions:
• How do consumers experience transactions when payment and consump- tion are temporally separated?
• What is the theoretical rationale behind pre-payment pricing schemes?
• What theoretical arguments does the behavioral economics literature offer to explain consumer acceptance of payment systems that are based on post-payment or pay-as-you-go pricing schemes?
In the next section we discuss the relevant literature in behavioral economics that lays the foundation for subsequent theoretical arguments. In the section on transactions we discuss the rationale behind preference for payment systems based on pre-payment pricing schemes. The section on challenges to pre- payment is divided into four subsections. We provide arguments in each subsection from four different theoretical perspectives to explain why consum- ers may sometimes prefer post-payment or pay-as-you-go pricing schemes.
The final section concludes.