Microtransactions work from a business standpoint for a few reasons. First, credit card processing is expensive for merchants. For an online retailer to handle a Card-Not-Present transaction, it generally works out to about thirty cents plus three percent of the total plus a daily "processing" fee to handle all of the charges processed that day. So for a $20 charge, ninety cents go to the credit card company, plus whatever that transaction's share of the processing fee may be. It adds up.
Second, they help mitigate risk. For electronically distributed software and content, it's fairly well known and accepted that the primary loss factor is piracy...people who never bought it in the first place. The second largest loss factor, though, is the chargeback.
Let's say that I make a new game, GameX, and decide to sell it online. In order to sell it online, I take credit cards or PayPal. I decide that the best price balance for me to make money on top of the card fees and PayPal fees as well as encourage impulse purchases is $5. This means that forty-five cents out of every sale are going towards processing charges. Now, I'm targeting a niche market, and I only sell 1,000 copies. After charges (ignoring the processing fee), that means that my game cleared $4,550. (I'm excluding my bandwidth charges for the software here.)
Now, let's say that one customer who actually bought the game decides to contest this $5 charge on his credit card. (This is called "friendly fraud.") He received the game, played the game, and just decided to contest it for whatever reason. The moment it is contested, $5 (not $4.55) get deducted from my account. Because I'm a small-volume e-retailer, I also get charged a $25 chargeback fee. I then have twelve days to challenge this charge being contested. Assuming I win, I get that money back, but I only have a 30-40% chance of that happening with electronically distrubted software. If the charge is contested a second time, $30 goes away again and I have only two ways of trying to get it back. The first is to make an appeal through Visa/MasterCard. Doing that requires that I spend $150 to file the appeal, and pay them $250 to review the appeal. Obviously, that's not worth it, especially considering that retailers only win their appeals under 40% of the time. The other way is to send a collection agent after you, but given that most collection agents have a minimum charge of $30, that isn't worth it either.
Now, in this case, one customer wiped out the profit of over six sales. From what I hear from other e-tailers, in the above example, fifteen chargebacks are a more likely number, which reduces what I clear down to $4,100 after dispute charges. In other words, those fifteen chargebacks wiped out nearly 10% of my income. That isn't counting the manhours lost fighting the chargebacks in the first place, or other expenses necessary to keep a business going. In addition, because over 1% of my charges were charged back, I'm now seen as a "high-risk" e-tailer, and I start getting higher charges and extra charges per month.
Microtransaction services like Xbox Live Marketplace and the Wii's Virtual Console help by reducing/eliminating a lot of this risk for developers. Let's use Microsoft Points as an example.
When you spend your $20 on Microsoft Points, you get 1600 points to do with as you wish. The reason that it is 1600 instead of 2000 is that when you purchase your points, Microsoft takes their cut then. Their cut goes towards maintaining and upgrading the service, handling chargebacks, et cetera. Based on what you see above, that means that out of Microsoft's share of that 400 points, about 90 are going to the credit card companies, and potentially as much as 300 are going to chargebacks. Whatever remains after that goes to Microsoft to maintain the Points service (employees, servers, auditing, etc.).
Now the rest of this money is virtualized, and is immune from chargebacks. Now points can be utilized by services, like Windows Live Messenger, the Zune Marketplace or Xbox Live. So, let's say that I get GameX on Xbox Live Arcade. I decide on 400 points for my price point ($5 real money) and sell my 1,000 units. My end result, assuming no additional fees on my end, is $4,000. It's $100 less than I had after the chargebacks, but I didn't have to exert any manpower towards pursuing the friendly fraud. When I get that check at the end of the month, I don't need to worry about parts of it vanishing sometime in the next sixty days because of chargebacks. (The Live service itself takes a small amount of points to cover bandwidth costs for the content, but I'm excluding them because they are comparable to the bandwidth costs I excluded above.)
Now for the real upside of microtransactions. Let's say that I make a small expansion pack for GameX, say an extra 20 levels. I can drop it on Xbox Live Arcade for an obscenely low amount (say, 100 points) because I'm not having to pay the credit card processing charges, etc. For me to sell the same item outside of Live for real money and clear the same amount of money after processing fees and asshole chargebacks, I'd have to increase the cost to nearly $2. I can actually sell something on Live for one point if I choose to. There's no way I could do that with a credit card.
There are still some downsides, though. Right now, neither service has a means of transferring purchased points to other console owners. Neither service has a means of transferring ownership of purchased content either. That said, I can see the customer service headaches associated with handling either of these two scenarios, so the downsides are minor at the moment. However, they are points that are going to have to be addressed going forward.
Services like Microsoft Points and Wii Points help eliminate a lot of the risk and headache associated with electronic distribution. As we transition to microtransactions, you're going to see some great examples (the Oblivion expansion pack on Xbox 360 for 800 points compared to $20 for the PC), some pathetic examples (*cough* horse armor *cough*), and some "what the fuck are they thinking" examples (*cough* GT:HD *cough*). Please try to be patient with us as we experiment here...we're as new to this concept as you are.