Tuesday, June 14, 2011

Don't Forget Transaction Costs

Recently I had a discussion with a friend about exactly where the money goes when iTunes takes their fee from a sale. For each $0.99 song, it's estimated that Apple pays $0.70 to the major labels (which is over 85 percent of their sales), and $0.60 to $0.65 to independent labels. This means that the average price per song is approximately $0.69, of which Apple keeps about 30 cents from every sale.

This might seem like a huge amount but what everyone forgets is that this isn't pure profit; Apple has costs too. There are network fees, transaction fees, and general administrative expenses associated with operating the iTunes Store. It's believed that the network fee is about $0.05 per song, which includes the delivery fee and the hardware and software to facilitate delivery, and the operating expenses are a little less than $0.05 per song, based on the relatively small number of Apple employees that are believed to work on iTunes.

That leaves the biggest and most overlooked cost of all - the transaction cost. This is the amount that the bank charges for the privilege of using a credit card. It's believed that when iTunes first started this cost was as high as 24 cents per sale, which left Apple with a mere penny or two of profit for every sale. It's now believed that they've brought this cost down to about a dime, which still leaves a profit of about 10% (or 10 cents) on every sale, which is far below what the perception is.

The point of all this is that transaction costs are frequently overlooked when doing business, and they are the secret expense that eats your profit. If you take credit cards for merch and music, I guarantee that's it's costing you way more than what a giant like Apple can arrange.

All credit cards charge you multiple fees. First of all, there's a monthly transaction that's a minimum of $20 (usually more), a "gateway" fee of between $5 and $20, and a monthly minimum transaction total. Slip below that total and you're charged a penalty.

Then there's the transaction costs per sale, which can go from $.20 to as high as $.35 (it's usually higher for an Internet transaction), plus a charge of between 1.5 and 3% of the total of the sale. Add all that up and it means that if you only make a dozen or so song sales a month, you've actually lost money. Even if you've met your monthly minimum, you still may be only making less than half of a $1 sale thanks to the transaction costs involved.

Hopefully these transaction costs will soon come under control as micropayment fees become more widely available. This is were the traditional bank costs are bypassed, and  only a small fixed fee per transaction is paid. Paypal has recently instituted a system of micropayments, and I've written about more about other possibilities in other blog posts. Check out my recent post of Square for a good example of this type of fixed transaction fee.

So be aware of your transaction costs in order to be sure that you're earning exactly what you think.
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