How do different payment methods deliver cost and credit efficiency in electronic commerce?

•We derive retailer transaction cost functions of online payment instruments.•Our analysis is based on a unique dataset consisting of 16 m sales transactions.•Invoice is the most cost-efficient payment method for small transaction sizes.•Prepayment is the preferable payment method for transactions above a value of €22.•Credit card and PayPal cause higher costs and do not show scale efficiency.

Using unique data consisting of more than 16.3 million sales transactions provided by a leading European fashion e-commerce company, this study evaluates several payment instruments, including invoices, credit cards, PayPal payments, and prepayments, from an online retailer’s perspective in terms of cost and credit efficiency. The authors identify the transaction size, allowance costs for fraudulent customers, and type of credit card provider that influence retailer transaction costs. Moreover, the results reveal that, for small transaction sizes, invoices are the most cost-efficient payment method, while prepayments dominate for large transaction sizes. Electronic payments in terms of both credit card and PayPal cause higher payment costs, and do not show scale efficiency in e-commerce. Furthermore, this research illustrates differences in the collection time of accounts receivable across payment methods, implying the cost of capital that arises for the retailer. The results lead to the conclusion that prepayments and PayPal payments are associated with the lowest cost of capital.