Pricing Information

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Pricing Information

• Hal R. Varian

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Britannica v. Encarta

• Britannica 200 years, 1,600 for set
• 1992 Microsoft purchased Funk Wagnalls to
  create Encarta
• Britannica response
• Sales dropped 50 between 1990 and 1996
• Online subscription at 120
• CD first for 200, then 70-125
• Free access, Summer 1999
• Now subscription for 69.95, but link to full
  article for free (versioning)

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Wikipedia v Encarta

• Wiki developed by Ward Cunningham circa 1994-95
• Wikipedia started 2001 by Larry Sanger and Jimmy
  Wales
• Currently 1.6 million articles (in English)
• 250 other languages, 21 with more than 50
  thousand articles
• Microsofts response looking for volunteers to
  keep Encarta up to date.
• "Microsoft offers cash"
• "Paid entries in Wikipedia?

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Production Costs of Information

• First-copy (fixed) costs dominate
• Sunk costs not recoverable
• Variable costs small no capacity constraints
• Microsoft profit margins of 92
• Leads to significant supply-side economies of
  scale and scope

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Economies of Scale and Scope

• Traditional supply-side economies (cost effects)
• Economies of scale
• cost of incremental units less than average cost
• equivalently average cost is declining in units
  produced
• often due to fixed costs
• Economies of scope
• cost of producing additional products reduced
• often due shared resource
• E.g., Google infrastructure allows them to offer
  additional services at relatively low cost (e.g.,
  Google Scholar)

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Economies of Scale and Scope

• Demand side (revenue effects)
• Economies of scale
• value of product increases with number of users
• often due to network externalities
• Economies of scope
• value of product depends on availability of other
  products
• systems effects DVD player disk, hardware
  software
• Interoperability/compatibility
• Windows MS Office
• Google calendar Gmail
• due to branding, reputation, etc
• Virgin Air, Virgin phone, etc.

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Implications for Market Structure

• Scale scope on cost/revenue sides imply market
  cannot be "perfectly competitive
• bidding wars lead to downward price spirals
• Britannica, Encarta, Wikipedia
• spreadsheet wars in mid-80s
• Two sustainable structures
• Dominant firm/monopoly with entry barrier such as
  cost advantage, network effects (e.g., Microsoft)
• Differentiated product (e.g., magazines)
• and combinations of above

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Example of commoditized information

• CD ROM phonebooks 1986 Nynex charged 10,000
  per disk for NY directory
• Nynex employee consultant started rival product
• Hired Chinese workers at 3.50 daily wage
• Partnership broke up
• Bidding war between ProCD and Digital Directory
  Assistance (Bertrand competition)
• Competitive price reductions
• Price forced to marginal cost

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What to do to achieve sustainability

• Exploit economies of scale and scope on demand
  side and supply side
• Supply side/cost strategy
• but if everyone tries to do it, watch out
• first-mover (really best-mover) advantage
• Demand side strategy
• build a network/community eBay, YouTube
• differentiate your product
• add value to the raw information to distinguish
  yourself from the competition
• target specific markets (as with social
  networking sites)
• compare MySpace, Facebook

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Cost Strategies for Commodity Business

• Reusability sell the same thing over again
• Baywatch, Reuters, FoodTV, SciFi channel
• Reduces average cost
• Look for supply-side economies
• scale natural in info business
• scope often arises

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Revenue Strategies for Commodity Business

• Differentiate your product
• West Publishing and page numbers
• Google API to Maps User Created Content
• Look for demand-side economies
• scale network effects (e.g., via community)
• scope interoperability, branding, reputation,
  bundling

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First-mover Advantages

• Avoid greed
• Respond to threat quickly and decisively
• Example Intuit and Microsoft
• Limit pricing to discourage entry
• highly credible with high sunk costs to entry
• Play tough
• Discourage future entry
• Microsoft Embrace and extend
• Engage in constant innovation (Amazon, Google)
• Value to incumbent of controlled experiments
• Example of MSN search

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Hard to do for Incumbent

• May not recognize threat till too late
• CP/M
• Wordstar
• VisiCalc
• AOL

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Personalize Your Product

• Personalize product, personalize price
• Search-based advertising
• Google, Yahoo, MSN chief players
• Pay per click model
• Auction off the best positions
• Very effective ads due to high relevance
• Very high margins due to low marginal cost
• Will explore in detail later

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Know Your Customer

• Registration
• Required NY Times
• Billing Wall Street Journal
• Yahoo/Microsoft collect addresses
• Allows demographic targeting via ZAG
• Know user behavior
• Observe queries
• Observe clickstream
• Yahoo and Microsoft behavioral targeting
• "Online retailers are watching you"

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Logic of Pricing

• Quicken example
• 1 million wtp 60, 2 million wtp 20

Price (Dollars)
60
40
20
1
2
3
Quantity (Millions)
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Quicken example

• Assumes only one price
• Charging different prices gives 100 million
• But how do you get at extra value?
• Answer market segmentation/price differentiation
• Quicken Basic
• Quicken Deluxe
• Quicken Premier
• Quicken Home and Business
• But how to segment?

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Forms of Differential Pricing

• Personalized pricing
• Sell to each user at a different price
• Versioning
• Offer a product line and let users choose
• Group pricing
• Based on group membership/identity

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Personalized Pricing inTraditional Industries

• Airlines and yield management
• Direct mail and catalogs
• Britannica experiment
• Victorias Secret
• Supermarket scanners
• Profit margin more than doubled 1993-1996
• More effective than newspaper advertising due to
  targeting

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Promotional Pricing

• Sales, coupons, rebates
• Only worthwhile if these segment market some
  use, some dont
• Offer credible signal of price sensitivity
• By proving you are price sensitive, get a lower
  price
• But by same token are a nuisance
• "Rebates expiring"

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Personalized Pricing new techniques on the
Internet

• Auctions
• Ebay, Priceline, Dovebid,etc.
• Will discuss in later lecture
• Huge lock-in for auction markets due to network
  effects
• Buyers want to be where sellers are and vice
  versa
• Compare eBay US and Yahoo Japan auctions

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Group Pricing

• Price sensitivity traditional
• low price to more elastic (sensitive) demand
• Network effects, standardization
• value of good goes up if your group adopts
• significant switching costs for organization
• site licenses offer big discount because of this
• Product endorsement/viral market
• click here to email to a friend

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Group pricing price sensitivity

• International pricing
• US edition textbook 70
• Indian edition textbook 5
• Problems raised by Internet
• Localization as partial solution
• Keyboards, languages, etc.
• Grey market in cameras and warantees

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Sharing as group pricing

• Transactions cost of sharing
• History of video rental
• Only video sales
• Rise of video rental
• Pricing for ownership
• Revenue sharing model
• Academic journals
• Library price (for shared copies)
• Individual price
• Now bundling

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Summary

• Understand cost structure
• Commodity market be aggressive, not greedy
• Avoid commoditization if you can differentiate
  product and price
• Understand consumer
• Continual experimentation
• Personalize products and prices