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

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Wikipedia v Encarta

• Wiki developed by Ward Cunningham circa 1994-95
• Wikipedia started 2001
• Currently 763,225 articles
• Many languages
• Microsofts response looking for volunteers to
  keep Encarta up to date.

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Production Costs of Information

• First-copy costs dominate
• Sunk costs - not recoverable
• Variable costs small no capacity constraints
• Microsoft profit margins of 92
• Significant supply-side economies of scale
• Marginal cost less than average cost
• Declining average cost

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Economies of Scale and Scope

• Supply-side (cost effects)
• Economies of scale
• cost of incremental units less than average cost
• often due to fixed costs
• Economies of scope
• cost of additional products reduced
• often due to product line economies in design and
  manufacture

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Economies of Scale and Scope

• Demand side (revenue effects)
• Economies of scale
• value of product increases with number of users
• due to network externalities
• Economies of scope
• value of product depends on other products
• due to compatibility Windows 9x MS Office
• due to branding, reputation, etc.

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Implications for Market Structure

• Cannot be "perfectly competitive
• bidding wars lead to downward price spirals
• e.g., spreadsheet wars in mid-80s
• 2 sustainable structures
• Dominant firm/monopoly with cost advantage
• Differentiated product
• and combinations of above

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Strategy

• What to do
• Cost leadership through economies of scale and
  scope
• supply side/cost strategy
• first-mover (really best-mover) advantage
• Differentiate your product
• demand-side/revenue strategy
• Add value to the raw information to distinguish
  yourself from the competition

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Example of Commoditized Information

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

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Cost Strategies for Commodity Business

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

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Revenue Strategies for Commodity Business

• Differentiate your product
• Bigbook and maps, Yahoo/Google
• West Publishing and page numbers
• Look for demand-side economies
• scale network effects
• scope branding, reputation, bundling
• Yahoo, Google, etc.

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First-mover Advantages

• Avoid greed
• Respond to threat quickly and decisively
• Limit pricing to discourage entry
• highly credible with high sunk costs to entry
• Play tough
• Discourage future entry
• Embrace and extend
• Constant innovation (Amazon)

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Hard to do for Incumbent

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

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Personalize Your Product

• Personalize product, personalize price
• Search-based advertising
• Overture, Google chief players
• Premium ads at top, pay per impression (CPM) (a
  few cents)
• Select ads on side, pay per clickthrough (25
  cents)
• Very effective, very high margins
• Result 87B market cap for Google

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Know Your Customer

• Registration
• Required NY Times
• Billing Wall Street Journal
• AOLs ace in hole ZAG
• Know your consumer
• Observe queries
• Observe clickstream
• One-click shopping

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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 segementation
• Quicken for Windows
• Quicken Deluxe

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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
• Direct mail and catalogs
• Victorias Secret
• Lexis/Nexis
• Supermarket scanners
• Profit margin more than doubled 1993-1996
• More effective than other forms of advertising

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Promotional Pricing

• Sales, coupons, rebates
• Only worthwhile if these segment market
• Offer credible signal of price sensitivity
• Helps avoid bypass with software agents
• Bargain Finder
• Price Scan

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Personalized Pricing new techniques on the
Internet

• Auctions
• Ebay, Priceline, Dovebid,etc.
• Will discuss later
• Realtime closeouts
• Entertainment value of auctions a la eBay
• Huge lock-in due to network effects

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Group Pricing

• Price sensitivity traditional
• low price to more elastic demand
• Network effects, standardization
• value of good goes up if your group adopts
• significant switching costs for organization
• 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 solution
• Keyboards, languages, etc.

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Network Effects

• Compatibility
• Site licenses
• Variety of schemes per client, per user, per
  server, etc.
• Lock-In
• Dell and IBM maintenance agreement

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Sharing

• Transactions cost of sharing
• Videos
• Desire for repeat play
• Application Service Providers (ASP)
• Endorsement/viral marketing
• Hotmail
• E-pinions
• audioreview.com

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Summary

• Understand cost structure
• Commodity market be aggressive, not greedy
• Differentiate product and price
• Understand consumer
• Personalize products and prices
• Sales to groups