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
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Sales dropped 50% between 1990 and 1996
Online subscription at $120
CD first for $200, then $70-$125
Free access, Summer 1999
Offer subscriptions to libraries
Adopt Wikipedia model
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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 2.7 million articles (in English)
– 256 other languages, 21 with more than 50
thousand articles
• Microsoft’s 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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Other examples of
commoditization?
• What are some other examples of
information commoditization?
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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
• move to advertising model
• 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
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Required: NY Times
Billing: Wall Street Journal
Yahoo/Microsoft: collect addresses
Allows demographic targeting via ZAG
• Know user behavior
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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
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Quantity (Millions)
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
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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 in
Traditional Industries
• Airlines and yield management
• Direct mail and catalogs
– Britannica experiment
– Victoria’s 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 don’t
• 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
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US edition textbook: $70
Indian edition textbook: $5
• Problems raised by Internet
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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
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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
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