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
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Wikipedia v Encarta
• Wiki – developed by Ward Cunningham
circa 1994-95
• Wikipedia started 2001
– Currently 763,225 articles
– Many languages
• Microsoft’s 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
– AOL’s 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
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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 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 in
Traditional Industries
• Airlines
• Direct mail and catalogs
– Victoria’s Secret
• Lexis/Nexis
• Supermarket scanners
– Profit margin more than doubled 19931996
– 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
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