Pricing Information Hal R Varian Britannica v Encarta

Pricing Information Hal R. Varian

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 Offer subscriptions to libraries Adopt Wikipedia model

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? “

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

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)

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.

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-80 s • 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

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 Pro. CD and Digital Directory Assistance (Bertrand competition) • Competitive price reductions • Price forced to marginal cost

Other examples of commoditization? • What are some other examples of information commoditization?

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: e. Bay, You. Tube • 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 My. Space, Facebook

Cost Strategies for Commodity Business • Reusability: sell the same thing over again – Baywatch, Reuters, Food. TV, Sci. Fi channel – Reduces average cost • Look for supply-side economies – scale: natural in info business – scope: often arises

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

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

Hard to do for Incumbent • May not recognize threat till too late – CP/M – Wordstar – Visi. Calc – AOL

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…

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"

Logic of Pricing • Quicken example – 1 million wtp $60, 2 million wtp $20 Price (Dollars) $60 $40 $20 1 2 3 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 • • Quicken Basic Quicken Deluxe Quicken Premier Quicken Home and Business – But how to segment?

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

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

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"

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 e. Bay US and Yahoo Japan auctions

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”

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

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

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