1. CMIS 520 March 14, 2005 Information Rules Chapter 1 and 2 Pricing Information

2. CMIS 520 March 14, 2005 Information Goods Anything that can be digitized  Software, text, images, videos, music, etc.  a.k.a. content, digital goods ‘Experience’ Goods Unique cost characteristics Unique demand characteristics

3. CMIS 520 March 14, 2005 Information Goods: Unique Features System of Products Complements  Different manufacturers  Strategy for complementors as well as competitors  Compatibility as strategic choice  Standards and interconnection Product lines  High fixed cost, low incremental cost  Leads to value based pricing

4. CMIS 520 March 14, 2005 Information Goods: Cost Characteristics First Copy Costs  One of the most fundamental features of information goods is that their cost of production is dominated by the “First Copy Costs” (Fixed Costs).  Once the first copy of an information good has been produced, the cost of creating a duplicate is next to nothing (Marginal Cost).

5. CMIS 520 March 14, 2005 Information Goods: Cost Characteristics Distributing Information Goods  With recent advances in information technology, the cost of distributing information goods has fallen, causing first copy costs to compromise an even greater portion of total costs.

6. CMIS 520 March 14, 2005 Information Goods: Cost Characteristics Economies of Scale  Fixed costs of production are large, but the variable costs of reproduction are small.  This cost structure can lead to substantial economies of scale.  The more you produce, the lower your average cost of production.

7. CMIS 520 March 14, 2005 Information Goods: Cost Characteristics Sunk Costs  The dominant component of fixed costs of producing information are Sunk Costs.  Sunk costs generally have to be paid up front, before commencing production.  In addition, marketing and promotion costs are large for information goods.

8. CMIS 520 March 14, 2005 Information Goods: Cost Characteristics Variable Cost Structure  The cost of producing an additional copy of an information good typically does not increase, even if a great number of copies are made.  Normally there are no natural limits to the production of additional copies of information.

9. CMIS 520 March 14, 2005 Information Goods: Cost Characteristics Marketing Opportunities  Information is an experience good.  Sellers of information goods can distribute free samples via the internet, enabling the information vendor to distribute free copies for essentially nothing.

10. CMIS 520 March 14, 2005 Costs Characteristics: Summary The cost characteristics of information goods has significant implications for competitive pricing strategies Information is costly to produce, cheap to reproduce. When the first copy of an information good has been produced most costs are sunk and cannot be recovered. Multiple copies can be produced at constant unit costs. No natural capacity limits for additional copies.

11. CMIS 520 March 14, 2005 Cost and Competition: Pricing Strategy Discussion Questions Is the market information goods a competitive market in which many suppliers offer similar products, each lacking the ability to influence prices? Is the ‘auction’ type of markets applicable where price is determined by the highest bidder? Is the ‘The Prime Costs Plus’ policy (as typically the case of physical goods) a viable option?

12. CMIS 520 March 14, 2005 Cost and Competition: Pricing Strategy Some Important Points Markets for information will not and cannot look like text book perfect competitive markets in which there are many suppliers offering similar products, each lacking the ability to influence prices.

13. CMIS 520 March 14, 2005 Pricing Strategy Some Important Points ‘Auction’ type of market where a product is sold to the highest bidder works for goods in fixed supply such as stocks or airline seats. but this is not a viable option for a good which the incremental production cost is zero. ‘The Prime Costs Plus’ policy, typically applied in the case of physical goods, is also not a viable option for information goods.

14. CMIS 520 March 14, 2005 Cost and Competition “Information Commodity Markets don’t work” Nynex developed the first CD Directory of the NY Area in 1986 and charged $10K per CD to large clients. Executive in charge of the product James Bryant left Nynex to Set up Pro CD, to produce a national directory. Others followed. Phone Companies wouldn’t rent their computerized listings to CD companies at a reasonable price for fear of cannibalizing their $10 Billion Yellow Pages. Pro CD hired Chinese workers at $3.50 per day to type in every listing in the phone book twice. The resulting CD database had 70 million listings.

15. CMIS 520 March 14, 2005 Costs and Competition  Copies of the CD were produced for less than $1 each. By the early 1990’s the CD Phone Book sold for hundreds of dollars.  In 1999 at least half a dozen competitors offered national CD phone directories for $20.There are also several Internet services that offer free directory service, they depend on advertising revenue.  Today the CD phone directory has apparently morphed into an otherwise free internet service industry, providing menus of additional personal information services for a charge, such as background checks, criminal records, credit history, etc..

16. CMIS 520 March 14, 2005 Costs and Competition The CD Phone Directory is a Classic example of why Information commodity markets don’t work. Once several firms have sunk the costs necessary to create the product, competitive forces tend to move the price towards marginal cost, i.e. the cost of producing an “additional” copy. Competition among sellers of commodity Information pushes prices to zero. Free information on the Net is simply selling at Marginal Cost - “zero”

17. CMIS 520 March 14, 2005 Cost and Competition Market Structures for Information Goods. High Sunk Costs and Low Marginal Costs have significant implications for market structure of information industries. Final Analysis there are only 2 sustainable structures for Marketing Information. The Dominant Firm Model. Differential Product Market. Amalgams or combinations of both models are not uncommon.

18. CMIS 520 March 14, 2005 Cost and Competition : The Dominant Firm Model. May or may not produce the “best” product, but by virtue of it’s size and scale economies it enjoys a cost advantage over it’s rivals. Microsoft is great example of dominating thus controlling the market for PC Operating Systems.

19. CMIS 520 March 14, 2005 Cost and Competition Differential Product Market. When a number of firms produce the same kind of information with many different varieties. This is the most common market structure for information goods Publishing, film, television, and some software markets fit this model

20. CMIS 520 March 14, 2005 Cost and Competition Combinations Amalgams or combinations of the two models are not uncommon. All Markets are differentiated, it’s a matter of how much. In the TV Listings Information Market, TV Guide Dominates, selling around 1 billion copies per year.

21. CMIS 520 March 14, 2005 Cost and Competition TV Guide Example. Many Local advertiser supported guides are distributed free as standalones or with Sunday Newspapers that compete with commodity information in TV Guide. Competition from GIST TV and other online is starting to take-off coupled with WEB TV. Today TV guide has free internet listing service, which provides a platform for advertising-up and coming shows much like the paper guide. They also offer very low yearly subscription rates for the paper guide - just $5.

22. CMIS 520 March 14, 2005 Cost and Competition Principles of Competitive Strategies Differentiate your product. Add value to the raw information and distinguish your product from the competition’s. In a dominant firm industry, Achieve cost leadership through economies of scale and scope. These classic principles are just as valid in information markets, offering new opportunities to exploit them.

23. CMIS 520 March 14, 2005 Cost and Competition Principles of Competitive Strategies Pricing policies are central to either strategy. To succeed you must become the price and cost leader based on scale, or create a unique information resource and charge based on value. If you dominate the market and don’t worry about competitors you still have to worry about high value pricing. Stockholders still want high returns on investment.

24. CMIS 520 March 14, 2005 Cost and Competition Differentiation Lesson from the CD phone book Story – Don’t let your information become a commodity. Do everything you can to differentiate your product from others. Strategy in the Britannica- Encarta Battle requires product differentiation. Three market segments are emerging: a multimedia bells and whistles market, an educational market, and an authoritative reference market.

25. CMIS 520 March 14, 2005 Cost and Competition Cost Leadership If it is hard to differentiate your product you can at least try to sell a lot of it. If you can sell more than others, your average costs will be lowest allowing you to make more money when others cannot. To sell a lot you will have to lower your price, and thus earn a smaller amount on each unit sold.To win you have to make up for it in volume. This can be a dangerous game If two or more firms discount heavily, counting on scale economies that come with market leadership. Both cannot succeed.

26. CMIS 520 March 14, 2005 Cost and Competition Latest Britannica – Encarta Britannica has a wide range of authoritative products available from internet subscription service - $70, CD/DVD - $50, and four distinct hard bound encyclopedia sets ranging from $500 to $2,000, plus specialized CD/DVD in depth profiles, such as World Religions, US Presidents, etc.. for $10. Encarta is only available as CD/DVD in deluxe and basic versions, each for $20.

27. CMIS 520 March 14, 2005 Cost and Competition : First Mover Advantage First Mover Advantage can be a successful strategy in the presence of the scale of economies endemic in the information Industries. Such leadership may not be worth winning at the cost of a bloody price war. Best way to secure a leadership position is through an early presence in the Market, combined with a forward looking approach to pricing.

28. CMIS 520 March 14, 2005 Cost and Competition First Mover Advantage. Britannica example shows how historical leaders are at risk from new technologies reducing the cost of creating and distributing information. The differentiation strategy adopted often make use of the technology that threatens them. If differentiation is difficult or limited, the incumbent information provider can always adopt a cost leadership position. Owing to economies of scale the Market Leader often tends to be the cost leader.

29. CMIS 520 March 14, 2005 Cost and Competition First Mover Advantage. The historical leader should be able to find a pricing strategy to retain leadership position if the newcomer has no advantages in terms of cost or technical prowess. If you are alert, scale economies should work with you not against you. Don’t think you are entitled to continue to set selling prices as high as you have in the past.

30. CMIS 520 March 14, 2005 Cost and Competition First Mover Advantage. A two pronged approach offers the best chance for the historical leader to make money. Even if it cannot prevent it’s information from becoming a commodity. First, don’t be greedy. Exercise “Limit Pricing”, sacrifice some short-term margin by dropping prices to make their markets less attractive. Second, play tough. Turn the threat of commoditization on it’s head and use it to your advantage. If you can convince potential competitors that you will respond with dramatic price cuts if they enter your market, then you won’t have to lower prices now to discourage entry.

31. CMIS 520 March 14, 2005 Cost and Competition: Discussion Q Has Microsoft been a first mover in anything?

32. CMIS 520 March 14, 2005 Personalizing your Product Pricing and Product Design  If you are successful in creating a unique source of information and avoid commoditization, you have some breathing room in terms of both pricing and product design – how you package and present your information.

33. CMIS 520 March 14, 2005 Personalizing your Product How do you get the most value for what you’ve got? 1. Personalize or customize your product to generate the most value for your customers. 2. Establish pricing arrangements that capture as much of that value as possible.

34. CMIS 520 March 14, 2005 Know Your Customer Maximize value Personalize an information product 2 Main ways to get customer information:  Registration and billing Demographic information  Observation Search queries Clickstream

35. CMIS 520 March 14, 2005 Know Your Customer Registration and Billing  Internet Service Providers (ISPs) and major sites which require registration or payment the ZAG (zip code, age and gender)  Advertisers can purchase customer demographics for a premium or fee Offer incentives in order to gather customer information Coupons Giveaways Contests

36. CMIS 520 March 14, 2005 Know Your Customer Registration and Billing Continued  Customers are hesitant to provide personal information for fear of how it will be used over 40% give false information

37. CMIS 520 March 14, 2005 Know Your Customer Observation  Save and Analyze user queries/ searches  Monitor clickstream  Challenges A lot of data to sort HTTP protocol is “connectionless”  Java ability to write your own browser able to monitor user behavior

38. CMIS 520 March 14, 2005 Pricing Your Product Internet makes it easy to personalize your product and also to price your product Products highly tuned to customer’s interests  Pricing flexibility  Tailored goods Research Reports – Forrester Research & the Research Board  Mass Market Consumer Information Goods Ex: Quicken

39. CMIS 520 March 14, 2005 Pricing Your Product Tradeoff when setting one price  Set high price and sell only to consumers who place a high value on your product  Set a low price and sell to lots of consumers IDEAL SITUATION: Sell the product to each different consumer at that consumer’s maximum willingness to pay

40. CMIS 520 March 14, 2005 Pricing Your Product Perfect Price Discrimination  Charging each customer just what he or she is willing to pay  Very difficult  How? Point-to-Point Technology ( or One-to-One Marketing)  Can sometimes arrange for multiple, personalized prices

41. CMIS 520 March 14, 2005 Pricing Your Product A.C. Pigou (1920)  Described One-to-One Marketing as First Degree Price Discrimination  3 Types of Differential Pricing Personalized Pricing – Sell to each user at a different price Versioning – Offer a product line and let users choose the version of the product most appropriate for them Group Pricing – Set different prices for different groups of consumers, as in student/senior discounts

42. CMIS 520 March 14, 2005 Personalized Pricing Charging different prices to different consumers  traditionally with mail order catalog inserts.  pricing based on location, demographics, and/or past purchase behavior Information technology enables MORE personal pricing by optimizing packages & charging accordingly

43. CMIS 520 March 14, 2005 Personalized Pricing INTERNET - offers more pricing opportunities  price based on what consumers are buying now  offer specials based on consumer’s internet click stream  can mark up/down prices immediately  inexpensive form of market research as well

44. CMIS 520 March 14, 2005 Personalized Pricing EXAMPLES: Airlines: pricing depends on when flight is booked, restrictions consumer is willing to accept, travel history, etc. Information providers: pricing depends on type of enterprise, size, time of day used, printing frequency, etc. ‘Smart’ cash registers: offer discounts to those who are price sensitive or those purchasing competitor’s products

45. CMIS 520 March 14, 2005 Personalized Pricing Summary of personalized pricing  Personalized product & pricing  Know the customer  Differentiate prices when possible  Use promotions to measure demand

46. CMIS 520 March 14, 2005 Group Pricing Economist refer to group pricing as “third- degree price discrimination” where prices are based on group identity 4 reasons to sell to groups  Price Sensitivity  Network Effects  Lock-In  Sharing

47. CMIS 520 March 14, 2005 Group Pricing Price Sensitivity – members of groups can be charged different amounts for the same product TurboTax now has a site just for you. Fast. Simple. Rock your refund. Taxes in plain English Get a Russell Simmons Rush Pre-paid Visa ® Card Best Buy 10% instant coupons Up to $200 off cool trips like Vegas and Miami

48. CMIS 520 March 14, 2005 Group Pricing Network Effects occur when the value one user places on a good depends on many other people are using it  Software Site Licensing

49. CMIS 520 March 14, 2005 Group Pricing Lock-In  When companies use standardized products it can be very costly to switch to a new product  Employees have to be retrained  An effective technique to get customers is offer huge discounts to get them to use your product

50. CMIS 520 March 14, 2005 Lessons It is important to know how much you invest in producing and selling your information If you are in a market with many firms seize market share and find a way to add value to the information Differentiate by personalizing the information and price Invest in collecting market data Use this information to sell your customers personalized products at personalized prices Consider that higher returns can be obtained by selling to groups

51. CMIS 520 March 14, 2005 Questions