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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– Now subscription for $69.95, but link to full article
for free (versioning)
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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 1.6 million articles (in English)– 250 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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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• 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
– 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"
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Logic of Pricing
• Quicken example– 1 million wtp $60, 2 million wtp $20
Quantity (Millions)
$20
$40
$60
1 2 3
Price(Dollars)
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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 segmentation/price differentiation• 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 inTraditional 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– 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
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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
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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