Pricing Information

Hal R. Varian

SIMS
 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

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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
– 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
Price
(Dollars)
$60

$40

$20

1 2 3 Quantity (Millions)
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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 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
– 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

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