SIMS 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 –Now subscription for $69.95, but link to full article for free (versioning)

SIMS Wikipedia v Encarta Wiki – developed by Ward Cunningham circa 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""Microsoft offers cash" –"Paid entries in Wikipedia?“"Paid entries in Wikipedia?“

SIMS 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

SIMS 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)

SIMS 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.

SIMS 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

SIMS 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

SIMS 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

SIMS 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

SIMS 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

SIMS 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

SIMS Hard to do for Incumbent May not recognize threat till too late –CP/M –Wordstar –VisiCalc –AOL

SIMS 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…

SIMS 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""Online retailers are watching you"

SIMS Logic of Pricing Quicken example –1 million wtp $60, 2 million wtp $20 Quantity (Millions) $20 $40 $ Price (Dollars)

SIMS 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?

SIMS 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

SIMS 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 – More effective than newspaper advertising due to targeting

SIMS 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""Rebates expiring"

SIMS 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

SIMS 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 to a friend”

SIMS 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

SIMS 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

SIMS 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