1. SIMS Pricing Information Hal R. Varian

2. 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

3. SIMS Wikipedia v Encarta Wiki – developed by Ward Cunningham circa 1994-95 Wikipedia started 2001 –Currently 763,225 articles –Many languages Microsoft’s response: “looking for volunteers to keep Encarta up to date.”

4. SIMS Production Costs of Information First-copy costs dominate –Sunk costs - not recoverable Variable costs small; no capacity constraints –Microsoft profit margins of 92% Significant supply-side economies of scale –Marginal cost less than average cost –Declining average cost

5. SIMS Economies of Scale and Scope Supply-side (cost effects) –Economies of scale cost of incremental units less than average cost often due to fixed costs –Economies of scope cost of additional products reduced often due to product line economies in design and manufacture

6. SIMS Economies of Scale and Scope Demand side (revenue effects) –Economies of scale value of product increases with number of users due to network externalities –Economies of scope value of product depends on other products due to compatibility: Windows 9x + MS Office due to branding, reputation, etc.

7. SIMS Implications for Market Structure Cannot be "perfectly competitive” –bidding wars lead to downward price spirals –e.g., spreadsheet wars in mid-80s 2 sustainable structures –Dominant firm/monopoly with cost advantage –Differentiated product …and combinations of above

8. SIMS Strategy What to do –Cost leadership through economies of scale and scope supply side/cost strategy first-mover (really best-mover) advantage –Differentiate your product demand-side/revenue strategy Add value to the raw information to distinguish yourself from the competition

9. SIMS Example of Commoditized Information CD ROM phonebooks 1986: Nynex charged $10,000 per disk for NY directory Chinese workers at $3.50 daily wage Bidding war between ProCD and Digital Directory Assistance (Bertrand competition) –Competitive price reductions –Price forced to marginal cost

10. SIMS Cost Strategies for Commodity Business Reusability: sell the same thing over again –Baywatch, Reuters, FoodTV –Reduces average cost Look for supply-side economies –scale: natural in info business

11. SIMS Revenue Strategies for Commodity Business Differentiate your product –Bigbook and maps, Yahoo/Google –West Publishing and page numbers Look for demand-side economies –scale: network effects –scope: branding, reputation, bundling Yahoo, Google, etc.

12. SIMS First-mover Advantages Avoid greed –Respond to threat quickly and decisively –Limit pricing to discourage entry highly credible with high sunk costs to entry Play tough –Discourage future entry –“Embrace and extend…” –Constant innovation (Amazon)

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

14. SIMS Personalize Your Product Personalize product, personalize price Search-based advertising –Overture, Google chief players –Premium ads at top, pay per impression (CPM) (a few cents) –Select ads on side, pay per clickthrough (25 cents) Very effective, very high margins Result: $87B market cap for Google

15. SIMS Know Your Customer Registration –Required: NY Times –Billing: Wall Street Journal –AOL’s ace in hole: ZAG Know your consumer –Observe queries –Observe clickstream –One-click shopping

16. SIMS Logic of Pricing Quicken example –1 million wtp $60, 2 million wtp $20 Quantity (Millions) $20 $40 $60 123 Price (Dollars)

17. SIMS Quicken example –Assumes only one price Charging different prices gives $100 million But how do you get at extra value? –Answer: market segementation Quicken for Windows Quicken Deluxe

18. 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

19. SIMS Personalized Pricing in Traditional Industries Airlines Direct mail and catalogs –Victoria’s Secret Lexis/Nexis Supermarket scanners – Profit margin more than doubled 1993- 1996 – More effective than other forms of advertising

20. SIMS Promotional Pricing Sales, coupons, rebates Only worthwhile if these segment market Offer credible signal of price sensitivity Helps avoid bypass with software agents – Bargain Finder – Price Scan

21. SIMS Personalized Pricing: new techniques on the Internet Auctions –Ebay, Priceline, Dovebid,etc. –Will discuss later Realtime closeouts Entertainment value of auctions a la eBay Huge lock-in due to network effects

22. SIMS Group Pricing Price sensitivity: traditional –low price to more elastic demand Network effects, standardization –value of good goes up if your group adopts –significant switching costs for organization Product endorsement/viral market –“click here to email to a friend”

23. SIMS Group pricing: price sensitivity International pricing – US edition textbook: $70 – Indian edition textbook: $5 Problems raised by Internet – Localization as solution – Keyboards, languages, etc.

24. SIMS Network Effects Compatibility –Site licenses –Variety of schemes: per client, per user, per server, etc. Lock-In –Dell and IBM maintenance agreement

25. SIMS Sharing Transactions cost of sharing –Videos –Desire for repeat play –Application Service Providers (ASP) Endorsement/viral marketing –Hotmail –E-pinions –audioreview.com

26. SIMS Summary Understand cost structure Commodity market: be aggressive, not greedy Differentiate product and price Understand consumer Personalize products and prices Sales to groups