CMIS 520 March 14, 2005

Information Rules

Chapter 1 and 2

Pricing Information

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

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

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).

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.

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.

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.

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.

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.

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.

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?

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.

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.

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.

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..

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”

CMIS 520 March 14, 2005

Cost and CompetitionMarket 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.

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.

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

CMIS 520 March 14, 2005

Cost and CompetitionCombinations 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.

CMIS 520 March 14, 2005

Cost and CompetitionTV 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.

CMIS 520 March 14, 2005

Cost and CompetitionPrinciples 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.

CMIS 520 March 14, 2005

Cost and CompetitionPrinciples 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.

CMIS 520 March 14, 2005

Cost and CompetitionDifferentiation 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.

CMIS 520 March 14, 2005

Cost and CompetitionCost 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.

CMIS 520 March 14, 2005

Cost and CompetitionLatest 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.

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.

CMIS 520 March 14, 2005

Cost and CompetitionFirst 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.

CMIS 520 March 14, 2005

Cost and CompetitionFirst 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.

CMIS 520 March 14, 2005

Cost and CompetitionFirst 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.

CMIS 520 March 14, 2005

Cost and Competition: Discussion QHas Microsoft been a first mover in anything?

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.

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.

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

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

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

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

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

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

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

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

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

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

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

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

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

CMIS 520 March 14, 2005

Group Pricing Price Sensitivity – members of groups can be

charged different amounts for the same product

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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

Microsoft Office 2003

Pro commercial price $579.95 academic single copy $199.95 academic savings -$132.95 academic site license $67.00

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

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

CMIS 520 March 14, 2005

Questions