Support Material: Hackers, Hits and Chats
Keyterms: advertisements; bartering; business model; cash flow; channel conflict; cookie file; first mover advantage; lock-in; marginal costs; marketing mix; network effects; product; search engines; shopping bots; shopping cart abandonement; venture capital; word of mouth
The internet was to herald a new era where price assymetry would be removed and buyers would have similar product and pricing information as sellers. This level of transparency would force sellers into a price war that would move prices close to marginal costs in many markets.
- Price...what is it?
- The early internet days
- Price Transparency
- Price point of "Free"
- Price Opaqueness: Discrimination
- Dynamic Pricing: Auctions
- Shipping and Handling
- Online versus Offline Pricing
- Product and Price Bundling
- Online Payment Systems
- Online Payments for Offline Services
While this reality has yet to unfold, and unlikely will for a variety of reasons, the internet has brought some changes to pricing strategy that are worthy of note. This section discusses pricing issues, as the second element of the marketing mix (product, price, place and promotion).
Price... what is it ?When we consider the 'price' element of the marketing mix we are looking at what is exchanged for the product. What does the customer give up, what does the seller gain ? In most cases this is reflected monetarily, but this is not always the case. For many internet exchanges a company also extracts data from the exchange, and that data, either on its own or aggregated with other customers' data, has value. Companies can use the data to create subsequent market offerings to the customer, to tailor that particular product's price, or can resell the data to third party vendors who use it for other companies' marketing programs. The value of this data, in combination with the price charged, establishes the overall value a company receives from the transaction with a customer.
The above is further complicated by companies that use non-price business models. Many content companies sell advertisements to subsidize the content or make the content 'free'. This is the case for traditional news content (newspapers, TV, magazines etc.) and certainly the case for online content providers such as search engines, news sites and social networking sites. These sites do not charge for the services they provide (if they did customers reactions would be pretty swift and final) yet are essentially reselling their traffic to vendors who are trying to attract 'eye balls' (those purchasing advertisements).
A final means of price is the use of bartering. This was very common in the early days of the internet as new online businesses traded with each other services their cash flow could yet afford. Bartering still occurs as a business to business medium for transactions. In 2003 it was estimated to account for $1.7 billion in traded goods.
source: Can your business benefit from barter?
The early internet daysIn the early days of the web, pre- the dot com bust, we saw some pricing strategies that did not make sense in the short run, but were designed to acquire customers in some kind of 'land grab' strategy. The assumption being that once customers became loyal they would continue to use the appropriating service at a price-point that made economic sense to the companies in question, and competitors could no longer compete. Gaining first mover advantage at all costs was literally happening in many markets. Pets.com was a good example of this. They would sell their pet food (and other products) at deep discounts, with free shipping and handling (their products were not cheap to ship) in order to encourage customers to use their service. They would do this while simultaneously spending heavily on marketing to gain customers' mind share. Given there was no lock-in, this strategy was doomed to fail. Much venture capital money was spent in this way. The following companies are examples of dot.coms that could not sustain their business model, based essentially on a high marketing spend and low pricing strategy: pets.com; webvan and eToys.
source: Top 10 dot-com flops
Other interesting pricing models that appeared, and subsequently disappeared, during the early internet years included alladvantage (get paid to surf the web) and freePC.
Price TransparencyThe internet has created a medium that allows customers to easily seek out information on products, and a piece of that information is the price of the product. This level of price transparency was not available via other media. Transparency can come from using a regular search engine such as google to search for products, or from using bots that are designed to compare prices of similar products. Froogle is google's offering in this space. mySimon is a popular shopping engine. The following Naked Conversations on isbn.nu is an example of the class text on a more specialized book engine (cheapest: $7.45 from Alibris, April 21, 2006).
Some sites have considered excluding shopping bots from crawling their sites, but exclusion can remove sites from the marketplace if the marketplace chooses to adopt the particular engine, so it would be a risky strategy at best. Unless all sites decide to not participate (gain cooperation with retail competitors) then participation makes sense.
Many have predicted that the level of transparency that the internet provides will inevitably reduce price to marginal cost and drive competitors who are not lowest cost out of business. Sites try to counter this by garnering brand loyalty and lock-in. Thus why would someone use amazon.com to make a book purchase when logic would have it that a shopping bot will likely find the product cheaper at another internet store ? Customers trust amazon, amazon has enough data on the customer that it is able to create some lock-in (via unique presentation, convenience for the check out process etc.), and customers are inherantly lazy (there is effort in discovering the cheapest bargain for every transaction).
Price point of FreePrices that are free are so for a variety of reasons:
The cost structure of digital products, which essentially means each new customer comes at very little marginal cost, creates a great deal of flexibility in terms of reducing prices in order to acquire customers. Although this was a popular strategy in the early internet days, and one that failed for many, it still has merit when executed under the right conditions. Thus many companies are able to offer a free product / service, which is a dummied-down version of a more robust product which it hopes to sell to a portion of the customer base once the service provider has gained some lock-in. Skype is a good example of this strategy. It does not anticipate that a majority of its customers will use its paid services, but as long as a certain portion do, it can generate a positive revenue stream. Adding 'free' customers does not add additional costs to the service, yet makes the product more useful to each of its existing customers (network effects). Software companies also adopt a similar strategy, especially with software targeted at poorer students, who may eventually need to use the software, with more features (in the paid version) at a later stage (when they have money or the ability to recommend their company to make the purchase).
- Content provider business model noted above
- Cost structure: zero marginal cost
- Free now, pay later: lock-in
Price Opaqueness: DiscriminationWhile price transparency is a pretty well established phenomenon on the internet, less understood is the ability of retail stores to offer unique prices to each individual customer based on their cookie file and data in the retailer's data bases (example of dynamic pricing). Offline stores are not able to do this as price is mostly pre-printed on the product. Online the price is served up with the rest of the data on the web-site, which can be driven by the database and cookie profile. This creates opportunities for price discrimination (and testing) that is unique to this medium.
A retailer's goal is to drive revenue. If it can determine a customer is less price sensitive (via customer data) it can now charge a higher price than it charges for a customer it has determined is more price sensitive. Perhaps a customer who has only made purchases with a coupon; or purchased a certain line of clothing; or purchased only from the second hand product line. All these transactions may indicate a customer who is more price sensitive than the regular customer. This type of discrimination is virtually invisible to the consumer, and since the consumer takes no deliberate action (clip coupon, go to dollar discount store, visit off price retailer) it is natural for customers to assume that they are being served the same price. If this practice is discovered, it can create a pretty big back lash. Amazon understands this after it was discovered it was offering different prices to a customer when the customer removed his cookie file (basically removing his identity). The customer was being offered the same product at a cheaper price once the cookie file was removed. Amazon was essentially offering a new user a better deal than a loyal user on the assumption that new users had not established the lock in loyal users had established with the retailer. This tactic is actually pretty common on the offline world with incentives for new users to subscribe to a magazine for example. It is always a careful balance for a company to make these offers without disenfranchising its loyal user base.
source: Amazon's old customers 'pay more'
Price discrimination also occures in the form of using coupons. Dealcatcher.com is an example of a business that serves price sensitive shoppers with coupons and deals vendors offer its customers that are not offered directly from their own web-sites. Thus vendors (such as Dell.com) are assuming that customers of Dealcatcher are relatively price sensitive as compared to the population at large, and can use this 'channel' to help manage its overall demand for its products without offering deals on its own site to customers who are willing to pay the full price. Dell can also use coupon offers to manage the overall demand for its various products, as it has real-time data of its sales inventory levels. If it is running short of a system with a particular type of monitor, it can quickly offer a deal with a system with an upgraded monitor to balance the demand.
Price discrimination has occured in markets that clearly vary depending on their ability to pay for a product, especially products with costs heavily skewed to their IP costs (typically software, books and drugs). Take the example of providing text books to different university markets around the world. It is common to use different price points. For example students in India can ill afford $100 for each text book purchase, yet they are able to purchase text books similar in content as the text books sold for $100 to students in the US. The books may have examples that are modified to the local conditions, and may have reduced features such as coloured illustrations etc. but the essense of the book is available to students in India at a much reduced price-point. This creates opportunities for arbitrage. If the student in India can make this purchase, what is to stop students in the US making similar purchases, now we have access to the internet and to the information students in India see. A quick look at the price of "Introduction to Marketing" Kotler and Armstrong on Amazon.com makes one wonder how someone is able to sell this book for $49.75 (latest version, new) when it is being retailed by Amazon for $116.73.
While price discrimination is a useful tool to maximize revenue and manage demand, and is easier to use with the internet than with less interactive media, there are clearly times when price discrimination is illegal. The Robinson Patman Act prevents price discrimination within the distribution channel in order not to harm certain types of retailers (that compete with each other). You cannot discriminate on price based on race or ethnicity.
Dynamic Pricing: AuctionsIn the above section on price discrimination, we illustrated an example of dynamic pricing, offering a different price point based on the user profile of the person in the web store (using cookies and content from the store's database). Dynamic pricing has also manifested via auction formats:
The reverse of this is allowing the customer to offer a bid at a price point and see if a company is willing to accept that bid and provide the product (service.) This has become quite popular for perishable services (high fixed / sunk cost, low marginal cost) via services such as priceline.com. For example, Airlines have an incentive to sell all seats on a flight. Once the flight has taken off empty seats can no longer be sold (the perishable nature of the service.)
Dynamic pricing does require work on the part of the consumer and thus is a hassle, unless it is all done with technology on the server side (cookies and database content), transparent to the consumer. Thus this model works well with consumers who are willing to work at getting a deal, and thus are more price sensitive.
Dynamic pricing using an auction is also a good means to manage a product through the product life cycle. Thus when a company is about to launch a new product it may decide to 'dump' its existing product by selling on eBay. Anytime inventory is not moving as it should auction markets can become a good means to recover at least some revenue.
An odd alternative to this is the issue that occurs when a product is in short supply early in its lifecycle (Apple's iPod) that is the resold at higher than retail by the initial buyers to those with the higher demand for the product.
Shipping and Handling (S & H)While this was offered for free in the early days of the internet as an incentive with many online retailers, that was not sustainable over the long term. Online retailers would also offer incentives related to S & H. Amazon had an offer, buy two books and S & H was free. Inevitably this would lead many customers to identify a very inexpensive second book to make up the order. As long as the second book was less expensive than the cost of S & H for the first book on its own, it made sense. Of course the word of mouth nature of the internet made it easy for customers to figure this out.
Shipping and Handling is clearly a cost that needs to be paid that is not an issue with traditional retailers, where the consumer takes care of the cost by visiting the store, selecting the product and leaving with the product.
Appropriate charges are often times added on at the end of a transaction, which leads to high rates of shopping cart abandonment. The problem online retailers face is how to calculate this charge, especially when the actual cost of S & H is only known once the final list of products is selected by the consumer.
Online Pricing versus Offline PricingThere is a potential for channel conflict when a product is offered both online and offline. This is exacerbated if a pricing strategy is used to encourage consumers to buy online. If the product provider owns both channels then it is simply a business decision without conflict. If the product is offered through sites other than the company's retail environment this is where the conflict arises. There are likely many 'arguments' to suggest a product can be priced cheaper on the internet (retail rent, cost of instore sales people), but the key is the strategy behind the internet presence. Is it to shift consumers from the traditional retail environment (make the retail environment cheaper). Perhaps it is to target a different consumer segment (again, cheaper) that may be more price sensitive. But consider how do you avoid your regular consumers taking advantage of the internet offer ? Or is it to simply offer your current markets more choice in terms of purchase. It might well be that offering the same price, both on- and off-line appears the right strategy, despite the costs that drive each environment.
Product Bundling and PricingIt is quite common in the software industry to bundle products together and offer one price. In fact this is not exclusive to the software industry, a CD record is simply a bundle of songs from an artist. This bundle is sold at a fixed price, which creates some marketing opportunities for the marketer offering the bundle. Perhaps the marketer includes a piece of software that the consumer would not have necessarily been willing to pay for on its own, but once bundled, uses the product and becomes locked-in to additional use down the road. Or similarly the customer has the software as a result of the bundled purchase, does not use it until the need arises (some time later), and now uses the software rather than consider competing offerings from other sources since the one the user has is now 'free'. Given the economics of digital products (low to zero marginal costs, most marginal cost associated with packaging and delivery) it makes sense to bundle multiple products together.
Online Payment SystemsCredit cards are the major means of payment online. Traditional retailers that accept credit cards are able to do so online. Accepting credit cards does come come at a cost to the business and smaller businesses use alternative payment systems such as Paypal. Paypal, which is now owned by eBay, allows for payments between internet users and businesses while avoiding traditional banking mechanisms. It grew very popular as a medium of payment for eBay, more popular than eBay's own BillPoint. Other systems that are used include: WebMoney; E-gold and GoldMoney. These systems are not governed by traditional banking laws and thus come for a certain amount of criticism due to their lack of regulation.
MicropaymentsThe internet was heralded as a medium that would open up markets for small payments. Products that were typically bundled (magazines and newspapers bundling news stories and content; CD albums bundling multiple songs) would naturally unbundle as customers could make purchases of the order of cents for products that would not make sense outside of the internet where the cost of the transaction is greater than the value of the transaction (credit card fees for each transaction are typically 20 cents plus a percentage of the transaction). Micropayments on the internet would resolve this. The idea is that content providers on the internet can provide small units of content to large audiences and have a payment system that mediates this. Publishers could sell single articles, rather than an entire subscription for example. This means of payment is taking a while to gain traction. One example however is the iTunes Music Store success selling individual songs at 99 cents.
A robust micropayment system can certainly open up many possibilities in terms of making content that was previously not available to open search (subscription-based content) available to those willing to pay for the "chunks" of content. For example, as a student doing a research report, you may be willing to pay a couple of dollars for an analysis conducted by the Wall Street Journal, that was previously only available to those who pay yearly subscriptions.
BitPass is an example of a company exploring the micropayment area. Systems such as Paypal can facilitate micropayments.
source: Micropayments Redux at the iTunes Music Store; Here Comes the iTunes of News; Digital content spurs micropayments resurgence
Online Payments for Offline ServicesThus far we have discussed initiatives that have explored online payment issues and to some extent how these compete with offline systems. Finally we should look at how the internet has been used as a payment system for offline services, such as utility and phone bills. Many services are now accepting payments online. This is designed to reduce the cost of the payment system and make the payment process less cumbersome for the customer. Thus it is easier to manage your finances in a systematic fashion, than to simply write cheques and mail bills in once a month. Companies like Xpress Bill Pay are designed to offer online bill paying services to merchants who would rather outsource this service.