Cost of Producing Information
One of the most fundamental features of information goods is that their cost of production is dominated by the “first-copy costs” i.e. it is very costly to produce the first copy and very cheap to produce subsequent copies. It is often said, for example, that the “first copy costs” are more than 70% of the cost of an academic journal. With recent advances in information technology, the cost of distributing information is falling. Information delivered over a network in digital form exhibits the first-copy problem in an extreme way: once the first copy of the information has been produced, additional copies cost essentially nothing.
Information is costly to produce but cheap to reproduce. Explain
In the economist view, the fixed costs of production are large, but the variable costs of reproduction are small. This cost structure leads to substantial economics of scale: the more it is produced; the lower will be the average cost of production. The fixed costs of producing information goods are sunk costs, (costs that are not recoverable if production is halted.)
Investment in the construction of a building can be recovered by selling it. But if Movie flops, there isn’t much of a resale market for its script. Sunk costs generally have to be paid up front, before commencing production. In addition to the firstcopy sunk costs, marketing and promotion costs is large for most information goods.
The variable costs of information production have different cost structure: the cost of producing an additional copy typically does not increase, even if a great many copies are made. Normally there are no natural limits to the production of additional copies of information: if production of one copy can reproduce a million of copies at the same unit cost. It is this combination of low incremental costs and large scale of operation that leads to the 92 per cent gross profit margins enjoyed by Microsoft.
The low variable cost of information goods offers great marketing opportunities. Since information is experience goods, the seller can distribute free samples to experience it to know what it is. Telecommunication Industry also exhibit the same cost structure characteristic large fixed costs and small incremental costs, that is, substantial economics of scale. It costs a lot to lay optical fiber, buy switches, and make a telecommunication system operational. But once the first signal has been sent, it costs next to nothing to send additional signals over the fiber, at least until capacity is reached.
There may be very large costs to producing the first copy of such a database, but subsequent copies can be stamped out at less than $1 a piece. Suppose that several firms have produced such CDs. If the products have similar user interfaces and similar data, consumers will buy only from the cheapest producer. Since this price is likely inadequate to recover fixed costs, producers will be forced out of business until only a single seller remains. This single seller can now operate as a monopolist unconstrained by competition.
Cost and Competition
The cost characteristics of an information goods include:
- Information is costly to produce but cheap to reproduce.
- Once the first copy of an information good has been produced, most costs are sunk and cannot be recovered.
- Multiple copies can be produced at roughly constant per unit costs.
- . There are no natural capacity limits for additional copies.
It is not easy to assign value to ideas to even to determine ownership, even though information can be very expensive to produce. Hence, information commodity market does not work. Competition among sellers of commodity information such as phone numbers, news stories, stock prices, maps, and directories pushes prices to zero.
Market Structures for Information Goods
The high sunk cost, low marginal cost feature of information markets has significant implications for the market structure of information industries.
In the final analysis, there are only two sustainable structures for an information market:
1. The dominant firm model may or may not produce the best product, but by virtue of its size and scale economies it enjoys a cost advantage over its smaller rivals. Microsoft is everyone’s favorite example, since it controls the market for operating systems for desktop computers.
2. In a differential product market, a number of firms producing the same “kind” of information, but with many different varieties. This is the most common market structure for information goods: the publishing, film, television, and some software markets fit this model.
Many software markets involve both differentiated products and disparate marke tshares.Under such situation, the basic principles of competitive strategy are to:
- Differentiate product by adding value to the raw information to distinguish yourself from the competition
- Achieve cost leadership through economies of scale and scope
Personalization, sometimes known as customization, consists of tailoring a service or a product to accommodate specific individuals, sometimes tied to groups or segments of individuals. A wide variety of organizations use personalization to improve customer satisfaction, digital sales conversion, marketing results, branding, and improved website metrics as well as for advertising. Personalization is a key element in social media and recommender systems.
There are two methods of extracting the most value from the information that have been created, which are:
- Product Personalization or customization to generate the customer value.
- Price arrangement that capture as much value as possible
Product Personalization Example: Pointcast, News Provider
Pointcast provide a good example of how IT can be used to personalize information services and add value.The news stores that a user sees are highly personalized.Pointcast can be instructed to show the news headlines and stores on personalized topics.It will personalize the advertisement also. This ability to customize and personalize advertisement is a very powerful marketing tool.
In addition to make eeasy personalize product, the Internet also makes it easy to personalize price. If the information product meets the interest of customer, the seller can have price flexibility in the absence of generic competitive products in the market. The purest examples of tailored goods are research reports, such as those produced by Gartner Group and Forrester Research and the Research Board. The Research Board, for example, sells research reports to CIOs that are highly targeted to their interests and needs. In exchange, member companies pay subscription fees, simply because it’s hard to find such detailed and personalized information elsewhere.
If all customers for the product place essentially the same value on the product, the profit maximizing pricing decision is easy: just price the product at this common value and charge what the market will bear. The difficulty arises when consumers’ willingness’s to pay are heterogeneous. In this case the producer’s choice is not so obvious, since fewer consumers will buy at higher prices. Furthermore, if willingness-to-pay differs across customers, the producer would generally find it advantageous to charge different users different prices.
Forms of Differential Pricing There are three different forms of differential pricing:
• Personalized pricing • Versioning • Group pricing
i) Personalized Pricing
Personalized products can be sold at a highly personalized price. -This phenomenon is also known as “mass customization” or “personalization” and is also referred to as “first degree of price discrimination”. The vendor may offer different consumers different prices as a form of market research. Sellers place much emphasis on “owning the consumer.” This means that they can understand their consumer’s purchasing habits and needs better than potential competitors. For example, a seller can offer prices and goods that are differentiated by location, by demographics, or by past purchase behavior and/or characteristics. Sometimes the vendor has a good idea of what the price responsiveness of the different groups might be and sometimes it is conducting market research to discover price responsiveness. For example, Encyclopedia Britannica has conducted a direct mailing campaign to determine the consumer demand. The vendor selling via catalog can charge different prices to different consumers by personalizing the price.
Second-degree price discrimination refers to a situation where everyone faces the same menu of prices for a set of related products.It is also known as “product line pricing”, “market segmentation”, or “versioning”.The idea is that sellers use their knowledge of distribution of consumers tastes to design a product line that appeals to different market segments.E.g. Books are available in hardback or paperback, in libraries, and for purchase.Movies are available in theaters, on TV, on DVD and on tape.Newspapers are available on-line and in physical form.Information versioning has also been adopted on the Internet. E.g. 20-minute delayed stock prices are available on Yahoo for free, but real-time stock quotes cost $9.95 a month. In this case, the providers are using “delay” to version their information.
It is also referred to as “third-degree price discrimination.” of selling at different prices to different groups. It is, of course, a classic form of price discrimination and is widely used.
The following are the main four reasons to group pricing:
_ Price sensitivity: If member of different groups systematically differ in their price sensitivity, seller can profitably offer them different prices. Examples: student and senior citizen discounts
_ Network effects: If the value to an individual depends on how many other members of his group use the product, there will be value to standardizing on a single product. Microsoft has exploited this desire for standardization with its Microsoft Office suite.
_ Lock-in: If an organization chooses to standardize on a particular product, it may be very expensive for it to make the switch owing to the costs of coordination and retraining. Again, Microsoft serves as the obvious example.
_ Sharing: In many cases it is inconvenient for the individual user to manage or organize all information goods that he or she want to consume. Information intermediaries such as libraries or system administrators can perform this coordination task.
Versioning Information Goods
Versioning means offering information product in different versions (quality) for different market segments.For example, if a product line is offered with one product targeted for professional users and one product for amateur users to split a market, then this strategy is called “versioning”
TYPES OF VERSIONING
Information is like an oyster: it usually has the greatest value when it is fresh. This is especially true of “strategic” information, such as information about stock market or interest-rate movements, where individuals possessing the information have a strategic advantage over those lacking it. But the principle applies more broadly, since we all like to think of ourselves as being up-to-date. The fact that your information customers want the latest information means they will pay more for fresh information. Delay is a tried and true tactic for companies selling various services, not just information. Federal Express, not known for “delay,” offers two classes of service, a premium class that promises delivery before 10 A.M. and a “next day” service that only promises delivery some time the next day.
Another possibility is to provide high-paying customers with more powerful search capabilities. It often makes sense to offer different search interfaces to experienced and inexperienced users. In many cases, experienced users tend to be users with high willingness to pay; they are the customers who first signed on to purchase the information and generally use it most intensively. Casual users typically welcome a stripped-down interface, while advanced users can handle additional capabilities.
A versioning strategy that is closely related to delay is control of convenience by restricting the time or place at which an information service is used. For example, Divx offers DVDs that can be viewed only during a particular forty-eight-hours period. Another example could be the off-hour internet access and downloading features at a much cheaper price than normal or busy hours.
You can also use visual resolution to discriminate between users. For example, PhotoDisk has a library of photographs on the Web. Professional users want highresolution images that can be printed in commercial journals; non-professionals want medium- or low-resolution images for newsletters. PhotoDisk sells different size images for different prices; at the time this chapter was written, it sold 600K images for $19.95 and 10Mb images for $49.95.
5.SPEED OF OPERATION
When selling software, a common strategy is to sell versions with different capabilities. Wolfram Research sells Mathematica, a computer program that does symbolic, graphical, and numerical mathematics. At one time, in the student version of Mathematica, the floating-point coprocessor was disabled, slowing down mathematical and graphical calculations. To implement this strategy, Wolfram had to add a floating-point library to the package at additional cost to itself, even though the soft ware package with the floating-point library sold for a much cheaper price. This same strategy shows up in hardware. The IBM Laser Printer Series E was functionally identical to the standard Laser Printer, but printed five pages per minute rather than ten pages per minute.
6. FLEXIBILITY OF USE
Another important dimension of information that can form the basis for versioning is the ability to store, duplicate, or print the information. Back in the days of copyprotected software, some software companies (such as Borland) sold two versions of their software—a low-priced version that could not be copied and a high-priced version without the copy protection. Nowadays, Lexis/Nexis imposes charges on some users for printing or downloading information.
The product line of Kurzweil, a software producer of voice recognition products. The products are distinguished by the total size of the vocabulary included and by the addition of vocabulary appropriate to specific professions. Note the dramatic differences in prices: the high-end version for surgeons is a hundred times more expensive than the entry-level software! Kurzweil has correctly recognized that different market segments have different needs—and that the high-end will pay handsomely for the enhanced capability.
8. FEATURES AND FUNCTIONS
The Quicken Deluxe version offers a mutual fund finder, a mortgage calculator, an insurance needs estimator, and other features valued by high-powered users. The basic version of the software offers only the core checkbook software. Intuit has pursued the same strategy with TurboTax, selling both a stripped-down and a deluxe version.
In some cases, comprehensiveness is a crucial dimension: some customers will pay a big premium for more complete information. Information completeness varies a great deal, depending on the context. Consider how people use Dialog. Public affairs specialists and journalists like the fact that they can now search newspapers around the country or around the world. Scholars and students writing in-depth articles will place great value on historical depth. For marketing purposes, managers often value information that is broken down by customer or offers lots of details about historical purchasing patterns.
A prime example of this is “nagware,” a form of shareware that is distributed freely but displays a screen at the start or end of the session encouraging you to pay a registration fee. Public television stations use this strategy in their fundraising drives. During one recent campaign, our local PBS station announced that it would stop breaking into the musical performances if users would just donate another $10,000 to meet the station’s goal!
The final dimension that we consider is technical support. Netscape originally made its browser available for free in a download over the Internet and for a price on a CD that came with a manual and access to technical support. Of course, by offering a downloadable version for free, Netscape gets around the “experience good” problem we described earlier. There are as many dimensions on which to version as there are dimensions to your product. Versioning is thus very productspecific.
ADJUSTING PRICE AND QUALITY
Your goal in versioning your information product is to sell to different market segments at different prices. By creating low-end and high-end versions of your product, you can sell the same thing to customers with significantly different levels of willingness to pay.
If your premium-price, high-end product attracts some lowend customers, that’s great: you’re getting more revenue from them than if they had stuck to the low-end product. So, it pays to make your high-end product as attractive as possible. The problem arises at the other end of the product line: if your low-end version is too attractive to attract some customers who would otherwise pay minimum price for the high-end version. There are two ways to avoid this low-end Version, cannibalization. First, reduce the price of the high-end product to make it relatively more attractive. Second, reduce the quality of the lowend product to make it relatively less attractive
In selecting product line, the firm develops the high-end version first and then degrades to obtain lower quality versions.Information good vendors usually adopt such a high-to-low or “value-subtraction” versioning strategy to exploit the cost savings in content, design, and code reuse.In many cases, in fact, production of the low-quality version incurs additional costs, since it is often a degraded form of the high-quality version.
ii. Pitfalls of Versioning and How to avoid
Pitfall is the hidden danger in business specially in the pricing process .One of the pitfalls in degrading the quality of the information goods is that it discourages high-willingness-to-pay consumers from purchasing it.
To overcome this problem is to offer the high-end product only, with a premium price. In dealing with customer choice, the cheaper versions will enhance consumer choice; customers picking them are revealing that they value the option to buy a low-end version of the product at a discount.
iii. ONLINE AND OFFLINE VERSIONS
Information is available both on online and offline version. In many cases, offline information is actually more convenient to use. For example, many readers feel that it is easier to read text book on paper than on a screen.
In many ways, selling information online and offline is like selling physical products through two separate channels of distribution.
How many versions?
1.Analyze Your Market
- Think about whether your market naturally subdivides into different categories of consumers and whether their behaviors are sufficiently different that they want (or are willing to tolerate) different quality of product.
- Are there professional and amateur users? If so, what distinguishes them?
- Your low-end information product should be lacking the key attributes that high-end customers crave for
- Come up with versions that both give value to your customers and raise revenues
2.Analyze Your Product
- Identify its key attributes segmenting the market
- offering a high-end and a low-end version with clear differences in customer value
- Enhance features for sophisticated customers who re willing to pay more
- Degrade features for amateurs
- make the product relatively unattractive to the high willingness-to-pay users but still attractive to the next group down.
- Quite often, low end version can help to advertise the high end version too.
The Goldilocks principle is the idea that there is an ideal amount of some measurable substance, an amount in the middle or mean of a continuum of amounts, and that this amount is “just right” for a life-supporting condition to exist. The analogy is based on the children’s story, The Three Bears, in which a little girl named Goldilocks tastes three different bowls of porridge, and she finds that she prefers porridge which is neither too hot nor too cold, but has just the right temperature. Since the children’s story is well known across cultures, the concept of “just the right amount” is easily understood and is easily applied to a wide range of disciplines, including developmental psychology, biology, economics and engineering.
In economics, a Goldilocks economy sustains moderate economic growth and low inflation, which allows a market-friendly monetary policy. A Goldilocks market occurs when the price of commodities sits between a bear market and a bull market. Goldilocks pricing is a marketing strategy that, although not directly related to the Goldilocks principle, uses product differentiation to offer three versions of a product to corner different parts of the market: a high-end version, a middle version and a low-end version.
The idea behind versioning is to engage in differential pricing by offering different types or editions of a product. Shapiro and Varian (1998). Ideally, the different versions should be perceived as having different levels of quality. The number of versions can also be related to the number of distinct market segments.
v. Customizing the Browser
Controlling the browser allows the seller of content to increase the quality of what it is selling.Consider a browser used to view on-line newspaper articles. If the owner of the content controls the browser, then it can choose the features of the browser to enhance the quality of consuming the content.For example, if the consumer is viewing page 7 of the article, it is likely that page 8 will be the next piece of content he looks at, so the browser could download page 8 in the background.
Java could be used to customize information about the user behavior, and hence help in versioning information.Using Java, some of the features that makes information more valuable to the user, can be turned off for some classes of users and offer professional access to this information.
The practice of joining related products together for the purpose of selling them as a single unit is called Bundling .In the other words It is a marketing strategy that joins products or services together in order to sell them as a single combined unit.
Bundling allows the convenient purchase of several products and/or services from one company. Bundling arrangements usually feature a special pricing arrangements which make it cheaper to buy the products and services as a bundle than separately. Bundling is also often a way for creating a larger market for relatively low value products by selling them cheap (or giving them away free) with a higher value product .
For example, giving away free floppy disks with the purchase of high-end computer software. The floppies might be an incentive to buy that particular software, and quite possibly the software price has a slight mark-up in it to cover the cost of the floppies
Not all providers will mention bundling as an option to their customers; therefore, it is important to check whether you can bundle services together. Bundled services will often save consumers money.
Impose some inconvenience cost on the consumer
Low price Sales
- consumer has to watch for the sales to occur
- consumer has to clip the coupon and remember to take it to the store
Promotions are often ways to segment the market into price-sensitive and non price-sensitive components.Price sensitive: lower willingness to pay