Key Points

“Ignore basic economic principles at your own risk. Technology changes. Economic laws do not.”
“We won’t tell you that devising business strategy is like restoring an ecosystem, fighting a war, or making love. Business strategy is business strategy”
“If you think your position as a market leader is totally secure, try reciting the following mantra three times: ‘CP/M, Wordstar, VisiCalc’“.

Summary

This book discusses the principles behind the economics of “information goods”.

Prices

In the language of economics, information involves high sunk costs, and very low marginal costs - in other words, information is expensive to create, but costs next to nothing to reproduce, and there are virtually no limits to the amount of copies that can be produced. Information commodoties trend towards the marginal cost: zero, meaning that selling information commodities is not likely to be successful in the long run. There are two sustainable structures for an information market:

In the dominant firm, the largest company in the market has a cost advantage through economics of scale.
A differentiated product market, like the film industry, involves a number of firms producing the same type of information, with many different varieties.

This leads to the conclusion that the strategies to follow are to either differentiate your product, or be the cost leader in your market. A price war may lead to a victory that isn’t worth winning because of the extremely slim margins. If you are the dominant player in the market, don’t be greedy - it’s often better to sacrifice some of your margins in order to keep out competitors. Don’t start a price war unless you are sure you can win, but if you are, be seen as willing to “drop the bomb” and slash prices. By sending this signal, you make other companies wary of encroaching on your territory, knowing that they won’t recoup their investments if you cut prices to the bone.

You have some room to maneuver with regards to pricing and your product if you are fortunate enough to have a unique source of information. To capture as much value as possible, personalize your product to its target as closely as possible. Targeted on-line advertising is an example of this.

Whatever your business, knowing your customer is valuable, and need their feedback in order to improve, and better target your product. The internet makes it much easier to collect current and pertinent data about your customers.

Price discrimination is the art of attempting to match as closely as possible the curve describing what people will pay for your product. A few people will be willing to pay a lot, but if your price is high, you exclude all the people willing to pay less money. On the other hand, too low a price, and you lose out on the money the high spenders would have been willing to pay. There are three ways of implementing differential pricing:

Personalized pricing - each user buys at their own price.
Group pricing, where different groups (students, retirees, etc) get their own price.
Versioning - different versions of the product that the user can select from.

Many web sites, especially airlines, and even amazon.com, change prices for each individual on the site based on their behavoir. Information products sold on the internet offer a great deal of flexibility in setting individual prices.

Reasons why it may make sense to target groups rather than individuals.

You can offer different prices to different groups depending on how sensitive they are to prices.
Network effects: by exploiting the fact that a product becomes more valuable the more it’s used, by offering incentives to standardize on a single product, it may be possible to acquire an entire market segment. Network effects are covered in greater detail later.
Lock in: Once a product has been selected and acquired, changing may be very costly.
Sharing: it may be easier for a group of people to pool resources to utilize information goods.

Versioning

The concept of versioning refers to the practice of creating different versions of the same product at different price points. In the world of books, hardback versions are usually released some time prior to paperbacks. Those who are willing to pay more will purchase the hardback, while those who are more price sensitive may choose to wait for the paperback. In this way, the publisher maximizes revenues, because customers self-select into groups who are willing to pay more or less.

The key to versioning is to select the aspects of your product that are important to some users, and less so to others. Several strategies that may prove effective are:

Delaying cheaper versions. Real time stock information costs money, whereas free quotes are available after 15+ minutes.
A more elaborate user interface for higher paying customers. They’re the experts, usually, and want a pleasant, efficient experience.
Image Resolution.
Speed - cheaper products are slower (sometimes artificially so, so as to be able to differentiate between purchasers).
Flexibility - often times more expensive products are more flexible in what they permit the user to do.
Capabilities, features and functions.
“Nagware” - it’s free to use, but pops up windows and reminders within the program itself that since you downloaded it for free, and are enjoying its use, perhaps it would be good of you to pay the registration fee.
Support - if you actually pay, you are entitled to some support, for free.

Customers may find the concept of versioning annoying, but remember that that segment of the market might not have been served at all were it not for a cheaper, reduced feature version.

Another useful tactic is to utilize people’s “extremeness aversion” in order to steer them away from a cheaper product. By creating three versions, people will naturally tend towards the middle one as the “safe” choice, even in cases where the low end version would meet their needs.

Bundling can be an effective strategy, where one of the included products is not something the customer would have been likely to buy by itself. An example is the Wall Street Journal on-line edition, which is offered at a low price to people who are already print subscribers. If, on the other hand, the customer would likely buy both products at their full price, bundling is likely to lose money.

Promotional pricing is a technique used for price discrimination that works because of the “inconvenience” involved. A sale might only last a few days, and you may have to wait for it to occur. Rebate coupons are often not redeemed. Through this inconvenience, people self-select - those who can pay the full price do, but there is still an opportunity to collect money from those who can’t or won’t and are willing to put up with the inconvenience to get the better price.

Be wary of getting into a competition based only on price, though, because you risk turning your product into a very low margin commodity.

Intellectual Property

Lock in

Network effects

Cooperation strategies

Control strategies

Links

Hal Varian His columns in the New York Times are good reading if you liked the book.

Carl Shapiro

Squeezed Books

Business Knowledge - Extracted, Compressed, Discussed

Summary: Information Rules: A Strategic Guide to the Network Economy

Differences between revision 4 and 5