Pricing Strategy of Pricing Strategy of Digital ProductsDigital Products

동아대학동아대학 경영정보학과경영정보학과 김현수김현수

Table of ContentsTable of Contents

nn Traditional economic theoriesTraditional economic theories

nn Supply CurveSupply Curve

nn Cost CurveCost Curve

nn Quality and Customers’ valuationQuality and Customers’ valuation

nn Attention Attention

nn Pricing StrategiesPricing Strategies

MotivationMotivationnn Why eWhy e--business is so difficult to make profit?business is so difficult to make profit?

nn Easy to start eEasy to start e--business, easy to fail business, easy to fail

nn Developing web server is just like raising signboard Developing web server is just like raising signboard

nn We only know one star company but do not know We only know one star company but do not know thousands of fallen rocks.thousands of fallen rocks.

nn Need to know the digital product itself. Need to know the digital product itself.

nn Pricing digital product is difficult becausePricing digital product is difficult because–– Digital product can not be scarceDigital product can not be scarce

–– Unlimited supplyUnlimited supply

–– Quality uncertaintyQuality uncertainty

nn Different economy and management situation: Different economy and management situation: production, inventory, advertising, sales, marketing, production, inventory, advertising, sales, marketing, pricing, etc. pricing, etc.

nn Need new principles of Digital Economy, Digital Need new principles of Digital Economy, Digital Company ManagementCompany Management

nn InterInter--Disciplinary Disciplinary nn What’s after the era of eWhat’s after the era of e--business? business?

–– Efficient market, the dream of economists? Efficient market, the dream of economists? –– Or monopoly by a global enterprise? Or monopoly by a global enterprise?

nn Super highway Super highway --> virtual community > virtual community --> e> e--businessbusinessnn The key factors: electronic marketplaceThe key factors: electronic marketplace

What are digital products?What are digital products?

nn Information Information

nn Entertainment productEntertainment product

nn Symbols, tokens and conceptsSymbols, tokens and concepts

nn ProcessesProcesses

nn ServicesServices

Characteristics of Digital ProductsCharacteristics of Digital Products

nn IndestructibilityIndestructibility

nn TransmutabilityTransmutability

nn ReproducibilityReproducibility

nn Demand FunctionDemand Function–– DDnn = f (P= f (Pnn, P, P11, … P, … Pnn--11, Y, T, P, A), Y, T, P, A)

–– Quantity = f(Price) : ceteris paribusQuantity = f(Price) : ceteris paribus

nn Demand CurveDemand Curve

nn Law of demandLaw of demand–– Upper limit Upper limit

–– Shift of demand curveShift of demand curve

Basic economic theoriesBasic economic theories

Price

Quantity

nn Supply functionSupply function

–– SSnn = f(P= f(Pnn, P, P11, … , P, … , Pnn--11, F, F11…F…Fmm, T, G), T, G)

–– S = f(P) : ceteris paribusS = f(P) : ceteris paribus

nn Law of supplyLaw of supply

nn Upper limitUpper limit

nn Shift of supply curveShift of supply curve

nn The shape of supply curve of digital productsThe shape of supply curve of digital products

Price

Quantity

EquilibriumEquilibrium

Price demand supply

surplus

equilibrium

shortage

Quantity

Digital productsDigital products

Concerns of output level in terms of material and labor input is meaningless Only the first copy of digital product concerns resource allocationThere are not natural capacity limits for additional copies

Price

Quantity

Cost functionCost function

–– Fixed cost (sunk cost)Fixed cost (sunk cost)

–– Variable costVariable cost

–– Average cost ( Total cost / Quantity )Average cost ( Total cost / Quantity )

–– Marginal cost ( Marginal cost ( DDTC / TC / DDQ )Q )

–– Lower limitLower limit

–– When AC is increasing, MC > AC, when AC is decreasing MC When AC is increasing, MC > AC, when AC is decreasing MC < AC< AC

CostTC

» MCAC

Quantity

nn Digital product is costly to produce but cheap to reproduceDigital product is costly to produce but cheap to reproduce

nn Once the first copy of a digital product has been produced Once the first copy of a digital product has been produced most costs are sunk and cannot be recoveredmost costs are sunk and cannot be recovered

nn Incremental cost (marginal cost) of production is zero.Incremental cost (marginal cost) of production is zero.

nn Competition among sellers of digital product pushes prices Competition among sellers of digital product pushes prices to zeroto zero

CostTC

»

MC

AC

Quantity

(Decreasing)

nn Marginal costMarginal cost

–– MC= PMC= P–– MC curve = supply curveMC curve = supply curve

nn Marginal cost of digital productsMarginal cost of digital products

–– MC MC --> 0 ( Is it true ?)> 0 ( Is it true ?)–– PerPer--copy copyrightcopy copyright

Price

P

Q

MC

Price

P

Q

E

MC

nn Competitive situationCompetitive situation

nn Monopolistic(market power) situationMonopolistic(market power) situation

P

Q

AC

Demand

P

QQ(AC)

AC

Pricing strategy in competitive situationPricing strategy in competitive situation

nn Dominant firm model : achieve cost leadershipDominant firm model : achieve cost leadership

nn Reduce average cost by increasing volume Reduce average cost by increasing volume

through reuse and resalethrough reuse and resale

nn FirstFirst--mover advantagemover advantage

nn To discourage entry, avoid greed and play toughTo discourage entry, avoid greed and play tough

How to gain market power?How to gain market power?nn A monopolistically competitive firm can A monopolistically competitive firm can

choose a profit maximizing price level choose a profit maximizing price level instead of merely accepting the market price.instead of merely accepting the market price.

nn The steeper demand curve indicates The steeper demand curve indicates monopolistic market situationmonopolistic market situation

nn To gain monopolistic market power To gain monopolistic market power differentiation is necessary differentiation is necessary

nn Quality, user valuation, preference.Quality, user valuation, preference.

Experience goodExperience good

nn Consumers must experience it to value itConsumers must experience it to value it

nn Uncertainty regarding the quality of Uncertainty regarding the quality of

products can lead to the collapse of marketproducts can lead to the collapse of market

nn Branding, Reputation, Preview, Trusted Branding, Reputation, Preview, Trusted

third partythird party

nn QualityQuality

nn Product differentiationProduct differentiation

Cost/Price TC

Willingness to pay

Quality

Cost/Price C

PH

PL

SL SHQuality

Product differentiationProduct differentiationnn Transmutability , Minimize competitionTransmutability , Minimize competitionnn Product differentiation, different segment of Product differentiation, different segment of

customers customers nn Customize products and charge individualized Customize products and charge individualized

pricesprices

nn Perfect price discriminationPerfect price discrimination–– Different prices for different consumers based on detail Different prices for different consumers based on detail

consumer informationconsumer information–– Prices are individualized to extract all individual Prices are individualized to extract all individual

consumer surplusconsumer surplus–– Reselling among consumers must be preventedReselling among consumers must be prevented–– Online negotiation and auctionsOnline negotiation and auctions–– Transmutability of digital productTransmutability of digital product–– Consumers can be billed independentlyConsumers can be billed independently

Negotiation process and information gathering may be more Negotiation process and information gathering may be more

costly than extra revenuecostly than extra revenue

Price

consumer surplus

Demand curveD

0 EQuantity

AttentionAttention

nn Viewer’s attention Viewer’s attention

nn PortalPortal

nn TV advertising model vs. Internet TV advertising model vs. Internet

advertising modeladvertising model

nn PointPoint--toto--point matchingpoint matching

Pricing Strategy [Shapiro & Varian, 1999]Pricing Strategy [Shapiro & Varian, 1999]

1. 1. Personalized pricing: sell to each user at a different Personalized pricing: sell to each user at a different pricepricePersonalize your product and personalize your Personalize your product and personalize your pricingpricing–– Know your customerKnow your customer–– Differentiate your prices when possibleDifferentiate your prices when possible–– User promotions to measure demand ( price sensitivity) User promotions to measure demand ( price sensitivity)

2. 2. Versioning : Offer a product line and let users Versioning : Offer a product line and let users choose the version of the product most appropriate choose the version of the product most appropriate for themfor them–– dimension : Delay, User Interface, Capability, etc.dimension : Delay, User Interface, Capability, etc.

–– Three version strategyThree version strategy

3. 3. Group pricing : Set different prices for Group pricing : Set different prices for different groups of consumers, as in student different groups of consumers, as in student discounts.discounts.

–– Group price sensitivityGroup price sensitivity

–– Network effects ( the value one user places on a good Network effects ( the value one user places on a good depends on how many other people are using it )depends on how many other people are using it )

–– LockLock--in in

–– Sharing Sharing

NonNon--sale methodsale method

nn RentingRenting

nn LicensingLicensing

nn LeasingLeasing

nn BundlingBundling

nn MicrobundleMicrobundle

nn subscriptionsubscription

ConclusionConclusion

nn New principles of economy and New principles of economy and

management to deal with digital productmanagement to deal with digital product

nn Reduce average costReduce average cost

nn CustomizationCustomization

nn QualityQuality

nn AttentionAttention