Pricing and the Internet

Richard T. WatsonThe University of Georgia

rwatson@mis.terry.uga.edu

The importance of pricing

Price -> revenuePricing is a critical managerial

decisionEconomic theory assumes buyers

and sellers are rationalProfit maximizationDemand and supply analysisPerfect competition

Real world

Bounded rationalitySatisficingGoals other than profit

maximizationBrand and image perceptionsCustomers are emotional

Internet impact

Dispersed buyers and sellers interact electronically

Search costs are reducedMarkets are more efficientA threat to marketersCustomers will increasingly make

prices

Competitive rationality theory

An abundance of choice makes customers more sophisticated

More searching and comparisonValue seeking behaviorMarketers try to be smarter stillCycle is acceleratedOversupply increases

Pareto principle

A small number of customers account for most of the profitsMexican cellular phone company

10% of customers create 90% of salesRecoup investment in months

80% of customers create 10% of salesRecoup investment in years

Spectrum of exchange

The range of transactions between actors

From theft by force to trading on an exchange

Marketing is effective somewhere between these two extremes

Customer value and pricing

High

Customer’svalue

to the firm

Low

Marketforces

A+

A

B

CCorporatestrategy

Theft byforce

Theft by stealthFraud

Products

and service

Seduction

Commodities

Trades on a stockexchange

Range ofmarketing

effectiveness

Directions

MarketingMoves customers up the pyramidMoves products and services away

from commoditizationCompetition

Moves customers down the pyramidMoves products and services towards

commoditization

Flattening forces

Technology facilitates customer searchbottomdollar.com

Customers make rather than take pricespriceline.com

Customers control transactionsGE and Caterpillar

Flattening forces

A return to one-to-one negotiationonsale.com

Commodization and efficient marketsMIS research market

Technology facilitates searching

Reducing transaction costsTransaction costs Examples of how the Web can affect

Search costs (findingbuyers, sellers)

A collector of tin soldiers wishes to identify sources. He can use search engines and comparison sites,using the search term “tin soldier.”

Information costs(learning)

A prospective customer wishes to learn more about digital cameras and what is available. Previously, shewould have had to read magazines, talk to knowledgeable individuals, and visit stores. She can now accessfirm and product information easily and at no cost, and obtain comparative product information andaccess suppliers on the Web.

Bargaining costs(transacting,communicating,negotiating)

The time normally taken by a customer to negotiate can now be used for other purposes as intelligentagents transact and negotiate on the customer's behalf.

On-line bidding systems can achieve similar results. For example, GE in 1996 purchased $1 billion ($910million) from 1400 suppliers over the Internet and there is evidence of a substantial increase since.Significantly, the bidding process for the firm has been cut from 21 days to 10.

Decision costs The cost of deciding over Supplier A vs. Supplier B, or Product A vs. Product B. The Web makesinformation available on suppliers (on their or comparative Web sites) and products and services. Forexample, Travel Web allows customers to compare hotels and destinations on-line.

Policing costs(monitoringcheating)

Previously, customers had to wait to receive statements and accounts, and then to check paperstatements for correctness. On-line banking facilitates customers to checking statements real time. Chatlines frequently alert participants to good and bad buys, and potential product and supplier problems(e.g., the flaw in Intel's Pentium chip was communicated extensively over the Internet).

Enforcement costs(remedying)

When a problem exists with a supplier, how does the customer enforce contractual rights? In the non-Webworld this might require legal assistance. Publicizing the infringement of one’s rights would be difficultand expensive. Chat lines and bulletin boards offer easy and inexpensive revenge, if not monetaryreimbursement!

Travelbids

Regular Listing: L006946 Quoted Price:$1718 Bidding Deadline:08/09/99 12:46 PMDescription: Air Qantas for 1, Atlanta to Melbourne, Aust. 10/13-25 Bid #B009090 Disc Bid Amt:$340 19.8% Bid Time:08/09/99 12:43 PM (MST) A Bid #B009088 Disc Bid Amt:$335 19.5% Bid Time:08/09/99 12:42 PM (MST) Bid #B009087 Disc Bid Amt:$330 19.2% Bid Time:08/09/99 12:40 PM (MST) Bid #B009086 Disc Bid Amt:$320 18.6% Bid Time:08/09/99 12:39 PM (MST) Bid #B009085 Disc Bid Amt:$310 18.0% Bid Time:08/09/99 12:39 PM (MST) Bid #B009083 Disc Bid Amt:$300 17.5% Bid Time:08/09/99 12:38 PM (MST) Bid #B009082 Disc Bid Amt:$275 16.0% Bid Time:08/09/99 12:37 PM (MST) Bid #B009081 Disc Bid Amt:$245 14.3% Bid Time:08/09/99 12:35 PM (MST) Bid #B009080 Disc Bid Amt:$240 14.0% Bid Time:08/09/99 12:35 PM (MST) Bid #B009079 Disc Bid Amt:$215 12.5% Bid Time:08/09/99 12:34 PM (MST) Bid #B009078 Disc Bid Amt:$210 12.2% Bid Time:08/09/99 12:33 PM (MST) Bid #B009077 Disc Bid Amt:$205 11.9% Bid Time:08/09/99 12:31 PM (MST) Bid #B009076 Disc Bid Amt:$200 11.6% Bid Time:08/09/99 12:30 PM (MST) Bid #B009075 Disc Bid Amt:$175 10.2% Bid Time:08/09/99 12:28 PM (MST) Bid #B009074 Disc Bid Amt:$170 9.9% Bid Time:08/09/99 12:24 PM (MST) Bid #B009073 Disc Bid Amt:$150 8.7% Bid Time:08/09/99 12:24 PM (MST) Bid #B009072 Disc Bid Amt:$145 8.4% Bid Time:08/09/99 12:20 PM (MST) Bid #B009071 Disc Bid Amt:$140 8.1% Bid Time:08/09/99 12:18 PM (MST) Bid #B009070 Disc Bid Amt:$135 7.9% Bid Time:08/09/99 12:12 PM (MST) Bid #B009067 Disc Bid Amt:$130 7.6% Bid Time:08/09/99 09:26 AM (MST) Bid #B009047 Disc Bid Amt:$125 7.3% Bid Time:08/08/99 01:58 AM (MST) Bid #B009041 Disc Bid Amt:$120 7.0% Bid Time:08/07/99 03:11 PM (MST) Bid #B009034 Disc Bid Amt:$115 6.7% Bid Time:08/06/99 05:25 PM (MST) Bid #B009027 Disc Bid Amt:$110 6.4% Bid Time:08/06/99 02:43 PM (MST) Bid #B009021 Disc Bid Amt:$105 6.1% Bid Time:08/06/99 12:52 PM (MST)

Migrating up and effective marketing

Differentiated pricing all the timeCreating customer switching barriersDe-menuing pricingBetter differentiationCustomers may pay moreConsider total costEstablish electronic exchangesMaximize revenue not priceReduce buyer’s risk

Differentiated pricing all the time

The same product and service can have different values to different customersAirlinesDrink vendors could charge more on a hot

day

Mass customization enables mass price differentiation

Creating customer switching barriers

Collect details on customers to raise switching costs

Knowing preferences is necessary for better service

The Web site should learn about the customer’s preferences

De-menuing pricing

Without automation, changing prices is costly and time-consumingIt takes time to filter through the distribution

network

Networks enable rapid dissemination of price changes

Change prices as needed

Better differentiation

Differentiate the buying experience as well as the product or service

Stage the customer experienceThe Web as theater for a unique personal

experience

Customers may pay more

Marketers often assume customers underestimate the value of a productThis may not be true

Try letting customers set the priceLondon restaurant

Consider total cost

Purchase price is one element of total acquisition cost

If Web-based purchasing reduces the total acquisition cost customers may pay a price premiumConvenienceOpportunity cost

Establish electronic exchanges

Bartering may be more effective than selling when prices are low

Barter excess suppliesMainly business-to-business

Maximize revenue not price

Airlines use yield management software to maximize revenue

Use Web to sell perishable, last-minute capacity

Return

Risk

•On-line

•Auction

Premium

Risk and return trade-off

Buyers may pay a price premium for reduced riskManheim Auctions

Pricing mechanisms

Negotiation

Auction

Reverseauction/Dutch

auctionSeller makes

Buyer makes

Seller and buyermake

Tender/yieldmanagement

Bid/yieldmanagementSeller makes

Buyer makes

Singletransaction

Multipletransactions

Tender/Calloption

Retail/Put optionSeller makes

Buyer makes

Fixed

Variable

Price

Pricing factors

Pricing directions

Weakbuyer

Weakseller

Strongbuyer

Strongseller

Retailingcommodity market

Dutch auction

Auction

Reverseauction

Negotiation

Integrated Internet pricing strategy

How does the firm interact with each class of customer?Personalized Web sites for A customers and

the opportunity to make pricesWeekly standard emails for the C customers

Blend communication technology, pricing mechanisms, and customer value concepts to manage revenue precisely

Marketing will become more like trading

Survival tactics

Efficiency is not enoughFast response is essential

Online bids must be answered within minutes

Accurate, dynamic cost analysisCreate trading teamsChange the mindset

Fixed to variable pricing Single to multiple interactions

Survival tactics

Learn what customers wantCustomer databasesData mining and OLAP

One-to-one marketingInformation is the heart of customer

serviceBoost the information content of

products and services

Conclusion

The Internet is having a fundamental impact on pricing strategyAt worst, it will flatten the customer baseAt best, it will increase the ability to differentiate

Customers will move along the exchange spectrum more rapidlyFlee to electronic commodity markets or seduced

to mutually valuable long-term relationships?

Creative pricing strategies are critical