January 13, 2005

1. e-Marketing Conceptual Overview Arvind Rangaswamy Web address: www.arvind.info email: arvindr@psu.edu January 13, 2005

2. Outline for Today’s Session • Emerging technology environment • Emerging market environment • Developing strategies aligned to current technology and market environments • Product strategies • Personalization/Customerization • Bundling • Pricing strategies • Differential pricing • Dynamic pricing • Flexible pricing

3. Technology EnvironmentThe Plug-In Architecture You/Your company can now plug into a massive existing technology infrastructure e-Marketing Applications • Facilitators • Government • InterNIC • ISO • The Internet Society Database providers Google.com Your company Web services Internet ServicesInfrastructure News/Entertainment Providers Netscape SAP Microsoft… Content and Software Infrastructure Telephone Co. ISP’s Cable Co. CISCO UUNET Sprintlink BBN Planet Hardware Infrastructure 3

4. As enabling technologies converge toward single standards (e.g., MS Office, Java, MP3) The markets they serve expand and fragment Standardization of TechnologiesFragmentation of Markets Time

5. ECONOMY INDUSTRY COMPANY YOU CUSTOMER MARKET SOCIETY The New Market Environment Supply • Digital Networked Convergence • Disappearing boundaries (temporal, geographic, across firms, across functions, etc.) • High fixed costs/low marginal costs (especially for digital products) • Economies of scale in both supply and demand • Separation of content, context, infrastructure, and brand • Customer-centric markets • Initiating contact • Establishing terms of trade • Exchanging value • Establishing relationships Exchange Value Demand 5

6. Business Strategy IT Architecture IT Strategy Governance Business Scope (What?) IT Scope Markets Distinctive Competencies (Why?) Governance (How?) Systemic Competencies IT Governance Processes Resources Processes/ Capabilities Resources Corporate Business operations IT operations The Increasing Need forStrategy/IT Alignment

7. Lessons inStrategy/IT Alignment • Spending smart is more important than being first in the industry – focus IT spending on enhancing innovation, differentiation, customer responsiveness, and productivity. • IT must reinforce business strategy, and business strategy must help identify winning IT investments. • Leverage IT for scale and scope. • Leverage IT with protected intellectual property. • Embed IT in processes that are inimitable, and/or not transparent to competitors. • Put the right people and processes in place before putting the right IT system. Source: Based, in part, on a McKinsey article titled Getting IT spending right this time (2003).

8. What Wal-Mart did on 9/11 • Within a few hours of the 9/11 attacks, sales of flags and other patriotic items started skyrocketing. • On Sept 11, the 2,700 Wal-Mart stores sold over 100,000 flags (compared to 6,400 the previous year on that day), and over 200,000 on Sept 12th. • Detecting these increases, Wal-Mart locked up all the supplies it could find before its competitors (like Kmart) could react. • Real-time tracking and analysis helped “adapt” to a demand surge.

9. How Texas Instruments Developed TI-92 • Product design and specs put on web site, and teachers participating in the T3 (Teachers Teaching with Technology) group were invited to provide suggestions. • A flurry of email suggestions resulted in engaging this group in “adaptive” design of the product. • TI-92 became the best selling calculator introduced by TI. • Lesson: The market owned the product. Therefore, the product owned the market!

10. How P&G Test MarketedCrest WhiteStrips • In addition to conventional test marketing in selected cities, P&G also tested Crest Whitestrips in direct channels (web and QVC). • From Sept 2000 to May 2001, before national launch, P&G’s web site sold 140,000 units and logged 1.1 million visitors. • The web site helped P&G adapt its marketing programs for the product in several ways: • Helped define the target segment (female (70%) and over 35) • Created buzz for the product before national launch • ….

11. Emergence of Customer-Centric Markets • Transparency and interactivity are re-shaping the processes by which supply and demand are synchronized in today’s markets. • Increasing “atomization” of transactions (e.g., personalized products and services). • Anytime, anywhere commerce is becoming commonplace in the US.

12. From Marketplace to MarketspaceOnline Exchange Processes • Global, 24/7 • Richer content and context for exchange (The “reach” vs. “richness” tradeoff minimized) • Lowered costs of routinized transactions • Two-way interactions • Access to larger number of buyers and sellers • Elements of the exchange process are atomized • Tighter integration of market exchanges with firm operations • More flexible ways to determine the terms of exchange • Auctions, Reverse auctions • Negotiations • Fixed price

13. The Exchange Processes for Digital Products are Being Completely Redefined • Digital products (e.g, software, music, entertainment that can be delivered on the Net) • reproducible at low marginal costs by anyone in the marketing channel (including customers) • low distribution costs (on the Internet) • are non-destructible • are customizable • have positive and negative externalities • result in high heterogeneity in customer value (thus, they need to be priced according to value, not cost)

14. The Exchange Processes for Digital Products are Being Completely Redefined • New strategies for managing digital products • Licensing • Metering (Web services) • Bundling products (tied to search engines) • Delivering interactive “product experiences” • Frequent product updates • Lower prices

15. The Exchange Processes for Non-Digital Products are Being Transformed • You can add digital content to any product. This separates choice from purchase for many non-digital products. • High-ticket items (e.g., Car) • Experience goods (e.g., Dentist) • How about for other products? • Complex products (e.g., Home alarm systems) • Low-involvement products (e.g., Groceries) • A cup of cappuccino • Online Browsing for non-digital products facilitate informed decisions.

16. Sources of Information forConsumers

17. Personalization andCustomerization Personalization/ 1-to-1 Customerization Marketing customization  LoHi Mass Customization Standardization LoHi Operational customization 

18. Timely Wants Preferences Core needs Customerization: Opportunity for Matching Offerings to Customer Wants Hierarchy of Needs The Internet (combined with other IT components) can improve the match between customer needs and company offerings. It is impacting how all three levels of needs are satisfied, with a stronger impact on how wants are satisfied. Customers are becoming more value-sensitive because of the richer, timely, and contextually relevant information available online. Timeless

19. Customized Relationship Increasing Difficulty Customized Customer Experiences Customized Product Customized Price, Package, Lead times, etc. Customized Content Layers of Customization

20. – TV and Movies on demand Seems Like Everything Can Now beObtained On Demand!

21. Source: Wired, October 2002 21

22. Potential Benefits of Customerization For customers: • Better meets their needs and wants. • Customers can influence part of the design and production process. For companies: • Offers opportunity to differentiate brand from competing brands. • Builds brands by building relationships with customers (through higher customer involvement, satisfaction, and loyalty) • Reduces/eliminates inventory. • Provides up-sell and cross-sell opportunities. • Provides, for the portion of the business that is manufactured for inventory, more accurate market information on changing customer tastes. • Stimulates continuous innovation.

23. Some Downsides to Customerization • Increases customer expectations. • Customers may not be willing to pay more. • Needs more integration across company functions, departments, and partners. • Increases complexity of choices for customers, and complexity of providing customer support for companies.

24. Product BundlingNeed a Car? The Auto Market Online

25. Need a Loan?The Loan Market Online

26. Need a car and a loan?Opportunity for a Bundler

27. Gift reminder service • Holiday specials • Everyday celebrations suggestions • Special occasion suggestions Ideas and Information • “Care and handling” • “Do it yourself” • Special events and educational workshops held at stores • Floral ideas • Garden ideas • Home ideas • Gift ideas • Gourmet ideas • Store locator • Recommendations by budget • Best sellers Flower / Gift Decision Process Product Offering • Need Recognition Gift Recommendations • Education on Flowers and Decoration • Gift guru • Favorite gifts • Gift frequency • Gift impossible • Gift baskets • Corporate gift services • Search For Ideas and Offerings Post-Sales Support • Order receipt email • eQ&A online customer service • FAQ • Customer service inquiry form • Post Sales Support and Perks • Product price • Product picture • Product description • Delivery information • Delivery availability • Evaluation of Alternatives Perks • Miles earned with flower purchases • Free gifts • Discounts at AOL & BN with flower purchases • Member specials • Message Selection • Purchase Decision • Shopping basket • E commerce transaction • Special shopping features • Delivery outside U.S. • 1-800-lasfloras.com • Gizmo fully-animated greeting cards • Physical cards in gifts Product Augmentationfor Non-Digital Products (1-800-Flowers) Source: Adapted from Rayport and Jaworski

28. Product Augmentationfor Digital Products (Schwab) Overall • General Goal Planner • Investor Profile • Sample Investment Plans Retirement • Retirement Planner • IRA Analyzer • Schwab Learning Center • Live Events • Principles of Investing • Understanding Market Cycles • “Did You Know” Q&A Offering On-Line Investment Process • Get educated about investing Estate • Estate Tax and Probate Calculator • Alternatives Comparison College • College Planner Tax • Tax Strategies • IRS Withholding Calculator • Online chat with Customer Service Representatives • Customer Service via phone • Customer Service via email • Customer Service at Branch • My Watch List • Plan investments • Post Investment Support Overall • Quotes and Charts • Analyst Center Stocks and Options • Stock Analyzer Bonds and Treasuries • Schwab BondSource Services CDs and Money Markets • SchwabOne • Perform Research • Margin Loans • Money Transfers • Automatic Investing • Options Service • After Hours Trading • Account Protection • Bill Payment • Perform Investment • Decide on Investment Annuities • Schwab Select Annuity Life Insurance • Insurance Needs Calculator • Schwab Signature Services • Schwab AdvisorSource • Options Service • Global Investing Service Source: Adapted from Rayport and Jaworski, e-Commerce

29. Internet’s Impact on Pricing • Differential pricing • Flexible pricing • Dynamic pricing/New price discovery processes

30. Traditional Pricing Meets New Realities Traditional Economic theory suggests that Price = Marginal cost is the likely outcome of competitive markets. Traditional Economic analysis also suggests that a necessary condition for Pareto- efficiency is: Marginal cost = Marginal willingness to pay. Question: What happens under high fixed cost and near zero marginal cost? (This is the case with many digital products).

31. Solution: Differential Pricing Making every customer pay marginal costs will not be efficient in this case. An alternative approach for seller is Differential pricing/ Nonlinear Pricing: -- yield/revenue management -- two-part tariffs, as used by ISPs such as AOL -- two-tier pricing through loyalty cards. Internet and other IT are making it easier for sellers to implement differential pricing in many categories, such as perishable products, and products with high fixed costs.

32. Price Differentials First Degree — Charge consumers exactly what they are willing to pay for product (e.g., college tuition) Price Discrimination Second Degree — Offer consumers a menu of options at different prices that correspond to consumers’ willingness to pay for the different options (e.g., volume pricing) Third Degree — Divide consumers into distinct segments, charging different prices to different segments (e.g., movie-theater pricing) Source: Textbook

33. Volume Discounts and Two-Part Pricing Simple Volume Discount Pricing Plan Consumer’s Demand for Electronic Music • Buy first three singles at $4 per single • After three singles have been purchased, buy two additional singles for $2 each • $4 is “left on the table” (consumer was willing to pay $20 for five songs) • Revenue: $16 • Profit: $8.50 • Value of . . . • First Single: $6.00 • Second Single: $5.00 • Third Single: $4.00 • Fourth Single: $3.00 • Fifth Single: $2.00 • Sixth Single: $1.00 • Seventh Single: $0.50 • Production cost of a single: $1.50 Two-Part Pricing • A flat subscription fee of $12.50 can be charged. • In addition to the flat subscription fee, a fee of $1.50 per single can be charged. • Given its demand schedule, the consumer is willing to pay the subscription fee and purchase five singles at $1.50 per single; recall that the consumer values the five singles at $20 • Total Revenue: $20 • Total Profit: $12.50 • Economically speaking, it is optimal to use a flat fee subscription model only when the marginal cost of producing the good is equal to zero. Source: Textbook

34. Value from….Value to Value from….Value to Service Service Service Service Appropriate Higher Cost Service Level Appropriate Low-cost Service Level Low-Value Customers High Value Customers Balance the value provided to a customer with the price received from the customer. The Need for Balancing Differential Pricing with Differential Service

35. Flexible Pricing • Bundled prices • “Pay per service” • Lease versus buy • ...

36. Bundling Strategy Strategy Result Company A:Purchases value bundle. Implicitly pays $1,500 for legal news, $500 for current news. Company B: Purchases value bundle. Implicitly pays $750 for legal news, $1,250 for current news. Company C: Purchases financial news. Pays more ($3,250 vs. $3,000) for financial news relative to Companies A and B.

37. Price Discovery(Involves both Buyers and Sellers in Price Determination) Many Auction Amazon.com Auctions eBay.com Yahoo!Auctions Exchange/Marketplace Chemconnect.com NewView Technologies (newview.com) VerticalNet.com Buyers Haggling/Negotiation Intagio.com Barter Business (bbu.com) www.framesoft.com Bidding FreeMarkets Priceline One Sellers One Many

38. Online Price Dispersion(From www.nash-equilibrium.com) Relative Dispersion is the coefficient of variation in prices charged by different sellers for the same products. It is zero when all sellers charge the same price for a product.

39. Internet Competitiveness(From www.nash-equilibrium.com) The Internet Competitiveness Index is a comprehensive measure of the level of competition. Increases indicate more competitive pricing, while decreases indicate a lessening of competition.

40. Why is Price Dispersion So Large? • Random variations? • Use of mixed strategies (regular price + promotion price)? • Price premium extracted by brands providing better value (Value sensitivity?) • Price discrimination based on consumers’ opportunity costs of time?