Overview of price discrimination

1. Overview of price discrimination • The profit motive: Consumers who value the good the most pay more than if prices were uniform. • Perfect, or personalized, pricing (1st-degree) • May require specifying both price and quantity to each customer. • Versioning (2nd-degree) • The text considers versioning the product, but it is also possible to create customize pricing schemes for the same product. • Key point: You can’t identify customers, so you have to allow them to self-select. • Group pricing (3rd-degree) • Assumes you can identify the group to which the consumer belongs. • Discount to the group with the higher elasticity of demand.

2. Three conditions required for price discrimination • Market power • Ability to identify the types of consumers • Ability to limit resales by one consumer to another • Services, Transaction costs, Adulteration of product, etc. • Note that social-welfare effects of PD are usually positive, but: • If one group would be happy to buy from another group, SW can be reduced by PD even if total output remains constant relative to uniform pricing. • Imposing time, effort, or inconvenience costs on consumers can decrease social welfare.

3. Two principles of versioning • Offer versions tailored to different customers. • Emphasize the differences to your customers, to help them choose.

4. How to create a product line? • Consider the different product attributes, and the different types of consumers. • Delay, User interface, Convenience, etc. • Novices, Power users, Legal versus medical professionals, etc. • Quality differences may be either: • Vertical - all groups agree on which product is best; they just disagree on how much to value the difference. • Horizontal - some groups prefer one product; some prefer another. • The text mainly talks about vertical differentiation, which may be easiest/cheapest for information goods (just remove features to create a low-end product). But horizontal distinctions are also worth considering.

5. Guidelines for vertical versioning • Adjust both price and quality to ensure the high-end customers want the product designed for them. • Discount the high-end product’s price. • Subtract value from the low-end product by crippling it. • Pitfalls to watch out for: • Consumer irritation with using a “crippled” product. • Hackers undoing the crippling (Windows NT Wkstation vs Server) • How many versions? • Depends on the product and the customers, but... • When in doubt, choose 3 versions (Goldilocks pricing)

6. Offline versus online versions of information goods • There are differences for both consumer and seller: • Seller: Online distribution costs lower • Buyer: Online consumption may be more or less convenient than offline. • Dyson’s Dictum: “Treat online content as if it were free.” • Are the two versions complements or substitutes? • Give away complements. • Charge for substitutes. • Online distribution gives one the opportunity to customize the browser (via Java, etc.) as well as the content - this customization can be used to distinguish different online versions.

7. Nonlinear pricing: the “versioning” of pricing plans. • Quantity discounts. • Two-part tariffs. • A participation fee, plus a constant price per unit. • Bundling: • Aids by reducing dispersion in consumer values for multiple items. (Spreadsheet and WP example) • Subscriptions are examples of information bundles. • Technology makes it easier to allow consumers to “make your own bundle” of information goods. • Promotional pricing (sales, coupons, etc.) • Might conceivably be thwarted by “shopbots” in future

8. Discussion questions:Karen Brown’s Books • How does KB differentiate its product from others? • How does KB engage in price discrimination? • How might KB engage in price discrimination? • Consider these same questions for other providers of information goods, such as: • Boston.com • TidBITS (online Macintosh newsletter) • Eudora (email client software) • Groovelily (rock band)

9. Learning points: Price discrimination • Price discrimination can always increase profits, if done appropriately. • Price discrimination is only possible if one has market power. • The Internet makes it easier to change and to personalize prices. • Experimentation can help determine optimal prices. • Versioning is the form of PD least likely to generate complaints about “unfairness,” because it involves self-selection. • Versioning is particularly relevant for information goods.