Wall Street Journal
Information Rules: A Strategic Guide to the Network Economyby Carl Shapiro, Hal R. Varian
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In Information Rules, authors Shapiro and Varian reveal that many classic economic concepts can provide the insight and understanding necessary to succeed in the information age. They argue that if managers seriously want to develop effective strategies for competing in the new economy, they must understand the fundamental economics of information technology. Whether information takes the form of software code or recorded music, is published in a book or magazine, or even posted on a website, managers must know how to evaluate the consequences of pricing, protecting, and planning new versions of information products, services, and systems. The first book to distill the economics of information and networks into practical business strategies, Information Rules is a guide to the winning moves that can help business leaders navigate successfully through the tough decisions of the information economy.
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Chapter 3: Versioning InformationWe've seen that a key aspect of pricing information is to use value-based pricing: sell your product at different prices to different consumers, according to how much they are willing to pay for it. We looked at two approaches to value-based pricing in Chapter 2: personalized pricing and group pricing.
Personalized pricing requires knowledge about individual customers. The best intelligence about customers comes directly from them, as when customers communicate their needs and indicate the products they would like to see or the categories of information of interest to them.
We certainly encourage companies to develop and exploit two-way communications with customers. However, you can still get valuable data about customers without customer-provided profiles, without expensive marketing data, and even without consumers' active involvement. How? Answer: You can learn a great deal about your customers by offering them a menu of products and seeing which one they choose.
For example, if you offer a product line with one product targeted for professional users and one product for amateur users, you can simply observe your sales figures to see how your market splits. We call this strategy "versioning." It means offering your information product in different versions for different market segments.
in this chapter we show you how to design your "product line" to capture the greatest profit from the information you are selling. Your profits will depend on both the total value you create for your customers and the fraction of that value which you are able to extract through the fees you charge for the information. To maximize your profits, you want to make the total value created as large as possible and then extract as much of that value as you can. This observation leads to the two basic principles for designing a product line of information goods.
- Offer versions tailored to the needs of different customers. A full line of information products will maximize the total value of the information you are providing.
- Design these versions to accentuate the needs of different groups of customers. Emphasizing customer differences allows you to extract more of the value you have created, as each customer selects the version that best meets his or her needs.
Economists call the second principle sefl-selection. You don't have to figure out what value the customer Puts on your information product, because the customer reveals that value through the version that he or she selects.
Consider the Quicken example in Chapter 2. How did Intuit actually solve its pricing problem? It created two versions of the software, Basic Quicken, which sells for about $20, and Quicken Deluxe, which sells for about $60. The Deluxe version has a variety of extra features that appeal to the power users but aren't that attractive to the occasional user.
Let's see how the two above principles have been applied to one of the oldest forms of mass-market information provision: the book. How can a publisher such as Viking make the most money selling the newest Stephen King novel? Viking would like to sell the novel at a high price to the avid fans who will pay a lot for their favorite author's most recent book. But a high price would no doubt discourage purchases by those who are less enthusiastic readers of Stephen King. Ideally, the publisher would like to sell every copy of the book at a different price-that is, engage in the kind of personalized pricing that we described in the previous chapter.
The problem is, the publisher has no way to tell what any given individual is willing to pay for the book. Politely asking those customers who place the highest value on the latest Stephen King book to pay extra" because they like it so much will not do the trick for obvious reasons. (Even if Viking or its distributors could keep track of readers who had rushed out to buy prior Stephen King books, attempting to charge more to this group would only encourage them to hide their identity or buy the book through another channel.) So it appears that the best the publisher can do is to differentiate the price by groups: sell at one price to the book club members, say, and at another price to retail book stores.
In fact, the publisher can do much better by applying our second principle: designing versions to emphasize customer differences. Here, high-value customers are impatient to get the book, while lower-value customers can more easily wait. The main difference here involves patience. Thus, the key to versioning books is to delay before offering less expensive versions. This is precisely what publishers do. After selling hardback copies to the intense fans, libraries, and book clubs, Stephen King's publisher then releases the book in paperback-so all those other fans can purchase it. And finally, after a few years, the book might even be remaindered and sold at an even lower price to those who scrounge around on the bargain tables. The book example is no doubt familiar to you. But our extraction principle applies widely to the sale of information of all types.
When you think about it, releasing different versions over time is a pervasive strategy for selling information. Movie producers initially release their productions in first-run theaters. After a few months they move to the hotel and airline market. A few months after that, they sell to the home video market. All those young, impatient people go to the movies. Parents with small children and empty nesters stay home and watch the videos a few months later.
DESIGNING YOUR PRODUCT LINE So how can you use versions of your information in a way that induces self-selection? The key is to identify dimensions of your information product, such as timeliness, that are highly valued by some customers yet of little importance to others. Then offer versions that differ notice...
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Meet the Author
Carl Shapiro is the Transamerica Professor of Business Strategy at the Haas School of Business at the University of California at Berkeley. He is also director of the Institute of Business and Economic Research, and professor of economics in the economics department, at UC Berkeley. He earned his Ph.D. in economics at M.I.T. in 1981 and taught at Princeton University during the 1980s. He has been editor of the Journal of Economic Perspectives and a fellow at the Center for Advanced Study in the Behavioral Sciences.
Professor Shapiro served as Deputy Assistant Attorney General for Economics in the Antitrust Division of the U.S. Department of Justice during 1995-1996. He is a founder of the Tilden Group, an economic consulting company. He has consulted extensively for a wide range of clients, including Bell Atlantic, DirecTV, General Electric, Intel, Iomega, Kodak, Rockwell, Silicon Graphics, Sprint, Time Warner, and Xerox, as well as the Federal Trade Commission and the Department of Justice.
Professor Shapiro has published extensively in the areas of industrial organization, competition policy, the economics of innovation, and competitive strategy. His current research interests include antitrust economics, intellectual property and licensing, product standards and compatibility, and the economics of networks and interconnection.
Hal Varian is the dean of the School of Information Management and Systems at UC Berkeley. He is also a professor in the Haas School of Business, a professor in the economics department, and holds the Class of 1944 Chair at Berkeley. He received his S.B. degree from M.I.T. in 1969 and his M.A. (mathematics) and Ph.D. (economics)from UC Berkeley in 1973. He has taught at M.I.T., Stanford, Oxford, Michigan, and several other universities around the world.
Dean Varian is fellow of the Guggenheim Foundation, the Econometric Society, and the American Academy of Arts and Sciences. He has served as co-editor of the American Economic Review, and as an associate editor of the Journal of Economic Perspectives and the Journal of Economic Literature.
Professor Varian has published numerous papers in economic theory, industrial organization, public finance, econometrics, and information economics. His current research involves the economics of information technology. In particular, he is investigating strategic issues in technology management, the economics of intellectual property, and public policy surrounding information technology.
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