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Business
Horizons Pricing
Strategy and the Net. Among marketing mix
variables, price alone directly affects a firm's revenue. Setting prices
is a critical issue managers face. Traditional economic theory argues that
decision makers are rational, and that managers will set prices to
maximize the firm's surplus. Consumers are similarly rational and will
seek to maximize their surplus by purchasing more of a product or service
when the price is lower. Prices in markets that approach a form of pure
competition are set by a confluence of supply and demand, and firms try to
price goods and services so that marginal revenues equal marginal costs. Yet in the real world
of marketing, there is ample evidence of the bounded rationality of
marketing decision makers who seem to set prices with factors other than
profit maximization in mind. Pricing strategy sometimes focuses on gaining
market share; at other times it concentrates on competitors by seeking
either to cooperate with or to destroy them. Often pricing is about brand
or product image, as marketers seek to enhance the status of a brand by
concentrating on its position in the mind of the customer, rather than on
volume. Likewise, real-world customers are as emotional as they are
rational and purchase brands for the status and experiences they confer,
rather than merely on the utility they provide. From a marketing
perspective, managers have tended to employ a range of pricing strategies.
Most marketing textbooks describe the pricing of new products as high at
launch, then lowered, to "skim the cream." Alternatively,
companies price new products low right from the beginning of the life
cycle, to ward off competition and "penetrate" the market.
Managers have also resorted to such tactics as discounting and rebates,
price bundling, and psychological or "odd-number" pricing to
appeal to customers. The advent of a new
medium for buyer and seller interaction, the Internet, is changing the
issue of price for both customers and suppliers in a way that is
unprecedented. While the Net and its multimedia platform, the World Wide
Web, have been seen by most marketers to be primarily about promotion and
marketing communication, the effects they will have on pricing will, in
all likelihood, be far more profound. What impact will the
Internet have on both the pricing decisions managers make and the pricing
experiences customers will encounter? For comfortable marketers, the Net
may have the most unsettling pricing implications they have yet
encountered; for the adventurous, it will offer hitherto undreamed-of
opportunities. For many customers, the Net will bring the freedom of the
price-maker, rather than the previously entrenched servitude of the
price-taker. We introduce here a
scheme for considering the forces that determine a customer's value to the
firm and the nature of exchange. Using this scheme, we will identify the
forces that can affect pricing on the Net and suggest strategies that
managers can exploit. Analyzing the gamut of exchanges between buyers and
sellers, we provide some thoughts on the likely direction of the pricing
of electronic transactions. |
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The Internet and the
Web What exactly is this
phenomenon called the Internet? It is an electronic medium based on
broadcasting and publishing that facilitates two-way communication. In
exchanges that are neither physically face-to-face nor time-bound, buyer
and seller interact through networked computers so that individuals and
organizations can communicate directly with one another regardless of
location or time. The Web is best understood as a hypermedia platform that
"rides" on the Net. For customers, the
Web facilitates searching through a profusion of sites for information on
solutions to problems, as well as accessing the opinions and experiences
of peers by logging on to bulletin boards and chat rooms. Intelligent
agents--software that will search, shop, and compare prices and
features--give the Net shopper further buying power and choice. They cut
buyers' search costs across standard online storefronts, specialized
online retailers, and online megastores, and can transform a diverse set
of offerings into an economically efficient market. The search phase of
the consumer decision-making process, which can be expensive and
time-consuming in the real world, is reduced in terms of both time and
expense in the virtual. As Dickson's (1992) theory of competitive
rationality predicts, an abundance of choice leads to customer
sophistication--customers become smarter and exercise this choice by
shopping around, comparing prices, and seeking the greatest value more
assertively. Marketers try to deal with it by innovation, but this in turn
leads to imitation by competitors, which leads to more oversupply, which
further accelerates the cycle of competitive rationality by creating more
consumer choice. The Net has the potential to accelerate the cycle of
competitive rationality at an unprecedented rate, creating huge pricing
freedom for customers and substantial pricing dilemmas for marketers. Internet Pricing and
Market Dynamics Two simple but
powerful models, illustrated graphically in Figure 1, give greater insight
into Internet pricing strategies. The first model, on the left, simply
applies the well-known Pareto principle, also known as the
"80-20" rule, to the customer base of any firm. For most companies,
all customers are not created "equal--some are much more valuable
than others. For example, a Mexican cellular phone company found that
fewer than 10 percent of its customers accounted for around 90 percent of
its sales, and that about 80 percent of customers accounted for less than
10 percent of sales. Seen another way, while margins earned on the most
valuable customers allowed the company to recoup its investment in them in
a matter of months, low-value customers took more than six years to repay
the company's investment. In Figure 1, we
divide a firm's customer base into four groups, which may best be
understood in terms of an airline's frequent flyer program. The C
customers, by far the largest number, nevertheless account for a very
small portion of an airline's revenues and profits. These customers
probably are not even members of the frequent flyer program, and if they
are they inevitably seldom accumulate enough air miles for an award. Not
likely to be loyal, they fly rarely, and when they do their main
consideration is ticket price. |
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Category B customers
are the "silver card" frequent flyers. They fly more often than
Cs, and even accumulate enough miles to claim rewards. However, they are
still apt to be price sensitive, and exhibit signs of heterogeneity by
shopping around for the cheapest fares. Category A customers
represent great value to the firm; in airline terms, these are the
"gold card" holders. They use the product or service very
frequently, and are probably so loyal that they do not shop around for
price, even when there may be significant differences among suppliers.
Because they represent substantial value to a firm such as an airline,
they may be rewarded not only with miles but with special treatment,
including upgrades, preferential seating, and the use of lounges. Finally, the A+
category of customers represents a very small but very valuable group that
accounts for a disproportionately large contribution to revenues and
profits. Not only do these customers reap the rewards of value and
loyalty, they may be known by name to the firm, which inevitably performs
services beyond the norm for them. The model on the
right in Figure 1 is derived from Deighton and Grayson's (1995) notion of
an exchange spectrum based on the extent to which a transaction between
actors is voluntary. At one extreme, an exchange between actors can be
seen as extremely involuntary, as in the case of theft by force. At the
other extreme is a highly voluntary form of exchange, such as the trading
of stocks or shares by two stock exchange floor traders. Deighton and
Grayson refer to this type of exchange as "unambiguously fair,"
with no need of inducement for either party to act. Indeed, economists
would argue that this bilateral exchange is the closest approximation to
pure competition in the microeconomic sense. The two fully informed
parties believe that each will be better off after the exchange. Between the extremes
of the spectrum there is a gray area, which we label the "range of
marketing effectiveness." Adjacent to fraud there is what Deighton
and Grayson refer to as "seduction." Second, and next to
commodities, there is the vast array of products and services purchased
and consumed by customers. The customer may often be "seduced"
into purchasing these products and services, though often some bear many
of the characteristics of commodities. In a differentiated market,
products vary in terms of quality or cater to different consumer
preferences, but often the only real differences between them may be a
brand name, packaging, formulation, or the service attached to them. Where does marketing,
as we know it, work best along this exchange spectrum? The answer is, in a
narrow band labeled the "range of marketing effectiveness,"
which straddles most products and services and extends from somewhere near
the middle of seduction to the near edge of commodities. Here the parties
are not equally informed; as Deighton and Grayson put it, the "merit
of the transaction [is] more ambiguous for one than the other."
Marketing induces customers to exchange by selling, informing, or making
promises to them. Obviously, activities such as theft or fraud cannot be
seen as marketing. Yet marketing is also unnecessary or at best
perfunctory at the other end of the spectrum. Two traders on a stock
exchange floor can hardly be said to market to each other when they trade
bundles of stocks or shares. The price contains all the information they
need to transact the deal. The market is simply too efficient in these
areas for marketing to work well. Paradoxically, marketing is not
effective when market s are efficient. |
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Illustrating the two
concepts in this scheme--the Pareto distribution of the customer base and
the exchange spectrum--helps us understand pricing strategy more
effectively, particularly with regard to the effect of the Internet on
pricing for both sellers and customers. With regard to the Pareto
distribution, the objective of firms should be to migrate as many
customers upward as possible--that is, to turn C customers into Bs, Bs
into As, and so forth. By so doing, the firm will increase its customer
equity, or in simple terms, maximize the value of its customer transaction
base. Forces in the market, however, including competition and the
customer sophistication referred to by Dickson, tend to force the customer
distribution down, turning As to Bs, and Bs to Cs. Similarly, in the
case of the exchange spectrum, marketing's task is one of moving products
or services away from the zone of commodities, and more to the location of
seduction. Likewise, the marketplace forces of competition and customer
sophistication have the effect of turning products into commodities,
depressing prices and reducing essential differences, with cheap PCs and
mass-market consumer electronics as obvious examples. Managers must
understand the forces that may impel markets toward a preponderance of C
customers, and products and services toward commodities. Technology
manifests itself in many such effects. On a more positive note, it also
offers managers some exciting tools with which to overcome the effects of
market efficiency and halt or at least decelerate the inevitable
degradation of the customer base. Forces that Flatten
the Customer Value Pyramid and Narrow the Scope of Marketing So even as companies
attempt to migrate customers up the value pyramid and broaden the range of
marketing effectiveness on the exchange spectrum, forces are at work in
the market that mitigate in the opposite direction. While these forces
occur naturally in most markets, the effect of information technology (IT)
has been to put them into overdrive. Technology
facilitates customer search. The customer's information search is a
fundamental step in all models of consumer and industrial buying behavior.
Searching is not without sacrifice in terms of money and time. A number of
new Internet technologies greatly facilitate the search, ranging from the
simple through the more advanced, proactive seeking to the actual
negotiation of deals on the customer's behalf. Search engines and
comparison sites can lower the customer's costs of finding potential
suppliers and comparing products and prices. More sophisticated tools,
such as intelligent agents, will seek out the lowest prices and even
negotiate for lower ones. Making versus taking
prices. Particularly in consumer markets, suppliers tend to make prices
while customers "take" them. A notable exception is auctions,
but the proportion of consumer goods purchased in this way has always been
very small, devoted mainly to used goods. The opposite situation is now
occurring in a number of instances on the Web. Online auctions allow
cybershoppers to bid on a vast range of products as well as such services
as airline tickets and hotel rooms. |
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At a higher level of
customer price making, Priceline.com invites customers to name their price
on products and services ranging from airline tickets to home mortgages.
In the case of airline tickets, customers name the price they are willing
to pay for a ticket to a destination, and provide credit card details to
establish good faith. Priceline then contacts airlines electronically to
see if the fare can be obtained at the named price or lower, and
undertakes to return to the customers within an hour. Customers control
transactions. Caterpillar uses its Web site to invite bids on parts from
preapproved suppliers, who bid online over a specified period. The
contract is awarded to the lowest bidder. Negotiation time is reduced and
the average savings on purchases is 6 percent. In this way, the customer
has taken almost total control of the transaction, for suppliers find it
difficult to compete on anything but price. There is little opportunity to
differentiate products, engage in personal selling, or add service, as
traditional marketing strategy would have suppliers do. A return to
one-to-one negotiation. In pre-mass market times, buyers and sellers
negotiated individually over the sale of many items. It is possible that
markets can move full circle, as buyers and sellers do battle in the
electronic world. The struggle should result in prices that more closely
reflect their true market value. "The future of electronic commerce
is an implicit one-to-one negotiation between buyer and seller," says
Jerry Kaplan, founder of Onsale Inc., a Net auction site. "You will
get an individual spot price on everything" (Cortese and Stepanek
1998). As negotiation costs drop significantly, it might be practical to
have competitive bidding on a huge range of purchases, with one
intelligent agent bidding against another on behalf of buyers and sellers. Commoditization and
efficient markets. Commodities were among the first goods to be sold
electronically. Price, rather than product attributes, good selling, or
warm advertising, is the determining factor when selling commodities. If
the commodity happens to be perishable, such as airline seats, oranges, or
electricity, the Web is even more compelling. Suppliers have to get rid of
their inventory fast or lose revenue. The problem on the Web is that when
customers can easily compare prices and features, commoditization can also
happen to some high-margin products. Strong brand names alone may not be
enough to maintain premium prices. In many cases, branded products may
even prove interchangeable. Customers may not trust a new credit card
company that suddenly appears on the Web because they do not know its
reputation, but they may easily switch between American Express and Diners
Club, or Visa and MasterCard. Countering the Forces
of Technology on Pricing Considering all these
forces, companies could understandably become quite pessimistic about the
future of marketing strategy, especially over the flexibility of pricing
possibilities. Yet all is not doom and gloom; there are strategies firms
may exploit that will allow them to migrate customers up the Pareto
pyramid, making marketing more effective in a time of market efficiency. |
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Differentiate pricing
all the time. The Information Age--and the advent of computer-controlled
machine tools--lets consumers have it both ways: customized and cheap,
automated and personal. This deindustrialization of consumer-driven
economics has been termed "mass customization." The Web has
already been an outstanding vehicle for mass customization, with
personalized news services such as CNN and the customer interaction pages
of online stores such as Amazon.com. However, the Web also offers managers
the opportunity to exploit a phenomenon that service providers such as
airlines have long known: The same product or service can have different
values for different customers. Airlines know that the Friday afternoon
seat is more valuable to business travelers, and charge them accordingly.
The Net should allow the ultimate in price differentiation by customizing
the interaction with the customer. The price can also be differentiated to
the ultimate extent that no two customers pay the same price. Use customer data to
optimize pricing by creating customer switching barriers. The Web allows
sellers to collect detailed data about customers' buying habits,
preferences, even spending limits, so they can tailor their products and
prices to the individual buyer. Customers like this because it recognizes
them as individuals and serves them better. Web sites recommend books that
match customer preferences, rather than some critic's, and advise on music
that matches customers' likes, rather than the Top 20. This in turn
creates switching barriers for customers that competitors will find hard
to overcome by mere price alone. Although customers may be able to
purchase the product or service at a lower price on another Web site, that
site will not have made the effort to learn about the customers, and so
will not be able to serve them as well. Use technology to
"dc-menu" pricing. Most firms have resorted to "menu"
or "list" pricing systems in the past to simplify the many
problems caused by attempting to keep prices up-to-date. Without
automation, there is a significant expense associated with changing
prices, known as the "menu cost." For firms with large product
or service lines, it used to take months for price adjustments to filter
down to distributors, retailers, and salespeople. But electronic networks
reduce menu cost and time to near zero, so there is no longer a valid
excuse for not changing prices when they need to be changed. Be much better at
differentiation--stage experiences. The more similar to a commodity a
product or service becomes, the easier it is for customers to compare
prices and buy on that basis alone. Marketers have attempted to overcome
this in the past by differentiating products--enhancing quality, adding
features, branding. When products reached a phase of parity, marketers
entered the age of customer service and differentiated on that basis.
However, in an era of growing service parity, the staging of customer
experiences may be the ultimate and enduring differentiator. The Web
provides an excellent theater for staging unique personal
experiences--whether aesthetic, entertaining, educational, or
escapist--for which customers will be willing to pay. |
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Understand that
customers may be willing to pay more than you thought. Marketers make a
big mistake by assuming that customers will expect and want to pay less on
the Web than they do in conventional channels. Indeed, managers in many
industries have a long record of assuming that customers underestimate the
value of a product or service, and would typically pay less for it if
given the chance. A very successful restaurant in London invites customers
to pay what they think a meal is worth. Some exploit the system and eat
for free; however, on average, customers pay prices that give the
establishment a handsome margin. This phenomenon has already been
identified on the Web by Watson et al. (1999), who found that car dealers
pay significantly more for used vehicles via an online sale than they do
at the "real world" equivalents. Establish electronic
exchanges. Many firms, particularly those in business-to-business markets,
may find it more effective to barter than to sell when prices are low. A
number of electronic exchanges have already been successfully established
to enable firms to barter excess supplies of components or products that
would otherwise have been sold for low prices. In this way, the company
rids itself of excess stock and receives value in exchange that exceeds
the price it would have realized. Chicago-based FastParts Inc. and
FairMarket Inc. in Woburn, Massachusetts operate thriving exchanges,
helping firms get rid of some $18 billion in excess inventory generated
yearly in the United States. Maximize revenue, not
price. Many managers overlook a basic economic opportunity: that in many
instances it is better to maximize revenue rather than price. Airlines
have perfected the science of yield management, concocting complicated
pricing schemes that not only defy customer comparison but also permit
revenue maximization on a flight, despite the fact that the average fare
might be lower. Many airlines now use their Web site to sell tickets on
slow-to-fill or ready-to-leave flights, either on specials or on ticket
auctions. They also make use of external services such as Priceline.com to
both discern market conditions and sell last-minute capacity. Apart from
their own Web sites, airlines, hotels, restaurants, and theaters can also
use sites such as lastminute.com to market seats, rooms, tables, and
tickets a day or two before due date. Consider total
purchase cost. The purchase price is one element of the total cost of
acquisition. Searching, shipping, and holding costs, for instance, can
contribute substantially to the acquisition cost of some products. In
circumstances in which Web-based purchasing enables a customer to reduce
the total cost of a purchase, the customer may be willing to pay more than
through a traditional channel. For industrial buyers, opportunity costs
may be a significant component of the total price tag of a purchase. Car
dealers indicate that attending a physical car auction costs somewhere
between $300 and $1,300 in lost profits per day because they are not on
the dealership floor. Also, particularly busy consumers will recognize the
convenience of Web purchasing. Both these groups are likely to be willing
to pay a premium price for products purchased via the Web, if the result
is a reduction in the total purchase cost. The Web creates new ways for
sellers to cut the total costs faced by purchasers. Sellers can cap
italize on these cost reductions by charging higher prices than what
traditional outlets charge. |
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Pricing Mechanisms Before analyzing how
the Net changes pricing strategy, we shall examine a firm's pricing
options (see Figure 2). The first choice is to decide on fixed versus
variable pricing. Of course, no price is fixed for the long term, but
some, such as retailing, are fixed for significant periods. For the last
100 years, fixed pricing has tended to dominate because technology could
not support large-scale variable pricing. Today, many retailers still use
it because of the labor intensity of changing hundreds of prices in a
supermarket or department store. Under fixed pricing, either the seller or
buyer can make the price. In retailing and with a put option, the seller
makes it. Buyers make it when they put an item out for tender or buy a
call option. Because the lower cost of consumer searching means buyers can
easily compare the fixed prices of a range of sellers (remember
Priceline.com?), sellers that fix prices are apt to be pushed toward the
commodity end of the market exchange spectrum. The Net enables
customers to become both price takers and price makers, and for firms to
gain both buying advantages (by buying at good prices from their
suppliers) and earn commissions on customer trades (by allowing and
facilitating customers to trade with each other). IT, and particularly the
Web, have made variable pricing an option for many firms, which now have
the opportunity to change and disseminate prices as often as desired.
Prices can be set with a single transaction or multiple interactions. A single transaction
means that one party sets the price and the other can take it, but the
price does not change during that transaction. Sellers in the travel
industry use yield management systems to dynamically adjust the prices
they offer customers. Buyers are likely to use a single transaction tender
method when they feel there is a need to evaluate, as well as price, the
bidder's ability to meet quality, design, and delivery requirements. This
is often the case in construction and large-scale projects. When setting
prices, buyers could also use yield management to modify in real time the
prices they offer sellers as the buyers react to market trends and the
actions of other price makers. In multiple
transactions, the final price of an item can result from a series of
interactions, as in an auction, when the buyer may make several bids at
successively higher prices before the selling price is established. In a
traditional auction, buyers establish the price through competitive
bidding, as in the case of eBay. The seller gets to set the price in a
reverse auction, where the buyer indicates what is required and sellers
get to bid, with the lowest price winning the order. Reverse auctions have
been very successful for large industrial companies, such as GE and
Caterpillar. During a Dutch
auction, the seller offers the item at successively lower prices until the
offer is accepted or the price drops so low as to force the withdrawal of
the offered item. Land's End uses a Dutch auction called "On the
Counter" to dispose of clothing and other items. It starts with a
price below the normal catalogue value and then lowers it in increments of
25 percent every two days until the item is sold or the price is 75
percent of the starting price. |
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Negotiation occurs
when both the buyer and seller participate in setting the price through a
series of interactions. Nextag.com allows buyers to find the product of
interest, make an offer, and respond to the seller's counteroffer.
Sometimes multiple sellers will participate in an interaction. Pricing, we believe,
will increasingly move from fixed to variable (the left arrow in Figure
2), a trend that was established in the travel industry some years ago
when yield management systems were adopted. Moreover, variable pricing is
more likely to move from single to multiple transactions (the right arrow
in Figure 2), such as a sequence of bids or offers/counter offers, as this
is more likely to favor those who have the greater power in the
buyer/seller interaction. With both parties having such a variety of
approaches to setting prices, we can now consider the situations under
which each should select these options. Pricing on the Net: A
Conceptual Framework The power of buyers
and sellers is a key in determining competitive forces in an industry,
says Porter (1985). When buyers have more power than sellers, they force
prices lower; when power swings in the other direction, prices move
upward. Figure 3 captures the outcome of the pricing power game between
buyers and sellers. Weak buyers and
sellers. When both parties are weak, we see pricing systems such as
retailing (relatively fixed prices), stock and commodity markets, and
Dutch auctions. Power is typically diffused among a large number of buyers
and sellers, and competition is intense. Both buyers and sellers can try
to use the Net to reach a large number of sellers and buyers,
respectively, by extending trading hours and overcoming the tyranny of
geography. Thus, many traditional retailers have moved online (such as
macys.com), stock exchanges have extended their trading hours, and some
sellers are using Dutch auctions to dispose of old stock (such as
landsend.com). The weak/weak sector
is the natural state in Western-style economies. Competition and
government act to restrict monopoly power (witness the Justice
Department's action against Microsoft) and weaken both buyers and sellers.
Because the Web makes it easy for the parties to connect, and pricing
information is so readily available, the Web can exacerbate the fragility
of weak sellers and buyers. Sellers caught in this sector are in danger of
being driven toward the commodity end of the exchange spectrum. They need
to employ the previously described methods for moving up the spectrum to
the domain of marketing effectiveness. In some markets, such
as residential real estate, there can be a relatively small number of weak
buyers and sellers. This can be confounded further by what we call
"information fuzziness." Here, the product is not standardized,
and if the information is truly fuzzy it becomes almost impossible to
standardize and compare the product or service. Thus, it is very difficult
to compare two houses at the same price in the same city, let alone across
cities or regions. Sellers who wish to avoid competing on price will look
for opportunities to introduce some degree of fuzziness in their
offerings, but this is obviously easier to achieve in some markets (real
estate) than in others (stock trading). The Net can be used to
differentiate products. A well-designed Web site with an appealing
appearance and friendly ambiance should be more successful in attracting
and retaining prospects. A high-quality Web site (easy to use, useful,
entertaining, supporting the full range of business processes) is better
at retaining customers. Thus, weak sellers need to develop Web marketing
skills to ameliorate their position. |
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Strong sellers and
weak buyers. Strong sellers will typically do better when they force
buyers to make the price. So they should favor auctions, as indicated by
the downward arrow in Figure 3. In this case, there are no powerful
buyers, because there simply are too many of them. However, unless the
product is genuinely rare (a gate at a busy airport), highly local
(desirable real estate), or a monopoly (government control of the
electromagnetic spectrum), this situation will usually be quite rare and
difficult for the seller to achieve. When circumstances create seller
power, the seller should use technology to reach as many buyers as
possible. Weak buyers facing a powerful seller should use the Net to try
to find alternative sellers or substitute products to weaken the seller's
power. Strong buyers and
weak sellers. When a powerful buyer faces many weaker sellers, the buyer
should establish a reverse auction by attracting as many sellers as
possible, shown by the leftward arrow in Figure 3. This is what
Caterpillar has achieved, and the practice has spread rapidly to large
purchasers in the public sector. When Pennsylvania's state government
began online reverse auction purchasing in the winter of 1998-99, it
entered into an agreement with FreeMarkets OnLine. The deal provided for a
series of online reverse auctions that the state's Department of General
Services uses to buy simple commodities such as fuel and office furniture.
By spring 1999, Pennsylvania and several of its vendors had traded online
to the tune of about $20 million. In these examples
there are no powerful sellers, again because there are too many of them.
This situation may also exist in peculiar local conditions, such as high
transport costs or government-maintained monopsonies. However, the
potential of the Net to weaken monopsonies should not be underestimated.
The same technology that enables a powerful buyer to interact with many
sellers can also be used by those sellers to reach many buyers. Moreover,
as other large buyers see the opportunity to interact with many sellers,
they will also adopt reverse auctions. Thus, the long-term impact of the
Net might be to weaken the power of strong buyers, particularly when the
source of this power is mainly geographical. Strong buyers and
sellers. When buyer and seller are both strong, such as in the
relationship between the U.S. government and a defense contractor, both
parties will try to find opportunities to increase their power and
strengthen their hand in negotiations. Buyers might attempt to fragment a
system--breaking it down into components so that there are more sellers
than would be the case if the entire bundle were purchased. In the days
when IBM dominated the computer industry, large companies would sometimes
separate the purchase of a new computer system into processor, disk
storage, display units, database management software, and other parts.
That way, separate suppliers could bid for each component, forcing IBM to
compete with Amdahl for the mainframe, Memorex for the disk storage, and
so on. This strategy pushed IBM from the total systems market, in which it
was very dominant, to the system component market, where competition was
more intense. Once a buyer decides to pursue a
"componentization" strategy, I t can use the Web to reach more
sellers, analogous to GE and Caterpillar's strategies. |
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Similarly, sellers
can use the Net to try to find new markets for existing products, thereby
reducing their dependence on a single strong customer. Thus, the standoff
between two strong parties might be ephemeral as each party in turn seeks
to resolve the power imbalance by moving to another sector of the pricing
circumplex. Clearly, the power of the Net can be used to reach more buyers
or sellers as required to weaken the power of the other party. Integrated Internet
Pricing Strategy The three frameworks
previously introduced provide a foundation for developing an integrated
Internet pricing strategy. The flexibility of the technology enables firms
to reach millions of prospective buyers and sellers cheaply with either a
mass message or an individualized one. A firm must first decide how it
interacts with each class of customers. Then it must decide which pricing
mechanism to use with each class of customers in each form of
communication. For example, it might provide A customers with personalized
Web pages and be a fixed price maker on these pages. However, using email,
it might also give them the opportunity to be price makers by allowing
them to bid for certain items that past buying behavior suggests would
appeal to them (a platinum airline customer receiving a personalized email
that offers an opportunity to bid for surplus seats to his favorite
vacation destination). Rewarding loyal A customers by giving them the
first shot at surplus goods is likely to have higher long-term returns
than opening up an auction to all comers, who will mostly be the
price-sensitive C customers. Alternatively, the
hundreds of thousands of C customers might receive weekly, non-customized
emails giving fixed prices for a range of items that can be purchased
interactively. To create its emailing list, the same firm could run
regular Web site auctions. An important benefit of an online auction,
besides getting rid of surplus goods, is that a firm can amass a large
email list of prospective buyers from among those who bid. For some
businesses, the real payoff of an auction could be the names added to this
list. Creative marketing
managers will blend Net communication options (email, Web site), pricing
mechanisms (retailing, yield management), and customer value (A+, C) to
manage revenue far more carefully and precisely than before. The power of
the Net to allow firms to communicate discretely with customers enables
pricing strategy to be dynamically fine-tuned to changing circumstances
and particular customer segments. Marketers will increasingly be able to
respond with the same alacrity as traders, but across a broader range of
products and with a vastly greater number of customers. Marketing will
become more like trading on steroids. Surviving in the
Internet Economy When facing intense
pricing competition, firms have traditionally resorted to raising
efficiency to lower cost structures. This is still a necessary condition
to compete in the Internet economy, but not enough. Firms must also be
able to react rapidly to sales opportunities, such as responding to an
online bidding system within minutes. To compete in this fast-paced
environment, they need information systems that can slice and dice cost
data to determine accurate minimum bids in real time. They need to build
the equivalent of an airline's yield management system so that they can
adjust prices dynamically to reflect current supply and demand conditions.
Just like commodity brokers, many firms may evolve groups that trade the
firm's products and services by constantly varying prices to match market
conditions. The Industrial Age notion of setting prices that are
relatively stable for long periods is unlikely to survive in the new
economy, and firms that do not make the adjustment from price setting to
price taking are likely to fail. |
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Firms wishing to
avoid intense price competition need to invest in learning about their
customers so they can successfully differentiate their products. This
implies building and maintaining a customer database that has extensive
data on each customer's preferences and buying behavior. It also means
building e-commerce applications that support one-to-one marketing, with
each customer potentially visiting an individualized Web site. By drawing
on its customer database, a firm can tailor each visitor's interaction to
stage a unique experience that potentially overcomes the price advantage
of a banal, one-size-fits-all Web site. Firms also need to
understand that information is the very heart of customer service. First,
you can't provide high-quality service unless you know and understand what
customers want. Second, most services have a high information content
(telling a customer when a parcel has arrived, categorizing a customer's
credit card expenses, detailing travel options). Firms that boost the
information component of their products and services differentiate them.
Again, IT in the form of databases and customized Web sites is the means
of converting information into service. The Internet is
having a fundamental impact on the pricing strategy of businesses opening
doors to buyers long closed by the effects of time, cost, and effort. It
has the potential to change the shape and structure of a firm's customer
base. At worst, it will flatten it, turning the majority of customers into
transactional traders who buy on the spot. However, used wisely, it can
migrate a significant number of the customers up the value triangle,
focusing marketing on high-value customers and enabling a firm to build
relationships with those that negate the impact of mere price alone. The new medium also
has the potential to move customers along the exchange spectrum in
unprecedented ways and at unprecedented rates. Technology may combine with
market forces to reduce most transactions to the level of commodity
trades, leaving managers with little opportunity to make prices. A far
more optimistic scenario, however, sees managers using technology in
combination with other marketing strategies to seduce the customer into a
mutually valuable relationship. Collaborative filtering supports a push
toward the seduction end of the exchange spectrum. Web retailers of books,
CDs, and videos use this technology to make recommendations to a customer
based on the selections of another customer with a highly similar
preference pattern. This is a particularly valuable service when customers
face a huge number of options. Because collaborative filtering is most
effective when a customer almost exclusively purchases a particular type
of product from one site, it fosters a mutually beneficial relationship. Considering market
situations in computer-mediated environments in terms of the power of
buyers and sellers provides a useful framework for decision-making with
regard to the effects of the Net on price. By representing these issues in
the pricing strategy circumplex in Figure 3, decision makers can avail
themselves of a useful tool for exploring both their current pricing
positions and the potential to move these positions in the future,
particularly by exploiting Net technologies. |
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Marketers have always
viewed price as one of the instruments of policy in the marketing mix--a
variable that, theoretically at least, can be manipulated and controlled
according to circumstances in the business environment and the nature of
the target market. In practice, however, many pricing decisions are not
taken by marketers, and are based more on such issues as cost and
competition than on any notion of customer demand. Seen pessimistically,
price decision making has been, and may continue to be, a mechanistic
process of calculating costs and attempting markups, or a knee-jerk
reaction to market conditions and competitive behavior. A more optimistic
view might be that pricing decisions can be as creative as those made
about the development of new products and services, or the development of
advertising campaigns. Indeed, pricing may be the last frontier for
marketing creativity Ignored or used mechanically, the Internet might be
the vehicle that destroys the last vestiges of managerial pricing
discretion. In the hands of the wise, it might be the digital wagon that
carries pricing pioneers to the edge of the digital frontier. Leyland F. Pitt is a
professor of marketing at the Curtin University of Technology in Perth,
Australia, and a fellow in marketing and strategy at Cardiff University in
Wales, Pierre Berthon is a professor of marketing at the University of
Bath in the U.K. Richard T. Watson is a professor of MIS and director of
the Centre far Information Systems Leadership at the University of
Georgia, Athens. Michael Ewing is an associate professor of marketing,
also at the Curtin University of Technology in Perth. The authors wish to
thank Ryan Bifulco, formerly director of Internet and distribution
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