Ascription is an Anathema to any Enthusiasm

Network effects. By definition, the utility function of a product with network effect is dominated by a term that grows with the number of users of that product. For example a phone is more valuable than a intercom entirely because there are more users on the otherside of the telephone network than there are users on the other end of an intercom.

Products with network effect - it would appear - have the key aspect required to generate a power-law distribution, i.e. they link up more customers in proportion to how many customers they have already attracted. It is common to say that products with a strong network effect tend rapidly to a winner take all monopoly outcome, e.g. an extreme case of the power-law distribution.

If you are a dominate vendor in such a market differencial pricing is a critical part of your toolkit. To get (and maintain) the network effect of a large installed base you must serve users with a low willingness to pay (say residents of the third world) while conversely you want to harvest the high revenues of users who are less price sensitive (say residents of the first world).

Meanwhile you have another problem. Some users bring exceptionally high value to your network - for example in the phone system the presense of the police and fire department brings substantial value compared to the typical residencial user. Such high value members of the product network are said to complement the network. You may wish to bribe (where the price goes negative) complementary users to get the substantial value they bring into the network.

These same issues arise when attempting to get a standard adopted. The advocates of the standard, who may only desire that the network exist so they can get on with their core activities, may find it desirable to take actions to drive prices down to drive up adoption. For example contributors to the standard may find it advantagous to relinquish intelectual property rights in support of getting the standard more widely adopted.

This kind of discounting to drive adoption occurs in both large and small enterprises. With an important emerging standard we might see IP rights being relinquished to lower the barriers to wide adoption. At the other end of the scale you might see a local grocery story use discounting to bring customers into the store. In both cases the discounting serves to increase market share. Of course network effects are not the only reason to grab market share. For example, if you can capture a relationship with a customer you can often sell him more stuff. I.e. discounting may be used to capture a customer into a sticky relationship.

Of course there is always the risk of a bait and switch. A player might actively advocate the adoption of a standard. Then, he waits until the standard has achieved critical mass and a strong network effect. Finally, he proceeds to assert his IP rights - collecting a tax from the users.

In a similar scenario a vendor might sell his product at low price points to third world customers so he can reserve the option of charging them higher prices should their nations GDP grow sufficently. That’s a kind of ground cover strategy.

Joel on Software is the nice web site of a small buisiness owner. Joel’s company makes two kinds of software: some for web site content management, and some for helping organizations coordinating their work.

I have a good friend who is curious why some people will freely reveal their trade secrets. For example open source authors. Joel freely reveals a lot about how he runs and thinks about his company: a great example of free revealing, but Joel’s not an open source guy. He’s trying to make a living.

One of his recent essays is a particular favorite of mind.
In his essay on complementary products Joels gives a particularly nice peak into how large businesses work to comoditize the industries around them. For example platform vendors work very hard to create a vibrant community of complementary products that add value to their platform.

One reason I’m interested in these things is that software platforms are almost indistinquishable from industry standards and I’ve come to believe that one way to look at Open Source is as a new forum for coordinating the creation of standards. If you’re into this kind of thing then Joel’s complaints about one platform vendor’s pricing model and the vendor’s response are great examples of the push and pull around this stuff.

Of course that Joel’s site apparently is lacking an RSS feed does give one pause.

The last time we raised the minimum wage was 1997. In constant dollars though we are back where we started. This is one of many interesting little economic facts found in the nice little series of Economic Snap Shots from the Economic Policy Institute.

In a follow up to the last posting on trying to figure out the lowest price for phone service in Chicago and other wonders of differencial pricing… Today’s New York Times happens to have an article about using expensive software systems to decide how to price products at department stores. Playing that game, the article reports, can raise gross margins 10%. Clearly you’ll be run out of buisiness if you don’t play the differencial pricing game and your competitors do.

There are numerous down sides of these kinds of games. Buyers percieve them as unfair. They causes customers to delay their purchase decisions, convinced that if they play the shopping game longer they will get a better price. It tends to make the sales process lousy: vendors that bundle a lot of service into the sale get punished. Shoppers go to them first. Collect the high quality pre-sale service, and then leave and buy someplace else. Sometimes this can lead to an industry working to get the practice regulated - some people call that price-fixing.

The software that is trying to figure out what to charge you for the hotel room, airline ticket, or college education are all looking for signals from the buyer that can be used to estimate what you are willing to pay. Private schools, public housing, etc. just go ahead and have you hand over your tax returns. Other merchants may poll your credit rating. The hotel booking software takes note of the time of day when you call. Department stores, about a decade ago, started adjusting prices thru-out the day so that I can get a shirt cheap if either I drop in at 8am on a tuesday or I’m willing to drive to an ‘outlet mall’ in a neighboring state on a saturday.

This search for signals from the buyer about his ‘hidden price’ leads to this kind profiling being called prejudicial pricing.

See also via google:

• differential pricing
• value pricing
• hidden pricing
• predjudicial pricing
• price fixing

Differential pricing is the art of charging customers not what it cost you to make the product but rather the maximum amout that reflects the value the buyer thinks he will extract from using that product. Sellers sometimes call this “value pricing.” This black art requires - if your the seller - getting the buyer to reveal his perception of how much use he will get from the product.

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