Krmer-Kalka How Digital Disruption Changes Pricing ...exeo- Changes Pricing Strategies...How Digital Disruption Changes Pricing Strategies and ... the pricing strategy must undergo a ... spawned new business models and products, but also new pricing

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  • HowDigitalDisruptionChangesPricingStrategiesandPriceModelsTobepublishedinKhare,A.,Stewart,B.&Schatz,R.(eds.),PhantomExMachinaDigitalDisruptionsRoleinBusinessModelTransformation.Springer2016AndreasKrmerandRegineKalkaAbstractThedigitizationoftheeconomyleadstosignificantchangesinthewaycompaniesdeterminetheirprices.Technologicalchanges(availabilityoftheInternet,digitizationofproduction,productinnovations)basicallyinfluencethecorporateenvironment,sincethebasisforpricingcanbeimproved.Companiescancollectandanalyzemorerelevantinformationandhenceoptimizetheirprices.However,thesecausesacceleratecompetitivereactions.Ontheonehand,consumerbehaviorchanges(moreinformationisavailableonline,search-enginesandpricerobotshelptofindbestoffers),ontheotherhand,marketstructuresbecomefragile(marketentrybarriersfornewcompetitorsarelowered,traditionalproductsarecannibalizedbydigitalproducts).Duetothesefactorsthepricingstrategymustundergoacompleterethink.Inaddition,thishasconsequencesforthetypesofpricingmodelsappliedinthedigitalage.Inthiscontext,thispaperfocusesonfourpricingmodels.Firstly,thedigitizationmakesitpossibletoofferproductsandservicesforfreetotheconsumer(FacebookandGoogleareparticularlyprofitableexamples),whileatthesametimeothersourcesofrevenuestreams(here:advertisingrevenue)aregenerated.Secondly,freemiummodelsareespeciallypopularwithstart-ups,whicharealsofreeofchargeforabasicservice,butforupgradedservices(fullrangeoffeatures,noads)userspayafee.LinkedIn,DropboxorSpotifyareprominentexamplesofthispricingmodel.Thirdly,subscriptionmodelshaveastrongboost.Sinceproductioncostsdropwhennewbusinessmodelsarebasedondigitization,subscriptionmodels(likeNetflix)whichhavealongtraditionbecomemoreattractive,nowadays.Fourth,pricingmodelswithflexibleprices,whicharedependentondemandandcustomerprofilewillbediscussed.Dynamicpricinghasagrowingimportanceinonlinetrading,butisalsobeingappliedmorefrequentlyinretailstores.Thispaperexaminestheimplicationsofdigitizationonstrategicandoperationalpricingdecisionsandshowsexamplesfromvariousindustries(retail,media,music)andenterprises.Thelimitsoftechnologicalchangesarealsodiscussed,mindfulofbothaspectsthecompanyperspectiveandtheperspective(andperception)ofthecustomer.Keywords:BigData,freemium,dynamicpricing,one-to-one-pricing1.0 GoodreasonstorethinkthecurrentpricingstrategyAfrequentlystatedkeyobjectiveofpricingstrategiesismaximizingsellersprofitsbycapturingconsumersheterogeneousproductvaluationsandaccountingforcompetitionandcannibalization(Kimetal,2009;Simon,2013).Furthermore,consumerswillingnesstopayandreactionstodifferentpricingstrategiesmaynotbepurelyrationalbutratherdrivenbybehavioralaspects,suchasperceptionsandpreferences.Therefore,consumersperceptionsofdifferentpricingmodelsmaybeanadditionalopportunityforcompaniestodifferentiatethemselvesfromcompetition(byapplyingapreferredorinnovativepricingmechanismthatisnottypicalfortheindustry).Today,formostbusinessesandmarketscustomerloyaltyandcustomerrelationshipmanagementhavebecomekeycompetitivefactors.Duringtheprocessofoptimizingpricesitisoftenassumed

  • thatthemarketiscomposedofsingletransactions,missingtheperspectiveofadynamiccustomerrelationshipwiththecompany.ThereforeKrmer(2015)proposesawideneddefinitionofoptimalpricing.Thisshouldincludethecustomerswillingnesstopayaswellastakingintoaccounttheeffectsoncustomerloyalty,andfuturegrossmarginsgeneratedbyindividualcustomersintermsofcustomerlifetimevalue.Thereareseveralmajorfactorsmotivatingacompanytorethinkitspositioninganditspricingstrategy:(1)excesscapacitiesraisethequestion,whethertherearewaystosignificantlyincreasesales.Inadigitalcompanytherearealmostnocapacityconstraints(atleastintheshortrun).(2)Managersincreasinglyfacetheriskofcommoditization.AsarecentstudyofRolandBerger(2014)shows-60%ofmanagersbelievetheyarecaughtina"commoditytrap"(asituationwhereevencomplexproductsandservicesaredowngradedto"commodities",withlimiteddifferentiationandacompetitionthatisprimarilyprice-based).Therefore,decisionmakersarelookingfornew(unconventional)waytosetprices.(3)Inmanynewmarkets,loweringpricesmakesthemarketgrowmorequickly.Thelowerthepriceis,thestrongertheadditionaldemandeffect.Forfirmsthatdonotfeartheriskofrevenuecannibalization,radicalpricereductionscouldbeanoptiontoattractnewdemand(KrmerandBurgartz,2016).Asaconsequence,itisstatedthatmanagersinmarketingandsalesincreasinglyseethemselvesexposedtostrongerpricecompetitionandevenpricewars(Bertini,2014).Essentially,therearefourpricingmodelsthatcharacterizethedigitalworldandhavethemselvesledtoacertaindisruptioninpricing:(1)Thefree(nocharge)offering,(2)thefreemiummodel(createdfromFreeandPremium),(3)thesubscriptionmodeland(4)dynamicpricing.Thediscussionbelowwillfocusonthesemodels.Nevertheless,otherpricingmethodshaveevolvedintheInternetage,whichare,however,lesswidespread(Figure1).Figure1Impactofachangedcorporateenvironmentonpricingmodels

    Onetrendistowardsparticipativepricing,whichgivescustomersmoreoptionstoacquireagreaterinfluenceonthesettingofprices(KrmerandBurgartz,2016 ;BertiniandKoenigsberg,2014).Themostprominentexamplesofparticipativepricingmechanismswithhorizontalinteractionareauction(classicauctions,reverseauctionsandexchanges)negotiations,inwhichthebuyerandsellerhaggle

    Positioning and pricing

    strategy

    Technology

    Data Consumer Behavior

    Competitive Pressure

    For Free (no charge

    B2C) Freemium Subscription model

    Dynamic pricing

    Pay-What-You-Want /Name-

    Your-Own-Price Auctions Provision / Commission

    Posted prices / typical discounts

    Corporate Environment

    Price models with top focus

    (prevailing)

    Other price models

    Digitization Commoditization

    New business models Risk of price competition

    IoT

    Bundling and non-linear

    pricing

  • overthepricefortheproduct;eBayiscertainlythemostprominentexample.Pay-What-You-Want(e.g.openbooks.com)andName-Your-Own-Price(e.g.priceline.com,bandcamp.com)arebothcharacterizedbythebuyersettingthefinalprice(Kimetal.,2009).Thesubjectiveevaluationofwhetherthepriceisadequatefortheperformanceandrepresentsfairvalueisthemainfactorinfluencingthefinalprice.2.0 PrevailingpricemodelsforthedigitaleconomySubsequently,firstapricingmodelispresented,whichisparticularlyextremeinitsdesign:amodelwherethepriceoftheproductorservicesiszero.Basedonthismodelanextensionisconsidered,theso-calledfreemiummodel.Incontrast,modelssuchassubscriptionfeeanddynamicpricingaremoredrivenbytheobjectiveofexploitingtheconsumerswillingnesstopay.Thisisparticularlytrueforanextremeformofdynamicpricing,whichusescustomerdataandprofilesinordertodevelopanapproachforone-to-onepricing.2.1 ForfreeAkeyobjectiveofinnovativepricingmodelsistoactivatelatentdemand.Toofferutilizationofaproductorservicewithoutbeingchargedseemsparticularlyeffectiveforattractingnewcustomers.Oneissue,oftenpointedoutfrombehavioraleconomicsisthatbenefitincreasesdisproportionatelyduringthetransitiontoazero-priceoffer("forfree").Ariely(2014,p.107)describesthisphenomenonasfollows:"Zeroisalmostanotherworld.Thedifferencebetweentwocentsandonecentissmall,betweenonecentandzerocents,however,enormous."Onestrategy-perfectlyexecutedbyGoogle-istochargethirdparties.Thefirststepwastoofferanoutstandingsearch-engineforfreeandtogeneratevaluetothecustomer,whichledtoanenormousflowoftraffic.In2015,mainlyduetoadvertisingAlphabet(Google)earnedprofitsofalmost$16bnaftertaxes,basedon$75bnrevenues.WhenGmailintroduceditsfreeservicein2004itprovided10timesmorestoragethanYahoo,theleadingprovideroffreee-mailatthetime.Yahoo,theleadingprovideroffreee-mail,respondedtoGooglesentrybymatching,andthenexceeding,Gmailsfreestorageoffer.AnotherexampleisFinnishtelecommunicationscompanyBlyk,whichoffers200freecell-phoneminutesamonthto16-to-24-year-oldswhofilloutasurveyandagreetoreceiveads.Blykthensellsaccesstoitscustomers,,andinformationaboutthem(DyerandHatch,2011).Anotherstrategymaybetoofferaproductfreeofchargeinthemarketinordertocreateanewmarket(forexample,asalaunchaction)ortostimulateadditionaldemandinoff-peakperiods.Megabus,aleadingsupplierofintercitybustripsusedthistrickwhenenteringtheGermanmarket(Krmer,JungandBurgartz,2016):itproposedtosupply20,000freeticketstogetintothemarketinJanuary2016(onlythepaymentofatransactionfeewasrequired).Bla-Bla-Car,aFrenchstart-upcompany,whichofferscarride-sharinghasafreeofchargeserviceinGermany,whileinFranceaprovisionalmodelwasestablishedoncethemarkethaddeveloped.Basically,theofferofafreeserviceseemsparticularlyattractiveforthestartofthelife-cycleofaproduct(launchingoftheproductfree,andlatercharginganormalprice),anextremeformofPenetrationStrategy.However,therearecounterexamplesaswell.ThusWhatsApp,theleadingsupplierofmessengerservices,announcedearlyin2016itwasabandoningits99-centsubscriptionfee.Obviously,thesubscriptionsystemintroducedin2013hadbecomeratherabarrier,preventingthecompanyfromgrowingfastenoughduringitsglobalexpansion(thevolumeofusersexceededthethresholdof1billionin2016).However,thecompanypledgednottointroduceads,andinsteadhopestofindawaytomakefirmspaytoconnectwithcustomersusingtheapp.Othercompaniesusefreeservicesasanintegralpartoftheirproductrange.GermanRail(DB)providesfreetraintravelforchildrenuptotheageof14,ifaccompaniedbytheirparents.Onthe

  • onehand,suchanofferalwaysincludestheriskofrevenuecannibalization,ontheotherhand,risksarelimitedhere.Furthermore,thefreetravelofchildrenleadstoanon-linearpricingofthefamilyjourneyandtherebyimprovesthecompetitivepositionofDB.Obviouslythemainadvantagesofofferingproductsandservicesforfreearetheattentiongainedandtherapidgenerationofcustomersbyreducingoreveneliminatingtheirfinancialrisks.Byusingpricingforfreecompanieshaveapowerfulmarketingandaneasysalespromiseandcanachieveagoodmarketpositionintheshort-term.But,ofcourse,therearerisks,whichneedtobetakenintoconsideration.Consumerscouldhavetheattitudewhatcostsnothingisworthnothing.Thisattitudedependsonthesubjectivevalueoftheproductand/orservices,andhastobeevaluatedbythecompanywithregardtotheirbrandidentityandportfolio.MoreoverastudyofShampanerandArielyshowedthatinthezeropriceconditionstestpersonsweremorelikelytochoosealessattractiveproductthantopayareducedpriceforahigherqualityandmoreattractiveproduct.Bytestingseveralpossiblepsychologicalantecedentsofthiseffect,theyfoundoutthattheaffectisthemostlikelysourceandconcludeIngeneral,thisresearchjoinsalargercollectionofevidence,showingthatzeroisauniquenumber(ShampanerandAriely,2006).Themostimportantdriverofthesuccessofthispricingmodelistofindawaytocrossfinancethezeropriceproduct.Asshown,themostsuccessfulstrategiesareeithertochargethirdparties,tocreateanewmarket,ortouseitasintegralpartoftheproductrange.2.2 FreemiumThedigitizederahasnotonlyspawnednewbusinessmodelsandproducts,butalsonewpricingmodels.Duringthelastdecadefreemiumacombinationoffreeandpremium-hasbecomethedominantbusinessmodelamongInternetstart-upsandsmart-phoneappdevelopers.Users,whoarejustinterestedinabasicproductorservice,receiveitforfree.Ifaservicewithhigherqualityispreferred,theusercanoptforasubscriptionfee.Nowadaysonlinemusicprovidersofferthepossibilityoflisteningtoanalmostunlimitedrangeofsongssimplybyfreeregistrationforanonlinemusicaccount.Thechallengefortheprovider,whichcoversthecost,istofindawaytocross-financesuchoffers.Oneoptionistoembedadvertisement;anotherisafreemiumapproach,apopularpricingmethodduetoitsuser-friendliness.Today,wefindvariousInternetservicesbasedonthefreemiumconceptsuchasLinkedIn,Dropbox,orSkype(Kumar,2014)andthemajorityofthesmart-phoneappsarebasedonthisconcept.Thereareobviousadvantagesofafreemiumstrategy.First,freefeaturesareapotentmarketingtool,whenbasicfeaturesofferedforfreemeetfundamentalconsumerneeds,suchas:freemusic(Spotify),freecloud-basedstorage(Dropbox)orfreecalls(Skype),andfreeservicesareconveyedinthesocialnetworksasaninstrumenttodistributenewservicesquickly.Secondly,itallowsnewventurestoscaleupandattractauserbasewithoutexpendingresourcesoncostlyadcampaignsoratraditionalsalesforce.Forventurecapitalistsitisanattractiveproposaltoseeabusinessgrowathighspeedandatthesametimegeneraterevenues.Herethesubscriptionfees,typicallychargedmonthly,comeintoplay,sincetheybecomeasustainablesourceofrevenue.Dropboxattracted200millionuserswithasimpleservice.Providedacustomerhasausernameandpasswordandthusauniquelogin,twogigabytesofcloud-basedstorageisprovidedforfree.Ifusersperceivethestoragevolumeastoolimited,theycanpay$9.99amonth(or,alternatively,$99ayear)for100GBofstorage.Hencethebusinessmodeltargetsatleasttwodifferentcustomersegments.Thefirstsegmentissatisfiedbytheadequacyofthefreeversionforbasicdocuments,thesecondsegmentneedsmorespacesincecustomersuseDropboxprofessionallyorbackuplargefiles(music,photos).Byacceptingthesubscriptionfeepeoplebelongingtothesecondsegmentcreateacashflowthatisnecessarytocross-financethefirstsegment.Althoughthereisacertainwillingnesstopayeveninthefirstsegment,Dropboxleavesthefullconsumersurplusontheuserside.

  • Oneimportantsuccessfactorforthefreemiumconceptis,therefore,toincreasetheconversionrate(orreducethecorrelationbetweenuserswhopaynothinganduserswhopaythesubscriptionfee).However,ahighconversionratecouldalsobecounterproductive(Kumar,2014).Acceptingthatoneofthebenefitsofafreemiummodelistheabilitytogeneratetraffic,meansthatasignificantbasiccustomervaluedeliveredforfreeisrequired.Additionally,thesuppliermustfindawaytomakeitsservicedistinctiveandcreateadditionalvalue.Anotherimportantpointiseasilyoverlooked:thelargenumberofuserswhodonotpayforperformance,notonlygeneratecostsbutarealsoanasset,fortheyincreasethecompanysgoodwill(animportantfactorwhenmeasuringcompanyvalueisthecustomerbase).WhileSkypeattracts400millionusers(manyofwhombecomepayingcustomers)Flickr,thefreephoto-sharingsite,hasamuchsmalleruserbaseandalowconversionrate.ThispartiallyexplainswhyeBaypaid$2.6billionforSkype(in2011Microsoftevenpaid$8.5billionincashtoacquireSkype;thenumberofusersamountedto660millionatthattime),andYahoopaidlessthan$30millionforFlickr.Furthermore,theselleralsohasunlimitedpossibilitiestogaininsightintotheirconsumersbyobservingtheusagebehaviorortounderstandcustomerbehaviorbetter(forexampleSpotifycanidentifywhatkindofmusicaspecificsegmentsprefersorsharesandcategorizescustomersbasedonthoseinformation,andcanusethesamedatatodefineupsellcampaigns(LinkedInoffersafreepremiumaccountortheoptiontouseLynda.com,aservicethatprovideseducationalvideos,foralimitedperiodoftime).2.3 SubscriptionThesubscriptionsmodelincludingayearlyormonthlypaymentdoesnotconstituteatrulynewformofpricing.Evenbeforethedigitalage,companiesusedsubscriptionseithertogeneratecustomerloyaltybyofferingsubscriptions,ortoachieveabasicutilizationofproductionandmarketingcapacities.Theunderlyingpricelogicofflatprice,however,hasasignificantdisadvantageinanon-digitalworld.Consumptionmustbelimitedatallcosts.Innewspapersandmagazines,agivencirculationdefinesthislimitation.Correspondinglimitationsforservicebranchessuchasfitnessstudiosortelecommunicationswouldhardlybefeasible.Anexampleforakindofnaturallimitationisembodiedbyhellofresh.de.Theonlinefoodservicesendstheirmembersweeklycookingboxesfilledwiththeingredientstoprepareaspecificrecipeforapriceflatpermonth.Dollarshaveclub.comfollowst...

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