Information rules

For information goods, value-based pricing is essential to maximizing returns. In its purest form, value-based pricing requires accurately determining the price consumers are willing to pay and developing delivery mechanisms meeting those price points.

The basic competitive strategy for success in selling an information good is to differentiate your product through the addition of value, evaluated solely from the end-user’s perspective, and achieve the lowest possible costs of production by utilizing economies of scale in the creation process. However, those two strategies will simply secure a place in the marketplace. Success is dependent on realizing the greatest possible return on your specific information assets.

Maximizing returns for the sale of an information product usually requires creating added value by offering personalization or customization add-ons. This is only possible if the seller knows the customer’s needs precisely. To obtain this type of data, a registration process may be used, service requests may be analyzed for patterns, a menu of choices may be offered to see which is most popular, or a two-way dialogue may take place with customers. It also requires developing differential pricing arrangements that captures as much of the added value for the vendor as possible.

The three types of differential pricing are selling at a personalized price to each user, selling at different prices to different groups, and having different versions selling at different prices.

Selling at a personalized price to each user is possible as airlines have done for years. With technology like smart cash registers and instantaneous pricing on the Internet, actual market response to price changes can be tracked in detail. By personalizing pricing, the price points at which returns to the seller are maximized can be determined and exploited successfully.

An information network like the Internet poses two key challenges for copyright owners. First, reproduction costs are reduced dramatically - eliminated entirely, in fact, for material in a digital format. However, historically whenever new reproduction technology has become available, it has increased demand for information goods rather than decreasing it.

For example, photocopiers have increased demand for printed material rather than acting as the death knell for publishing. The availability of libraries has boosted demand for books rather than decimating the publishing industry. And prerecorded video tapes have provided a major new revenue stream for movie production despite ready availability of copying. In all these cases, enhanced reproduction capacity grew the market significantly.

Therefore, the key issue for copyright owners is not how to completely protect assets but rather how to maximize the value of intellectual property using network economy dynamics. Since digital copies are perfect replicas, copyright owners can leverage this to their advantage to grow the market.

The second challenge is that distribution costs are lowered substantially on networks like the Internet, making distribution quick, easy and cheap. So copyright owners need to find ways to make this trend work for them rather than against them.

Lock-in occurs when the costs of switching from one brand of technology to another become substantial, effectively determining future choices based on past decisions. Users of information technology products and services are particularly susceptible to lock-in. Once a consumer selects a particular technology brand, they may receive inducements to continue using it. By developing a preference for that brand, the consumer can become entrenched in the system, facing significant switching costs that discourage adopting alternatives. Lock-in stems from choices made, whether consciously or not.

Failure to account for lock-in's switching costs leaves consumers vulnerable to opportunistic behavior from suppliers. However, for suppliers, these switching costs also determine the value of their installed customer base. To allow for lock-in as an information technology buyer, keep its consequences for later decisions in mind and mention this to suppliers as a reason for substantial upfront incentives. Explore alternative sourcing options, favoring open systems over closed, proprietary ones offered by a single vendor. Minimize lock-in effects within your power.

Feedback is a dynamic process which exists in any network. It occurs in the information economy in two distinct types:

Positive feedback refers to a virtuous cycle where success feeds on previous successes. The typical pattern is a slow start until ‘critical mass’ is achieved, then explosive growth and ultimately saturation as the value of all competing products is eliminated. A classic example is the network effect seen with the Internet - the more people that connect to the Internet, the more valuable it becomes by offering more content and services, thus incentivizing further adoption.

Negative feedback refers to a process where the strong get weaker and the weak get stronger until a state of equilibrium is achieved. Classic examples of industries exhibiting negative feedback are the automobile, steel, and petroleum industries.

Many information economy companies have harnessed the positive feedback cycle so effectively they have succeeded in creating temporary monopolies for themselves. That’s because for information systems, widely used technologies that achieve demand-side economies of scale are just as valuable as broad network reach that enables supply-side economies of scale.

However, these monopolies are only temporary, as superior products can supersede the technology. Further, not all information markets will exhibit positive feedback. Whether positive feedback occurs will depend on the balance between demand for variety and the potential for economies of scale. A positive feedback cycle is most likely to develop if demand for variety is low but economies of scale advantages are significant. Conversely, if demand for variety is high but economies of scale potential is low, a positive feedback cycle is highly unlikely.

Since the natural result of a positive feedback cycle in a network economy is that the winner takes all, assembling a winning team is critically important. This process has two key stages. First, product standards must be established. Some market participants will benefit from common standards, while others will not. At a minimum, the existence of standards will significantly impact competition within the marketplace. Standards offer advantages like enabling information sharing across a network, creating a bigger market and more value, reducing technology risk for consumers, alleviating lock-in concerns, promoting within-market price competition, and shifting the focus from systems to components. Consumers, complementors, and innovators tend to win when standards are set since technology risk declines, larger markets emerge, and greater opportunities to develop products exist. However, established incumbents may lose sales and sellers of substitute products could see their markets disappear.

Those participating in a joint effort to develop a new product standard should approach negotiations strategically and commercially. Keep R&D efforts progressing while talks continue, watch for side deal chances, get creative in securing favorable terms for participating, beware of vague promises, understand the intellectual property rights landscape, and consider preemptively building an installed base. Essentially, view standards setting itself in the broader business context rather than an isolated activity. Invariably, developing standards takes more time than expected and often involves political maneuvering. However, an agreed-upon standard lends credibility to a new technology.

Companies attempting to start a positive feedback cycle using a Controlled Migration or Performance Play strategy engage in a standards war. This occurs when incompatible technologies compete to become the de facto standard in a market exhibiting strong network effects. Success often hinges on a company's ability to wage the standards war effectively.

A company's likelihood of winning depends on its ownership of seven critical assets: 1) Control over an experienced user base; 2) Strong intellectual property rights; 3) R&D capabilities; 4) First-mover advantage and visibility; 5) Manufacturing competence or economies of scale; 6) Technical strengths in complements and add-ons; and 7) A strong brand reputation.

No single asset alone determines the outcome. Rather, their combined synergistic effect is most important.