Pricing Digital Goods – (Hint: Not Free)

The problem with digital goods is it is easy to get confused by its economics, the marginal cost is $0, selling a unit to customer does not make it unavailable to another and there are challenges in restricting use. This has led to supposedly new branch of economics, “economics of free and abundance”, led by Mr. Chris Anderson and has built a large following.

I have written several articles on the need to sell the value and not focus on the marginal cost. In the digital world matching price to value is more difficult than it is in physical world.  Economist Brad DeLong from UC Berkeley (my alma mater) writes in his 1999 paper titled, Speculative Microeconomics for Tomorrow’s economy,

In many information-based sectors of the next economy, the purchase of a good will no longer be transparent. The invisible hand theory assumes that purchasers know what they want and what they are buying so that they can effectively take advantage of competition and comparison-shop. If purchasers need first to figure out what they want and what they are buying, there is no good reason to assume that their willingness to pay corresponds to its true value to them.

When customers do not exactly know what they want and the value they get, the marketer will find it hard to make a value proposition and charge a price that captures that value. Difficult does not make it a good reason to give up on charging for digital goods and give it away for free.

In a Nov 1998 article in Harvard Business Review, economists Hal Varian  (also from Berkeley now at Google) and Carl Shapiro wrote (Harvard Business Review, 00178012, Nov/Dec98, Vol. 76, Issue 6)

But there is a practical way to set different prices for basically the same information without incurring high costs or offending customers. You do it by offering the information in different versions designed to appeal to different types of customers. With this strategy, which we call versioning, customers in effect segment themselves. The version they choose reveals the value they place on the information and the price they’re willing to pay for it.

It takes us back to what Ted Levitt said about customers buying holes and later what Clayton Christensen said about, “what job is your customer hiring your product for?”. The difficulty in value calculation comes from focusing on the “drill” and not on the “hole”. If marketers focus on what the customers really want and what job they are hiring the digital information for it becomes easier to tease out the value to customers and how it differs across segments. Then the marketer can target the segments with specific versions and position it appropriately to capture a share of the the value through effective pricing.

Proposals to give away your offering (Mr. Chris Anderson in Free/Freemium) or let the customer decide what they want to pay may capture your imagination but as Hal Varian (who was described by Mr. Chris Anderson as someone who taught him more about economics than any of his professors) said in 1998 (full ten years before these new models):

Success in selling digital goods does not require a whole new way of thinking about business. Rather, it requires the same kind of smart managing and smart marketing that have always set apart the best companies. The real power of versioning is that it enables you to apply tried-and-true product-management techniques-segmentation, differentiation, positioning-in a way that takes into account both the unusual economics of information production and the endless malleability of digital data.

The road to profitability in any market goes through STP! That’s Segmentation – Targeting – Positioning. The rule does not change whether you are selling physical or digital goods.

14 thoughts on “Pricing Digital Goods – (Hint: Not Free)

  1. I suppose eBooks are a great example of this. Amazon and Barnes & Noble were selling most new books at $9.99. Over the last few months the price of most new releases is routinely $12.99 and higher. The gap between the digital and paper format is shrinking. When you add in the cost of the device and the fact that you cannot resell or easily lend eBooks, you can get upside down quickly.


  2. Stephan
    That is the effect of reference price – what customers are used to paying for services despite the value they get. That said, we need to ask if any of these services really fill an existing and urgent customer need or created the need. There are 50 million or so blogs out there, do all of them really have a need?
    In case of introducing new services you can change the customer’s perception through effective segmentation, targeting and positioning. There will always be a segment with urgent needs that can be addressed by your offering, it may be very small but may have high WTP. The hard part is to find this segment and target it with the right version.
    Even there how you position the offering affects the price you can charge, no one would want to pay $500 if Apple positioned iPad as digital photo frame on steroids. How you position affects determines customer reference price and hence the price you can charge.

    let me know if you have a specific question, here are my other articles on reference price


  3. Could you address the problem that for the ordinary web-user most applications they use are free (Web browser / Email Account / twitter / / wikipedia) already? So they would expect any new product also to be free. — Stephan


  4. Roberto
    Microsoft’s bundling is not what Anderson is describing as free.
    You are correct that versioning is nothing but Segmentation and Targeting and that’s what I wrote as well.


  5. Information prices are high because owners of information are essentially monopolists. Without statutory monopolies (i.e., monopoly grants by the State, such as copyrights and patents), information prices would be close to zero (like the free software you can buy online).

    The versioning you refer to is just another term for the standard monopolistic practice of market segmentation or product differentiation, allowing the monopolist to get as close as possible to what the buyer is willing to pay.

    You talk of what the buyer is willing to pay for it. What about what the seller is willing to charge for it? When Microsoft bundles all kinds of free (as in zero additional cost) software with its OS, isn’t that the “free” that Anderson is talking about?

    The near-zero cost of information copies comes with the non-material nature of this good. The current prices charged for them are due to the artificial scarcity created through various kinds of monopolistic practices. Without these practices, we will see more information abundance.



Comments are closed.