Charging For Content – Google Vs. Murdoch

Much will be said and written about the reported news that Mr. Murdoch is close to signing a deal with Microsoft (source NPR), disallowing Google from searching and indexing his company’s content and getting paid by Microsoft for the search access.  We will hear more about how content is free or wants to be free, how it is commoditized and how people can get free content from somewhere else. The most vocal proponent of them all, Mr. Jeff Jarvis,  described WSJ’s move as, “it is suicidal”. At the other extreme, Mr. Murdoch described Google as, “stealing my content”.

The truth, however, lies somewhere in between.

On the content wants to be free argument:  This is an extreme position treating all contents as the same and treating all customers the same. The value of content is in the minds of the customers and it varies across segments. For instance, my WTP for WSJ opinion pieces is $0. There are news articles that add no unique value and hence by definition are commoditized. While other articles, even thought they have high value, fail to capture value because of alternative free means of accessing these articles (WSJ articles can be accessed for free through Google searches).

On customers don’t want to pay for content: It is a widely accepted notion that customers do not want to pay for access to content. There is no basis to these and any marketing research studies done are not rigorous enough. This is the very definition of Conventional Wisdom, and going against it will be seen as disastrous move.

Onit is suicidal”:   It definitely is not. WSJ still makes a great portion of its revenue from paid subscriptions. It takes a lot more Ads and CPM to get the same amount of revenue. For someone running one of the top sources of business information we should give WSJ the benefit of doubt that they did the revenue models and calculated loss of revenue from Google traffic. If they were not monetizing much of current traffic, it is not a devastating loss and it offers future revenue potential from subscriptions.

On the stealing argument: This is another extreme claim. What is true is Google can and does monetize search results with search Ads and it does not share those revenues with WSJ or with any other source. One thing Google or other search engines do is lowering customer’s reference price for the articles, preventing WSJ and others from capturing value. It is not that far off for Murdoch to get recover some of that by asking Google and Microsoft to pay for indexing access.

On charging for content: Charging for content starts with value,  communicating that value, and protecting that value through reference prices. How can you credibly communicate value of a newspaper or a Journal? WSJ is taking the approach of showing what is possible from reading, sometimes even drawing suspect causations based on correlations. Another example is Elsevier, which is communicating value of its online journals articles through by making (again somewhat suspect) causation arguments showing new research grant.  Both WSJ and Elsevier may be using causation argument when none exist but they are trying and spending resources on creating the value proposition while most others do not even know how to communicate theirs.

This is not a battle between Murdoch and Google or other search engines, this is the beginning of the efforts by content producers, those who create value,  to capture their fair share.

Should Barnes & Noble have Gone Big with nook?

Barnes & Noble received so many pre-orders on its ebook reader nook that it cannot anymore deliver nook for Christmas. With more than a month to go before Christmas, B&N says it can only deliver after January 4th.  It makes me think if they could have done things differently for the launch:
  1. Market size: Forrester says 900,000 eBook readers will be sold just during the holidays. Amazon is the market leader with 65% and Sony the rest. nook is the new entrant, and Barnes & Noble is not saying how many units they sold.  Introduction of this new and better looking and functional device definitely would have grown the market, bringing in new customers who did not want to go with Kindle. B&N should have planned on selling 400K to 500 units during Holidays.
  2. Did they plan on under supply to create buzz? I doubt it, even though brands have previously been accused of doing it to create buzz, Barnes & Noble already had enough buzz going for it with the device and the marketing campaign.  Since they priced it as penetration pricing, shouldn’t they line up the supply chain to meet the volume?
  3. So why did they not plan on selling 400K-500K units? If we assume their margin is so low that nook cost $250 to make, for 500K units the total cost is $125 million. They have no long-term debt in their books (amazing) and could have financed this investment with debt – besides they need not take long-term debt if they could strong-arm their suppliers to delay their account payable until after B&N gets paid. (Update: B&N did take debt but did not have the power to strong arm its supplier because there is only one)
  4. The device looks definitely better than Kindle and they positioned it as such – so why follow Kindle’s price leadership? If they had priced it higher could they have not only handled the lower demand but also delivered more profit?  For instance if they had priced it at $279 with a profit per nook (i am not including book sales) of $29, even if they managed to sell only a third of current sales (which is an unlikely drop) they would make more profit than current price.
  5. Customer Margin: nook profit is about total customer lifetime value, from all those ebooks customers buy, accessories and the 2-3 year refresh cycles. So footprint helps and they do not have to make up all the profit just from the device. But it appears they did not calculate what the demand is going to be and followed Kindle’s lead (which could easily be wrong as well).

Now I waited too long to order a nook and I am not going to gift one for the Holidays.

Update: Here is an estimate of number nook readers Barnes & Noble sold in the early days.

Is Ann Taylor’s Pricing Paying Off?

Ann Taylor reported their Q3-2009 went up despite drop in sales. Their gross margin went up by $7.7 million while their sales fell by $64.8 compared to same  Q3-2008. Kay Krill, President and Chief Executive Officer, commented,

Our results for the quarter were a direct result of our strategy to maximize gross margin performance by tightly managing inventories, focusing on full-price selling and controlling costs. I am pleased that our performance also reflects the cumulative benefits of our ongoing restructuring program initiatives.

I have been writing all along about the need to cut promotions, focus on protecting pricing and practice effective price management to deliver profit growth. But I am not fully convinced that price increase contributed to Ann Taylor’s profit growth. In fact they may have lost more than they gained from price realization and any profit growth was a result of their cost cutting. I will focus on the gross margin number when I say profit in this discussion.

Ann Taylor cut down on promotions and focused on charging full-price with the net result of increase in average prices. Another measure is inventory control. Total inventory per square foot at the end of the third quarter of 2009 was down 20.7% versus year-ago. If we assume (see note below) that this reduction can be equated with drop in volume of the same level, from the revenue change and volume change assumption we can compute that the average price increased by 10.6% (See end of this post). In other words 1% increase in price resulted in 2% drop in volume (price elasticity 2).

Their percentage gross margin  was 48.8% the previous year.

Loss of profit from drop in volume (due to increase in prices) = 20.7%*48.8% =  10.1% of  Q3-2008 revenue

Increase in profit from 10.6% price increase = (100%-20.7%)*10.6%   =        8.4%  of Q3-2008 revenue

This is a net loss due to drop in volume. Since their profit in Q3 2009 increased YoY, the profit increase is entirely due to cost control and other effectiveness measures in merchandising.

So did Ann Taylor make the right decision to improve prices? Could they have delivered higher profit by keeping their promotions and price levels? Unless there is a strategic reason to preserve brand premium and long term profit, this price increase was not a profit maximization move.

Footnotes:

On the volume drop  assumption, this could be wrong because sales volume is a flow metric while inventory was a point metric. But this  is inventory per square foot of store, so it is a good stand in for volume. Another possibility is that a portion of the 20% reduction is to respond to volume that is already lost due to recession (demand curve shift). If the price elasticity drops to 1 or low, then yes the price increase makes perfect sense.

Calculating price increase :

R = P * Q;       (P2/P1) = (R2/R1)*(Q1/Q2)  (R2=$527, R1=$462, Q2 = (100%-20.7%)*Q1)

Taxing Your High Volume Customers

When the pricing per unit is not uniform across all units and varies with quantity purchased, it is called non-linear pricing in economics. There are two main reasons a marketer will practice non-linear pricing:

  1. Customers have decreasing marginal utility with every additional unit and the price must change to reflect the reduced value. So if you are a maker of bottled water, you price your single bottle at one price and multi-pack at different price.
  2. Another reason is to reflect your decreased cost to serve the customer who buys high volume. Suppose you made and sold physical components, like the glass pane for LCD panels any customer buying high volume helps to defray  many different costs and  contribute to large proportion of your revenue and profits so you give a discount

Should you always decrease the price with volume? Non-linear does not mean prices will only decrease with quantities purchased, price per unit can increase as well.  There are three primary reasons for this:

  1. The value to customer increases non-linearly with the quantities they buy. For example, a $10 Mbps Internet connection enables new services that are of higher value than that is possible with a 7Mbps connection.
  2. The cost to serve the customer increases non-linearly after certain limit. For example, there is need for new investments or new costs that need to be passed along to the customer.
  3. Allowing the customer to consume high quantities comes at higher opportunity cost in the form of lost sales.

The third reason is exactly the case with cellphone providers. In a NYTimes article on Cellphone pricing plans, economists (surprisingly) described this as “weird”

“The whole pricing thing is weird,” said Barry Nalebuff, an economics professor at the Yale School of Management. “You pay $60 to make your first phone call. Your next 1,000 minutes are free. Then the minute after that costs 35 cents.

”To economists, it simply doesn’t make sense to make chatterboxes pay that penalty. After all, most businesses tend to give discounts to customers who buy more.

It is not weird if you look at how cellphone networks are provisioned. The way said cellphone pricing plans are structured is called three-part tariffs. At any given coverage area, served by one Radio Base Station, there is limited capacity. At any given time only so many users (voice or data) can be supported.  With all pre-paid subscribers a cellphone provider can size their system accordingly knowing how many total users they can support and based on call model how many simultaneous calls they can support.

Admitting a user to consume radio capacity beyond their allocated minutes will come at the expense of not providing service to other paid customers. Charging a higher unit price per minute will discourage those heavy users and nudges them to upgrade to next subscription level. When more such customers upgrade the cell phone provider can make additional investments in capacity.

There is nothing weird in not rewarding your high volume buyers. Cost reasons aside, if the value to the customer increases non-linearly your price should increase non-linearly as well, to capture a fair share of that value.

Careful what you ask for in WTP studies

In a seminal work titled “How the questions shape the answers” published in American Psychologist (1999), Norbert Schwarz describes how responses are influenced by question wordings, format and context. Schwarz writes,

“Self reports a fallible source of data and minor changes in question wording, question format or question context can result in major changes in the obtained results”

This is especially a more pronounced problem when it comes to survey questions that ask customers for their willingness to pay (WTP) for a product. When you directly ask a customer questions like:

  1. will you buy this product at  10?
  2. how much will you pay for product?  a) $4   b) $8   c) $10   d) $10    e)  $12
  3. will you buy this product if this were not offered free any more?

The researcher run the risk of getting answers that are not in any way  a true representation of what the customers will actually do. These kinds of questions assume that customers know how much they value the service and  customers are willing to disclose it. Another flaw in WTP studies is treating customer WTP as a fixed number in the minds of customers while it has been shown to be malleable (Thomas and Menon, Journal of Martket Research, 2006).

I saw a report from Forrester research on US customer WTP for online newpapers.  I admit I have not read the report but only their promotional blog post about it. The report claims 80% are not willing to pay for content From what I read I am not satisfied with study or its methods. The survey question was:

If the Web sites for the newspapers and magazines you read were no longer free, how would to prefer to pay for that content?

  1. Wouldn’t access them if I have to pay
  2. Subscription access to access all online content
  3. Subscription that combined print, web, and mobile device access
  4. Individual payment for each article read

The biggest flaw I find is anchoring – the question clearly reminds that the content has been free. The question  was too generic, asking  about newspapers and magazines you read and not about a specific newspaper or magazine. The respondents could be thinking of all newspapers, even those they read occasionally while answering this question.  There were no questions reminding respondents of value they get or to rank the online news sources by importance.   If the question had been,

If your most favorite newspaper cannot financially support the free online access, would you be willing to pay in one of the following ways?

  1. Subscription access to access all online content
  2. Subscription that combined print, web, and mobile device access
  3. Individual payment for each article read
  4. Wouldn’t access them if I have to pay

… the results would have completely different.

Based on their survey, Forrester  recommends:

  1. Publishers should continue to offer free, ad-supported products to the 80% of consumers who won’t pay for content online; and
  2. Publishers should offer consumers a choice of multichannel subscriptions, single-channel subscriptions, and micropayments for premium product access.

I do not agree. Even if we assume the 80% number is correct, does providing free provide higher profit than charging?  Do newspapers rally want higher reach (because of the Ad revenue)?

If a newspaper publisher really wants to find customer willingness to pay for content they need to do more targeted study of their readers,  use methods like Conjoint analysis to tease out the segments, how much customers in each value the product and focus on methods that help improve customer reference price before charging for content.

The net is the results are unreliable and Forrester’s recommendations are plain wrong.

Why are the Raspberry and Strawberry Yogurts Priced the Same?

You are walking along the dairy aisle, picking up Yoplait yogurts. You prefer the 99% fat free version, so you load up on some strawberry, some raspberry and some vanilla. The price? All of them priced exactly the same,  59 cents. (Let us ignore the one time promotions they run on one flavor to clear out the stock). After picking a dozen or so 99% fat free version you look up and find Yoplait Whips and it also has almost the same line up of flavors. Price? 79 cents.

  1. Why does the price vary across the types of Yogurt (let us call this vertical product line) but not across the flavors within a product line?
  2. Does it cost the manufacturer the same to make raspberry and strawberry yogurt? Should the cost difference be reflected in pricing?
  3. Do customers value the different flavors differently?
  4. Why does the price vary across product lines?
  5. Does a marketer stand to gain more profit by doing vertical line extension or by increasing variety within a product line?
  6. Can the marketer increase market share by increasing variety within product lines?

In their paper published in Marketing Science( Spring 2006, Vol. 25 Issue 2, p164-174) Stanford GSB professor Michaela Draganska and Kelloggs’ Dipak Jain asked just these questions and found the answers for the rest of us marketers.

We find that consumers value line attributes more than flavor attributes. Given that consumers value line attributes more than flavor attributes,  firms have a lot to gain by pricing their product lines differently whereas they have little to lose from pricing all flavors within a line the same. We also find that the value of a product line is not merely a function of the number of  flavors it includes: The calculated inclusive values indicate that more flavors do not always result in increased utility for consumers and hence higher market shares.

Firms’ profits would not significantly increase if they were to price  flavors within a product line differently. Therefore, the current pricing policy of setting different prices for product lines but uniform prices for all flavors within a line appears to be on target.

What does this mean to marketers? This tells what true versioning means, it is not just changing colors or toppings. Do not chase market share by making minor tweaks, this does not result in  profit increase. Strategy is about making choices. When in doubt about where to invest your R&D and marketing dollars, instead of expanding variety within a product line (horizontal versioning)  go for product line extensions (vertical versioning).