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.

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.

Wi-Fi In Airplanes – Stuck in $0 Reference Price

Update 2/1/2010: Southwest planning to offer Wifi (for a price). It definitely will help them to read this.

How much is getting Internet connectivity at 30,000 feet above sea level and while moving at 240 miles per hour worth to you?  How much are you willing to pay for it? How much are you willing to pay for WiFi connection in an airplane?

I predict that most will say different numbers  for these questions, progressively decreasing from a non-zero number to none other than $0 for the Wi-Fi question. The Wall Street Journal writes on the uptake of Wi-Fi in airplanes:

“There’s a very substantial decline in passenger usage the minute you start charging for the service,” said Michael Planey, a consultant specializing in in-flight passenger technologies. “It really begins to invalidate the model on which this service is being built for the next 10 years.”

wifi_demanAlaska Airlines found that even at a price of $1 lot fewer people used its service then when it was free. So the demand curve for this service will look something like the one shown here, dropping abruptly at a price just above $0.

Having connectivity is definitely of value to customers, some segments valuing it more than the others. But why are customers unwilling to pay for this value? The answer once again is the same one I showed in my Airline Unbundling study – Reference Price. Reference price is the price a customer used to paying for the service or expects to pay despite the value they get.  The purchase context does not matter to the customers, it is the price for the service. Everywhere they go, from coffee shops to hotels they received free Wi-Fi. So their reference price is $0.

The airlines should not have made this offer free to begin with but they need to do that for testing. They should have recognized this reference price effect and should have first worked on improving it before charging for it. One option I showed that worked in the unbundling study is introducing options, one high priced and another low priced. Presence of high priced option helps to improve reference price and hence customer acceptance of lower priced option. The airlines could have introduced a guaranteed speed, unlimited bandwidth version and a limited speed, limited bandwidth version at two different price points.

Another takeaway in this story is how a marketer can destroy future profit by setting a low (or $0) reference price. I am afraid however that this story is going to be  used by “Free” proponents like Mr. Chris Anderson. A case will be made about why free is the future and once again a reference will be made to the attractiveness of  $0 price, quoting Prof. Ariely’s work. I would like you as a marketer to be aware of the reference price effect and find ways to charge for this service that adds value to customers.

It is true that providing Wi-Fi at 30,000 feet is a high fixed cost operation and once you rolled out the service your costs are sunk and your marginal costs are $0. But before you made the business case for the investment the costs were not sunk and you should have made an analysis how much you expect to charge and how many customers would pay. You should not have invested with the hope that you will first get the customers and then figure out how to monetize it.

The net is, if the service is of value to customers then you should charge for it. What the customers are willing to pay for the service is not commensurate with value but lower because of the reference price. Focus on improving the reference price to capture a fair share of the value you add.

Lowering Prices To Generate Sales?

Here is another CEO who clearly believes lowering prices does not automatically guarantee  sales increase: Macy’s Terry J. Lundgren.  In his inteview with The Wall Street Journal, Mr. Lundgren  said,

WSJ: Do you think about lowering your average selling price or changing your product blend, as some of your competitors have done?

Mr. Lundgren: Here’s the challenge. We have [a men’s pants brand], and they typically go out the door between $29.50 and $32.50, with all the coupons and everything.

What Mr.Lundgren refers to as “out the door price” is the “pocket price“, the net price after all discounts. The net effect of the discounts and coupons is price leakage that erodes profit, clearly Mr. Lundgren is driving Macy’s to focus on its price waterfall.

Mr.Lundgren’s management serve as the best case study so for on the three components of effective price management:

Knowing the value add to segments:

Our purchasers are women. She’s spending the same amounts but just shopping with a great deal of discretion. Value is the word, even if it’s at regular price. The intrinsic value of what she’s buying is very important.

Incremental analysis: How much should sales rise to compensate for loss in profit from price cuts? (Lundgren is on the direction but he is comparing top-line while he should be doing incremental math on lost profit. There is also numbers error as pointed out by the commenter.)

So we were getting tremendous sell-through at low price points and no margins. And I am not making my pants sales for last year, because my average sale dropped by 30%. It’s really hard to make the math work. I have to have 30% more transactions on this product to break even.

Customer Margin: Understanding that loss leaders are effective only if they help generate incremental profit from customers who are attracted to the stores by low prices of loss leaders.

We and the manufacturer together agreed to mark them (pants) down to $21.99 or something like that. Selling like hotcakes. Every other pants around them stopped selling.

Does your business practice effective price management?

What is Price Realization?

[tweetmeme source=”pricingright”]

JCPenney Pricing Waterfall
JCPenney Pricing Waterfall

It is time to give some definitions of pricing terminologies, specifically definitions of Price Realization, Price Leakage, Pocket Price and Pricing water fall.  I will explain these concepts in the B2C context (a retailer), for a B2B explanation see this. Seen above is a picture that shows the pricing for a queen mattress at a JCPenney store. The prices and discounts are taken from a store visit. (Note that I did not consider interest income earned from credit card balance.)

List Price: Price is the method to capture value added by a product. The most common way to indicate prices to customer is the list price, be it price tags in retail or invoice price in B2B transactions.

Price Leakage: Unfortunately, both in B2B and B2C scenarios, a business is unable to get the customer to pay the list price. Due to sales pressures, competitive offerings and other macro-economic factors, the prices are marked down. Different discounts applied to the list price are referred to as Price Leakage. In the figure above, price leakages are show in color red. Last week JCPenney was running a 50% off sale with an additional 15% customer appreciation coupon. On top of these if a customer were to open a store credit card they gave an additional 10% off. JCPenney is also running a frequent shopper program called JCPRewards that gives back $10 for every $250 spent.

Pocket Price: The pocket price, the price finally collected after all applicable discounts, is significantly less than the list price. This is still not profit, because it does not include sales commission (if any) and marginal cost of the item sold.

Pricing Waterfall: The picture says it all.

Price Realization: Price realization is about decreasing price leakage, increasing pocket price  and hence keeping a higher proportion of the list price that flows directly to the bottom line (profit).   Price realization can be in the form of  higher list price, fewer discounts, additional charges or decrease in service offered (see Cadbury’s methods on this).

Effective price management is about moving away from price leakage to increasing the pocket price through price realization.

But is JCPenney leaving money on the table or is there more to this than it meets the eye?

Defusing Customer Backlash From Price Increases

My previous consumer behavior experiment led me to conclude that customer backlash to pricing changes stem from the reference price, the price they used to pay or a service despite the value they get. Recently I saw a blog post about Frontier Airlines by Mr. Andrew Hyde regarding its changes to standby policy. Frontier now charges a fee for going standby on an earlier flight. Before they did that they did not allow standby on earlier flights, this had caused Mr. Hyde to revolt and even say that he would never travel by that airline.

Mr.Hyde, as he points out in the comment, did not object to price increase per se and contrary to what I wrote earlier his objection was to change in policy without notice.  The net is customers will be less than willing to pay for services that used to be free because their reference price is $0.

This situation is no different from the customer backlash faced by US Airways before it decided to drop its $1.99 drink fee. It makes perfect business sense for Frontier to charge for this service regardless of the  costs associated with admitting a standby passenger on a partially empty flight. Frontier should have recognized the reference price effect if they were were planning to charge for the standby before they denied it to some. They should have  first worked to improve this from $0 to a positive value before introducing the price changes.

For instance, it could have sent all its travellers (anyone whose email address it has, past, present and future) a coupon or two for “Free standby”. Stated clearly in that coupon is the price of the standby and the value those customers get by using the coupon for a standby. This would have cost them nothing more than the cost of sending out the coupon but the effect is to improve the reference price of the standby service from $0 to the dollar amount marked in the coupon.

A business simply cannot ignore the effects of reference price and should actively work to manage it.