lecture 5

Question 1

what are the Properties of digital goods

Answer 1

1. Digital goods can be easily replicated
2. Digital goods can be easily distributed
3. Digital goods have an unusual cost structure

Question 2

explain the point that Digital goods have an unusual cost structure

Answer 2

• High cost of producing the first copy (high fixed costs)
• Low or zero costs of producing the second, third,… (low variable costs)
• Creation costs are ‘sunk’ (and not easily recoverable)
• No capacity-based limitations on production

So, digital goods are costly to produce but inexpensive to reproduce

Question 3

what are the Forms of Differential Pricing

Answer 3

Personalized pricing
Versioning
Group pricing

Question 4

what is Personalized pricing

Answer 4

– Sell to each user at a different price

– IT can better enable personalized pricing (e.g., purchasing pattern)

Question 5

what is Versioning

Answer 5

– Offer a product line and let users choose

Question 6

what is Group pricing

Answer 6

– Based on group membership/identity (e.g., student discounts)

Question 7

further explain Personalized Pricing

Answer 7

 Know your customer
– Directly (e.g., registration) and indirectly (e.g., clickstream)
 Personalize both product and pricing
– How travel agents personalize: put together a travel package for clients
interested in deep sea fishing that includes luxury hotels and services.
 Use promotions to measure demand – Market research is inexpensive on the Internet

Question 8

further explain Versioning

Answer 8

Different products, different prices
 LexusNexus offers a different price to each class of users (corporate, small biz, gov. edu) time of access (evening or day), how much you use the database (volume discount)
 Different products with varying product quality (offer full product line with different versions matching different needs)
 Maximize both value to customer (y-axis) and your share of this value (x-axis)

Question 9

what are the Common dimensions of versioning

Answer 9

 Comprehensiveness (all vs. selected features; v. low incremental cost
 Timeliness (current vs. delayed stock quotes; hard-cover vs. paperback; early adopters willing to pay more)
 Access channel (web-based vs. offline)
 Convenience (full-week rental vs. two days)
 Resolution or sound quality (e.g., basic vs. gold subscription to networking site)
 Annoyance (nagware in shareware to remember to pay)
 Speed (IBM installed chip to slow printers!)
 Support (commercial OSS vs. free OSS)

So you need to version and price information products according to factors that discriminate among customers

Question 10

further explain Group Pricing

Answer 10

Same product, different prices for different groups

 Identifygroupswillingtopayless,offerthemlowerprices  Need to be able to identify group membership easily

Question 11

Examples of group pricing

Answer 11

Wall Street Journal, Microsoft Office, movie tickets, magazines,…

Question 12

explain Group pricing and digital piracy

Answer 12

 Piracy lowers a consumer’s willingness to pay

 Identify ‘high-piracy’ groups, offer them lower prices

Question 13

what is Bundling

Answer 13

 Offering two or more products where at least one
product is provided at an incremental price less
than its stand-alone price
 Different customers value different features
differently - willingness to pay for the bundle is less dispersed than the willingness to pay for the components
 If you can’t figure out who values what, bundling is useful…

Question 14

explain Network Effects

Answer 14

The value of a product or service increases as the number of users grow (more users = more value)

Question 15

When network effects are present what happens

Answer 15

– The value of a product or service increases as the
number of users grows
– They’re among the most important reasons you’ll pick one product or service over another

Question 16

what are One-sided markets

Answer 16

– Comprised of a single class of users
(e.g., IM users)
– Same-side exchange benefits

Question 17

what are Two-sided markets

Answer 17

– Comprised of two distinct categories
of network participants (e.g., game
console owners & game developers), both of which that are needed to deliver value for the network to work
– Cross-side exchange benefits

Question 18

what is Network Effects aka

Answer 18

Network externalities

Question 19

what is Metcalfe’s Law

Answer 19

The value of a network increases in proportion to the square of the number of participants

Question 20

Network externalities
 Metcalfe’s Law: The value of a network increases in proportion to the square of the number of participants.
 Creates a virtuous cycle: what is it

Answer 20

– eBay’s success attracts more success
– Netflix had a new way of reaching customers – Long Tail Business
– eBay different in new way of reaching sellers – Long Tail in item availability.

Question 21

summarize network effects

Answer 21

 More units consumed –> higher value per unit  Success feeds on itself, ‘winner takes all’
 Expectations are important

Question 22

what is Positive feedback

Answer 22

when a firm becomes successful, its past and current success make it likely to succeed in the future
 ‘…success feeds on itself, the strong get stronger…’

Question 23

when does positive feedback happen

Answer 23

 Morecustomers->lowerunitcost(supply-sideeconomiesof scale)

 Morecustomers->larger‘network’->morevaluableproduct (demand-side economies of scale)

Question 24

what are the Possible consequences of positive feedback

Answer 24

 Dominance of a single firm or technology (MS Windows)
 Dominance of an inferior technology that got an early lead (Beta
vs. VHS)

Question 25

what is Collective Switching Costs

Answer 25

* Network effects lead to substantial collective switching costs * Even worse than individual lock-in (investments, social norms, psychological effects) * Due to coordination costs * Example: QWERTY (slow typing to reduce jam)

Question 26

what are the Sources of value for network effects

Answer 26

Exchange Staying power Complementary benefits

Question 27

explain Exchange

Answer 27

A product/service becomes more valuable when more users join because its users can communicate with more people

Question 28

explain Staying power

Answer 28

– Products/services with greater numbers of users have a stronger long-term viability. – Switching costs enhances staying power.

Question 29

explain Complementary benefits

Answer 29

Products/services that add additional value to the network

Question 30

How are network markets different?

Answer 30

 Early, fierce competition  Winner-take-all  The best product/service doesn’t always win

Question 31

explain Early, fierce competition

Answer 31

– Because “Tipping” can be remarkably swift due | to network effects. (e.g., Blu-ray vs. HD-DVD)

Question 32

eplain  Winner-take-all

Answer 32

– Natural monopoly  The major player can charge customers more and  Can enjoy substantial bargaining power over partners

Question 33

explain  The best product/service doesn’t always win

Answer 33

– Inferior products that move first may dominate | E.g., PS2 vs. Xbox

Question 34

what are Strategies for competing in markets with network effects

Answer 34

 Move early (Yahoo! Auctions vs. eBay in Japan)  Subsidize product adoption (PayPal)  Leverage viral promotion (Skype, Facebook feeds)  Expand by redefining the market (Nintendo Wii) – Or through convergence (iPhone)  Alliances and partnerships (NYCE vs. Citibank)  Leverage distribution channels (Java with Netscape; Microsoft bundling Media Player with Windows)  Seed the market with complements (Blu-ray DVD player in PS3 console; Adobe Acrobat reader)  Encourage the development of complementary goods – Offering resources, subsidies, free services (Microsoft; Apple) – Venture capital (Facebook’s fbFund)  Leverage backward compatibility – Provide adapter (Intel- & Power PC-based Mac; Bootcamp)  Rivals: Be compatible with the leading network (Microsoft’s Live Maps and Google Maps)  Incumbents: Close off rival access and constantly innovate (AOL; Skype; Mac vs. Windows)  Large, well-known followers: Pre- announcements) – Cause potential adaptors to delay a purchase decision – Only work if a firm is large enough to pose a credible threat to current market participants – Timing is important (not too early)

Question 35

The performance of a new technology is likely to be better if:

Answer 35

 It is a radical departure from an existing technology |  It does not attempt to build in compatibility with the existing technology

Question 36

The performance of a new technology is likely to be better if:  It is a radical departure from an existing technology  It does not attempt to build in compatibility with the existing technology However:

Answer 36

 Adoption is more rapid if the technology is backward compatible  Network effects aren’t much use if nobody migrates to your technology`

Question 37

A firm benefits from generating network effects if it:

Answer 37

* Is the only supplier of the product (control) | * Tries to get a very large user base rapidly (openness)

Question 38

A firm benefits from generating network effects if it: • Is the only supplier of the product (control) • Tries to get a very large user base rapidly (openness) However:

Answer 38

* Adoption is more rapid with open standards | * Profit margins are much higher with proprietary standards