Optimal Pricing In Non-Asymmetric Distribution Channel

Optimal Pricing In Non-Asymmetric Distribution Channel

There is one big problem that can destroy any business, irrespective of the quality of its solutions or products: lousy pricing mechanism. In other words, you have either over-priced or under-priced. Pricing is not magical; you have to work on it. You can start high and keep tracking sales to understand how customers are responding. If they are responding well, it may be that your price is low. You may upgrade the amount a little and check outcome.

For digital startups, it is even easier: you can check how many items were left on the cart to ascertain the inertia to pull the buy-trigger. If there are many items in the cart, you may decide to lower the price and then over time check if the hold-outs in the carts have dropped. By working on that process, you will attain a pricing optimality where the price and the product demand have attained equilibrium.

Yet, in the Internet age, there may not really be anything as optimal pricing because the distribution is unbounded and unconstrained which means that customers can see your competitors’ prices. Even if you are marginally higher, they could be moved to buy from the competitor. This brings a big challenge: how to make sure that you are price-aware and relevant in the age when pricing has become dynamic with software that set them, with instructions to match or beat an authentic price across the web. Your software has insights on the prices maintained by your competitors and quickly looks for ways to beat them. Internet has removed the information asymmetry because everything is available for robots to see online.

To understand the importance of pricing, Amazon during this holiday season will extend its price-matching to even 3rd party sellers on its platform. That means, after merchants have set their prices, Amazon can lower the prices to ensure the items sell. And when the items sell,  Amazon will cover the discounted price from its own money.

That might sound like a technical distinction, but it’s critical to a new discounting technique Amazon is deploying ahead of Black Friday and the holiday season. “Discount provided by Amazon” lets the company subsidize goods sold by third-party merchants on its online marketplace, making prices even more attractive to customers

“Amazon may fund a discount to customers beyond your item price on select products,” states a short message on Amazon’s “Seller Central” forum. “In these instances, you will receive payment for the order and pay referral fees based on the full item price you set.” (Sellers on Amazon pay “referral fees” to the company on items they sell.)

[…] The Wall Street Journal, which reported on the program over the weekend, said sellers claimed they weren’t alerted to the change.

According to the Journal, Amazon has lowered prices from third-party sellers by as much as 9%. For example, the Journal said a Boots No7 Instant Illusion Wrinkle Filler sold by kn9ght had been marked down 6% to $19.99, while a Risk Legacy board game sold by VirVentures was down 6% to $43.92, slightly less than the price offered by Walmart.

This does show that winning in this age of unconstrained distribution channel will require a lot of offering low margin products, if the goal is to attract customers. The alternative will be to create highly differentiated products which will be unique to a specific platform. But even with that, it makes sense to find ways to keep cost low.

I like how Jay-Z has managed to keep its concerts very popular, through cheap tickets to the masses, but extremely expensive pricing for the VIP sections. So, with that, Jay-Z sells a ticket for $6, severely subsiding it from thousands of dollars it charges those that actually have the money to pay for VIP seats. Finding a way to execute such in your product offering will bring success. You still need growth even as you need to boost revenue. That level of balance is catalytic and only possible when the expensive offering can bring value to entice the customers.

The Lesson Here

In the age where we do not have information asymmetry, typical when decisions in transactions are made with one party having more or better information than the other, we have to innovate for the balance between revenue and customer growth. There is the possibility that you can have a product online and after one month, no one has bought anything from you. The problem may not be the product, it is likely that customers have access to information that your pricing is off mark. And in the web, the switching cost is small, and that means they can buy from others without suffering any undue extra pain in the process.

That first customer, for a product or solution, is very critical, and to make that happen, experimentation on pricing is vital. You must find how to make that happen. As Jay-Z pricing strategy shows, the cheap tickets provide the ecosystems for the rich guys to have fun and be celebrated. Those rich guys will not pay the big money if there will not be people in the concerts. So, technically, the cheap ticket holders seed the opportunities for Jay-Z to command that level of price from the rich concert goers. This is a win-win: the non-affluent people get the cheap tickets and provide the buzz for the rich guys to have fun in the VIP sections. At the end, Jay-Z adds more millions in his bank accounts

This is unlike airlines which do not have any major correlation between economy and first class. They can fly the first class people even if they do not have enough people in the economy class. But in concerts, if you have 20 people that paid $10,000 each, without others joining in the show, there is no game. You need the $6 payers to bring the fun in the concerts. Jay-Z is innovating based on this pricing engineering. The $6 is so low that anyone can come to fill the stadium and create an atmosphere for lovers of concerts.

Amazon has already made it clear that it wants all ecommerce shopping destinations to end on its portal. There is nothing again to be written because Amazon is ready to lose money and profits to gain or keep market share. How do you compete against such competitors? The only option is to offer something that is unique and differentiated which cannot be price-matched because it is exclusive to you. I do believe that differentiation will be the new normal, for competitive startups, since big companies are using their sizes as their most important competitive capabilities. When you innovate and differentiate, you put a separation that cannot easily be compared and price-matched.

Go back and think on your pricing, and make it a learning science. There needs to be a number that kicks in the equilibrium for sales to happen, keeping customers happy while the bank accounts grow.

 


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2 thoughts on “Optimal Pricing In Non-Asymmetric Distribution Channel

  1. Insightful piece, Prof.

    Amazon’s new pricing strategy must be really hairsplitting for its competitors! Even differentiation won’t be a cheap investment. There is no doubt they got work in their hands.

    Jay-Z’s pricing strategy is pretty smart. Of course we get to see this kind of optimal pricing in the entertainment sector, particularly with shows, but the difference between $6 and thousands of dollars is huge! The question then is this: Are ‘VIPs’ in every industry? I’m thinking of a learning platform for instance.

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