HowDigitalDisruptionChangesPricingStrategiesandPriceModelsTobepublishedinKhare,A.,Stewart,B.&Schatz,R.(eds.),PhantomExMachinaDigitalDisruption’sRoleinBusinessModelTransformation.Springer2016AndreasKrämerandRegineKalkaAbstractThedigitizationoftheeconomyleadstosignificantchangesinthewaycompaniesdeterminetheirprices.Technologicalchanges(availabilityoftheInternet,digitizationofproduction,productinnovations)basicallyinfluencethecorporateenvironment,sincethebasisforpricingcanbeimproved.Companiescancollectandanalyzemorerelevantinformationandhenceoptimizetheirprices.However,thesecausesacceleratecompetitivereactions.Ontheonehand,consumerbehaviorchanges(moreinformationisavailableonline,search-enginesandpricerobotshelptofindbestoffers),ontheotherhand,marketstructuresbecomefragile(marketentrybarriersfornewcompetitorsarelowered,traditionalproductsarecannibalizedbydigitalproducts).Duetothesefactorsthepricingstrategymustundergoacompleterethink.Inaddition,thishasconsequencesforthetypesofpricingmodelsappliedinthedigitalage.Inthiscontext,thispaperfocusesonfourpricingmodels.Firstly,thedigitizationmakesitpossibletoofferproductsandservicesforfreetotheconsumer(FacebookandGoogleareparticularlyprofitableexamples),whileatthesametimeothersourcesofrevenuestreams(here:advertisingrevenue)aregenerated.Secondly,freemiummodelsareespeciallypopularwithstart-ups,whicharealsofreeofchargeforabasicservice,butforupgradedservices(fullrangeoffeatures,noads)userspayafee.LinkedIn,DropboxorSpotifyareprominentexamplesofthispricingmodel.Thirdly,subscriptionmodelshaveastrongboost.Sinceproductioncostsdropwhennewbusinessmodelsarebasedondigitization,subscriptionmodels(likeNetflix)–whichhavealongtradition–becomemoreattractive,nowadays.Fourth,pricingmodelswithflexibleprices,whicharedependentondemandandcustomerprofilewillbediscussed.Dynamicpricinghasagrowingimportanceinonlinetrading,butisalsobeingappliedmorefrequentlyinretailstores.Thispaperexaminestheimplicationsofdigitizationonstrategicandoperationalpricingdecisionsandshowsexamplesfromvariousindustries(retail,media,music)andenterprises.Thelimitsoftechnologicalchangesarealsodiscussed,mindfulofbothaspectsthecompanyperspectiveandtheperspective(andperception)ofthecustomer.Keywords:BigData,freemium,dynamicpricing,one-to-one-pricing1.0 GoodreasonstorethinkthecurrentpricingstrategyAfrequentlystatedkeyobjectiveofpricingstrategiesismaximizingsellers’profitsbycapturingconsumers’heterogeneousproductvaluationsandaccountingforcompetitionandcannibalization(Kimetal,2009;Simon,2013).Furthermore,consumers’willingnesstopayandreactionstodifferentpricingstrategiesmaynotbepurelyrationalbutratherdrivenbybehavioralaspects,suchasperceptionsandpreferences.Therefore,consumers’perceptionsofdifferentpricingmodelsmaybeanadditionalopportunityforcompaniestodifferentiatethemselvesfromcompetition(byapplyingapreferredorinnovativepricingmechanismthatisnottypicalfortheindustry).Today,formostbusinessesandmarketscustomerloyaltyandcustomerrelationshipmanagementhavebecomekeycompetitivefactors.Duringtheprocessofoptimizingpricesitisoftenassumed

thatthemarketiscomposedofsingletransactions,missingtheperspectiveofadynamiccustomerrelationshipwiththecompany.ThereforeKrämer(2015)proposesawideneddefinitionofoptimalpricing.Thisshouldincludethecustomer’swillingnesstopayaswellastakingintoaccounttheeffectsoncustomerloyalty,andfuturegrossmarginsgeneratedbyindividualcustomersintermsofcustomerlifetimevalue.Thereareseveralmajorfactorsmotivatingacompanytorethinkit’spositioninganditspricingstrategy:(1)excesscapacitiesraisethequestion,whethertherearewaystosignificantlyincreasesales.Inadigitalcompanytherearealmostnocapacityconstraints(atleastintheshortrun).(2)Managersincreasinglyfacetheriskofcommoditization.AsarecentstudyofRolandBerger(2014)shows-60%ofmanagersbelievetheyarecaughtina"commoditytrap"(asituationwhereevencomplexproductsandservicesaredowngradedto"commodities",withlimiteddifferentiationandacompetitionthatisprimarilyprice-based).Therefore,decisionmakersarelookingfornew(unconventional)waytosetprices.(3)Inmanynewmarkets,loweringpricesmakesthemarketgrowmorequickly.Thelowerthepriceis,thestrongertheadditionaldemandeffect.Forfirmsthatdonotfeartheriskofrevenuecannibalization,radicalpricereductionscouldbeanoptiontoattractnewdemand(KrämerandBurgartz,2016).Asaconsequence,itisstatedthatmanagersinmarketingandsalesincreasinglyseethemselvesexposedtostrongerpricecompetitionandevenpricewars(Bertini,2014).Essentially,therearefourpricingmodelsthatcharacterizethedigitalworldandhavethemselvesledtoacertaindisruptioninpricing:(1)Thefree(nocharge)offering,(2)thefreemiummodel(createdfrom“Free”and“Premium”),(3)thesubscriptionmodeland(4)dynamicpricing.Thediscussionbelowwillfocusonthesemodels.Nevertheless,otherpricingmethodshaveevolvedintheInternetage,whichare,however,lesswidespread(Figure1).Figure1–Impactofachangedcorporateenvironmentonpricingmodels

Onetrendistowardsparticipativepricing,whichgivescustomersmoreoptionstoacquireagreaterinfluenceonthesettingofprices(KrämerandBurgartz,2016 ;BertiniandKoenigsberg,2014).Themostprominentexamplesofparticipativepricingmechanismswithhorizontalinteractionareauction(classicauctions,reverseauctionsandexchanges)negotiations,inwhichthebuyerandsellerhaggle

Positioning and pricing

strategy

Technology

Data Consumer Behavior

Competitive Pressure

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B2C) Freemium Subscription

model Dynamic pricing

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Your-Own-Price” Auctions Provision /

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(prevailing)

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Digitization Commoditization

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pricing

overthepricefortheproduct;eBayiscertainlythemostprominentexample.Pay-What-You-Want”(e.g.openbooks.com)and“Name-Your-Own-Price”(e.g.priceline.com,bandcamp.com)arebothcharacterizedbythebuyersettingthefinalprice(Kimetal.,2009).Thesubjectiveevaluationofwhetherthepriceisadequatefortheperformanceandrepresentsfairvalueisthemainfactorinfluencingthefinalprice.2.0 PrevailingpricemodelsforthedigitaleconomySubsequently,firstapricingmodelispresented,whichisparticularlyextremeinitsdesign:amodelwherethepriceoftheproductorservicesiszero.Basedonthismodelanextensionisconsidered,theso-calledfreemiummodel.Incontrast,modelssuchassubscriptionfeeanddynamicpricingaremoredrivenbytheobjectiveofexploitingtheconsumers’willingnesstopay.Thisisparticularlytrueforanextremeformofdynamicpricing,whichusescustomerdataandprofilesinordertodevelopanapproachforone-to-onepricing.2.1 ForfreeAkeyobjectiveofinnovativepricingmodelsistoactivatelatentdemand.Toofferutilizationofaproductorservicewithoutbeingchargedseemsparticularlyeffectiveforattractingnewcustomers.Oneissue,oftenpointedoutfrombehavioraleconomicsisthatbenefitincreasesdisproportionatelyduringthetransitiontoazero-priceoffer("forfree").Ariely(2014,p.107)describesthisphenomenonasfollows:"Zeroisalmostanotherworld.Thedifferencebetweentwocentsandonecentissmall,betweenonecentandzerocents,however,enormous."Onestrategy-perfectlyexecutedbyGoogle-istochargethirdparties.Thefirststepwastoofferanoutstandingsearch-engineforfreeandtogeneratevaluetothecustomer,whichledtoanenormousflowoftraffic.In2015,mainlyduetoadvertisingAlphabet(Google)earnedprofitsofalmost$16bnaftertaxes,basedon$75bnrevenues.WhenGmailintroduceditsfreeservicein2004itprovided10timesmorestoragethanYahoo,theleadingprovideroffreee-mailatthetime.Yahoo,theleadingprovideroffreee-mail,respondedtoGoogle’sentrybymatching,andthenexceeding,Gmail’sfreestorageoffer.AnotherexampleisFinnishtelecommunicationscompanyBlyk,whichoffers200freecell-phoneminutesamonthto16-to-24-year-oldswhofilloutasurveyandagreetoreceiveads.Blykthensellsaccesstoitscustomers,,andinformationaboutthem(DyerandHatch,2011).Anotherstrategymaybetoofferaproductfreeofchargeinthemarketinordertocreateanewmarket(forexample,asalaunchaction)ortostimulateadditionaldemandinoff-peakperiods.Megabus,aleadingsupplierofintercitybustripsusedthistrickwhenenteringtheGermanmarket(Krämer,JungandBurgartz,2016):itproposedtosupply20,000freeticketstogetintothemarketinJanuary2016(onlythepaymentofatransactionfeewasrequired).Bla-Bla-Car,aFrenchstart-upcompany,whichofferscarride-sharinghasafreeofchargeserviceinGermany,whileinFranceaprovisionalmodelwasestablishedoncethemarkethaddeveloped.Basically,theofferofafreeserviceseemsparticularlyattractiveforthestartofthelife-cycleofaproduct(launchingoftheproductfree,andlatercharginganormalprice),anextremeformofPenetrationStrategy.However,therearecounterexamplesaswell.ThusWhatsApp,theleadingsupplierofmessengerservices,announcedearlyin2016itwasabandoningits99-centsubscriptionfee.Obviously,thesubscriptionsystemintroducedin2013hadbecomeratherabarrier,preventingthecompanyfromgrowingfastenoughduringitsglobalexpansion(thevolumeofusersexceededthethresholdof1billionin2016).However,thecompanypledgednottointroduceads,andinsteadhopestofindawaytomakefirmspaytoconnectwithcustomersusingtheapp.Othercompaniesusefreeservicesasanintegralpartoftheirproductrange.GermanRail(DB)providesfreetraintravelforchildrenuptotheageof14,ifaccompaniedbytheirparents.Onthe

onehand,suchanofferalwaysincludestheriskofrevenuecannibalization,ontheotherhand,risksarelimitedhere.Furthermore,thefreetravelofchildrenleadstoanon-linearpricingofthefamilyjourneyandtherebyimprovesthecompetitivepositionofDB.Obviouslythemainadvantagesofofferingproductsandservicesforfreearetheattentiongainedandtherapidgenerationofcustomersbyreducingoreveneliminatingtheirfinancialrisks.Byusing“pricingforfree”companieshaveapowerfulmarketingandaneasysalespromiseandcanachieveagoodmarketpositionintheshort-term.But,ofcourse,therearerisks,whichneedtobetakenintoconsideration.Consumerscouldhavetheattitude“whatcostsnothingisworthnothing”.Thisattitudedependsonthesubjectivevalueoftheproductand/orservices,andhastobeevaluatedbythecompanywithregardtotheirbrandidentityandportfolio.MoreoverastudyofShampan´erandArielyshowedthatinthezeropriceconditionstestpersonsweremorelikelytochoosealessattractiveproductthantopayareducedpriceforahigherqualityandmoreattractiveproduct.Bytestingseveralpossiblepsychologicalantecedentsofthiseffect,theyfoundoutthattheaffectisthemostlikelysourceandconclude“Ingeneral,thisresearchjoinsalargercollectionofevidence,showingthatzeroisauniquenumber”(Shampan´erandAriely,2006).Themostimportantdriverofthesuccessofthispricingmodelistofindawaytocrossfinancethezeropriceproduct.Asshown,themostsuccessfulstrategiesareeithertochargethirdparties,tocreateanewmarket,ortouseitasintegralpartoftheproductrange.2.2 FreemiumThedigitizederahasnotonlyspawnednewbusinessmodelsandproducts,butalsonewpricingmodels.Duringthelastdecade“freemium”—acombinationof“free”and“premium”-hasbecomethedominantbusinessmodelamongInternetstart-upsandsmart-phoneappdevelopers.Users,whoarejustinterestedinabasicproductorservice,receiveitforfree.Ifaservicewithhigherqualityispreferred,theusercanoptforasubscriptionfee.Nowadaysonlinemusicprovidersofferthepossibilityoflisteningtoanalmostunlimitedrangeofsongssimplybyfreeregistrationforanonlinemusicaccount.Thechallengefortheprovider,whichcoversthecost,istofindawaytocross-financesuchoffers.Oneoptionistoembedadvertisement;anotherisafreemiumapproach,apopularpricingmethodduetoitsuser-friendliness.Today,wefindvariousInternetservicesbasedonthefreemiumconcept–suchasLinkedIn,Dropbox,orSkype(Kumar,2014)andthemajorityofthesmart-phoneappsarebasedonthisconcept.Thereareobviousadvantagesofafreemiumstrategy.First,freefeaturesareapotentmarketingtool,whenbasicfeaturesofferedforfreemeetfundamentalconsumerneeds,suchas:freemusic(Spotify),freecloud-basedstorage(Dropbox)orfreecalls(Skype),andfreeservicesareconveyedinthesocialnetworksasaninstrumenttodistributenewservicesquickly.Secondly,itallowsnewventurestoscaleupandattractauserbasewithoutexpendingresourcesoncostlyadcampaignsoratraditionalsalesforce.Forventurecapitalistsitisanattractiveproposaltoseeabusinessgrowathighspeedandatthesametimegeneraterevenues.Herethesubscriptionfees,typicallychargedmonthly,comeintoplay,sincetheybecomeasustainablesourceofrevenue.Dropboxattracted200millionuserswithasimpleservice.Providedacustomerhasausernameandpasswordandthusauniquelogin,twogigabytesofcloud-basedstorageisprovidedforfree.Ifusersperceivethestoragevolumeastoolimited,theycanpay$9.99amonth(or,alternatively,$99ayear)for100GBofstorage.Hencethebusinessmodeltargetsatleasttwodifferentcustomersegments.Thefirstsegmentissatisfiedbytheadequacyofthefreeversionforbasicdocuments,thesecondsegmentneedsmorespacesincecustomersuseDropboxprofessionallyorbackuplargefiles(music,photos).Byacceptingthesubscriptionfeepeoplebelongingtothesecondsegmentcreateacashflowthatisnecessarytocross-financethefirstsegment.Althoughthereisacertainwillingnesstopayeveninthefirstsegment,Dropboxleavesthefullconsumersurplusontheuserside.

Oneimportantsuccessfactorforthefreemiumconceptis,therefore,toincreasetheconversionrate(orreducethecorrelationbetweenuserswhopaynothinganduserswhopaythesubscriptionfee).However,ahighconversionratecouldalsobecounterproductive(Kumar,2014).Acceptingthatoneofthebenefitsofafreemiummodelistheabilitytogeneratetraffic,meansthatasignificantbasiccustomervaluedeliveredforfreeisrequired.Additionally,thesuppliermustfindawaytomakeitsservicedistinctiveandcreateadditionalvalue.Anotherimportantpointiseasilyoverlooked:thelargenumberofuserswhodonotpayforperformance,notonlygeneratecostsbutarealsoanasset,fortheyincreasethecompany´sgoodwill(animportantfactorwhenmeasuringcompanyvalueisthecustomerbase).WhileSkypeattracts400millionusers(manyofwhombecomepayingcustomers)Flickr,thefreephoto-sharingsite,hasamuchsmalleruserbaseandalowconversionrate.ThispartiallyexplainswhyeBaypaid$2.6billionforSkype(in2011Microsoftevenpaid$8.5billionincashtoacquireSkype;thenumberofusersamountedto660millionatthattime),andYahoopaidlessthan$30millionforFlickr.Furthermore,theselleralsohasunlimitedpossibilitiestogaininsightintotheirconsumersbyobservingtheusagebehaviorortounderstandcustomerbehaviorbetter(forexampleSpotifycanidentifywhatkindofmusicaspecificsegmentsprefersorsharesandcategorizescustomersbasedonthoseinformation,andcanusethesamedatatodefineupsellcampaigns(LinkedInoffersafreepremiumaccountortheoptiontouseLynda.com,aservicethatprovideseducationalvideos,foralimitedperiodoftime).2.3 SubscriptionThesubscriptionsmodelincludingayearlyormonthlypaymentdoesnotconstituteatrulynewformofpricing.Evenbeforethedigitalage,companiesusedsubscriptionseithertogeneratecustomerloyaltybyofferingsubscriptions,ortoachieveabasicutilizationofproductionandmarketingcapacities.Theunderlyingpricelogicofflatprice,however,hasasignificantdisadvantageinanon-digitalworld.Consumptionmustbelimitedatallcosts.Innewspapersandmagazines,agivencirculationdefinesthislimitation.Correspondinglimitationsforservicebranchessuchasfitnessstudiosortelecommunicationswouldhardlybefeasible.Anexampleforakindof“natural”limitationisembodiedbyhellofresh.de.Theonlinefoodservicesendstheirmembersweeklycookingboxesfilledwiththeingredientstoprepareaspecificrecipeforapriceflatpermonth.Dollarshaveclub.comfollowsthesameconceptsendingtheirmembersspecificallychosenblades,shavesandcreamseachmonthforamonthlyflat-rate.Thefrequencyofthedeliverycanbeadjustedandthemembershipcaneasilybecancelledpermonthforboththeseonlineshops.ThehighmarketshareofthepublictransportinSwitzerlandisnotonlyduetoeasyaccessbytrainandbusaswellasoutstandingnetworkandquality,butalsoduetotheproliferationofthe“General-Abonnement”(GA),whichguaranteesunlimiteduseofbusesandtrainsinSwitzerland.Currentlyabout6%oftheSwisspopulationownthisnetworkcard.Asignificantproportionofthetotalpublictrafficisallocatedtothisticket.Consequently,theGAallowsthepublictransportsystemtopredictquiteaccuratelywithrespecttodemand,buttherecouldalsobecapacityconstraintsiftheGAisutilizedintensively.Theexamplealsoshowsthatnoeffectivelevyofwillingnesstopayispossiblewithflatpricing.Forthosewithlowtrainusethereisaslightdiscountcomparedtotheregularprice,whilstaverystronguseresultsinanextremelyhighdiscount(Kalt,BongaertsandKrämer,2013).InGermany,theBahnCardisawell-knownmarketingelement(5millionusers)toincreasetraintrips.CustomersofDeutscheBahnpayayearlycardprice(subscriptiondiffersacrosstargetgroups)andgetaccesstoa50%discountontheusualfullflexfare(BahnCard50),25%discountonfullflexandsaverfares(BahnCard25)respectively.

ThesubscriptionmodelisnotonlyusedbyindustrygiantslikeNetflixbutalsobypromisingstart-upslikeTheHonestCompany.LaunchedbyactressJessicaAlba,thee-commercecompanyTheHonestCompanycouldcollect100milliondollarsinSeriesDfundinginAugust2015-withanaverageratingof1.7billionUSdollars.Thebasicideaisamonthlyfeeforaconstantsupplyofecologicalproductsforbabiesandsmallchildren.Thesafetyofcapacityconsumptionand/orproductuseisoneadvantageofthesubscriptionmodel,whilstalsobeinganefficientinstrumentforcustomerloyalty.Itcanbeespeciallytargetedatheavyusersanduserswhoprefertohavecertainpricesecurity.Atthesametimethemodelincludesanentrancehurdle.Therefore,communicatingthekeyvalueisoneofthemainsuccessfactors,andthecustomerloyaltyismainlybasedonacontractuallevel.Inaddition,importantelementsofemotionalandnon-rationalcustomerloyaltymustbekeptinfocusandhavetobeexpanded.Finally,thereisanultimateriskfortheprovideriftheconsumptiongrowthisstrongerthanexpected,accompaniedbyanincreaseinthevariablecosts.2.4 DynamicPricingAstheeconomistPaulKrugmanhaspointedout,dynamicpricingismerelyanewversionoftheage-oldpracticeofpricediscrimination(Krugman,2000).Partiesinvolvedincommercehaveexperimentedwithvariablepricingsincethebeginningofcommerceitself.Yet,whatisnewabouttoday’sformofpricediscriminationisthatcurrenttechnologyhasmadedynamicpricingnotonlywidelypossible,butalsocommerciallyfeasibleandfaster.Overthepast15years,technologicaldevelopmenthasprogressedfurther.Digitalcompaniesoffercustomeraccountsinwhichalltheessentialdataisrecorded,theyknowaboutthesearchbehaviorofcustomersandtheirpreferences,evenbeingabletodiscerntheprobabilityofthemterminatingtheirrelationshipwithafirm.Incomparisontothepreviousthreemodelsthedynamicpricingisnottoberegardedasanacquisitioninstrumenttoattractnewcustomers.Itismoreageneralruleandthefactthatpricescanvaryduetospecificfactorsisnotopenlycommunicatedtoconsumers.Sinceforpricingmanagersthelimitationsofanundifferentiatedpostedpriceareclear,theyareworkingwithawidetoolboxtoadjustprices.Acommonformofdynamicpricingisvariationofpricesovertime.Ondaysortimeslotsinwhichthecompaniesexpectaclientelewithmorepurchasingpower,thepriceswillbeincreasedandcorrespondinglyreducedintimesofweakdemand.Thesearenormsthatconsumershaveexperiencedovermanyyearsforservicessuchasairlines,hotelsorcarrentals.Thesecompaniesstronglyrelyonyieldmanagementsystems,whichtrytoimprovecapacityutilizationandoverallrevenuesbyadjustingavailablepricestodemand(seeCross,HigbieandCross,2011;HinterhuberandLiozu2013).Morerecently,othersectorsliketheretailsectorarealsodiscussingtheincreasinguseofdynamicpricing.Afurthermoreextremeformofdynamicpricingistosetpersonalizedprices,inwhichdataanalystshelpcompaniesidentifythecharacteristicsofthepurchasingenvironmentorthecustomer’sprofileandbehaviorsimpactingtheirwillingnesstopay.IntheUnitedStates,forexample,TheWallStreetJournalfoundthatofficesuperstoreStaplesadjustedpricesasdidHomeDepot,andOrbitzthepopularonlinetravelcompany.InGermany,astudyverifiedthatacompanysupplyinglensesonlineofferedcustomersalowerpricewhenacquiredviaGoogle-ShoppingAdstothewebshopcomparedtothepriceviaadirectvisittothewebshop.Consequently,thedirect,andobviously,loyalvisitorpaysahigherpricethanacustomerprobablycomingforthefirsttimetothewebshop(Kobrück,2015).TheInternet,Bigdataanddigitizationenablefirmstotechnicallyincorporateinformationintotheirpricesettingwiththehelpofalgorithmssuchas

• Time-based-pricing:pricesrisesystematicallywhenincreaseindemandisforeseeableand

alternativelyfallwhenadecreaseindemandisforecast.Attractiveness,weather,schoolvacationse.g.canbeinfluencefactors

• Competitive-based-pricing:thecompetitor’spricechangescaninfluencetheownpricingpolicy

• Distance-based-pricing:thedistanceacustomerislocatedfromthenextbricks-and-mortarstore

• Browsing-basedpricing:thecustomer’sbrowsinghistoryprovidesknowledgeofitswillingnesstopay

• Past-behavior-pricing:thecustomer’stransactionsandhencehisloyaltyinthepast(product,priceetc.)determinethecurrentprice

• Devices-based-pricing:theuseofthetechnicaldevice(typeofsmartphone,PC,Laptop,Tablet),whichgeneratedthequery,influencestheprice

• Demographically-based-Pricing:thecustomer’sageandgenderallowsanestimationofhiswillingnesstopay

• DynamicMerchandising:pricesadjustmentasatoolforstockandinventorymanagement.OnlinebusinesseshaveexperimentedwithtailoredofferssincethedawnoftheInternetera.Amazonwasoneofthefirsttomoveinpricediscrimination.In2000,Amazon.comInc.infuriatedmanycustomerswhenitsoldDVDstodifferentpeoplefordifferentprices.Amazoncalleditmerelyatestandultimatelyrefundedthepricedifferencetopeoplewhopaidmore.(Valentino-Devries,Singer-Vine&Soltani,2012).JeffBezossaidinanewsrelease:“Wehavenevertestedandweneverwilltestpricesbasedoncustomerdemographics,”founderAmazon.comspokesmanBillCurrysaidthetestswereusefulindeterminingapricepoint—therightbalancebetweenhowmuchAmazon.comcouldchargeandstillmaintainagoodsalesvolume.Nevertheless,becauseoftheconsumeroutcry,Amazon.comendeduprefunding6,896customersanaverageof$3.10each,oratotalof$21,377.60.Despitethepubliccriticism,therewereeconomistswhojustifiedAmazon’sactivitiesasfair.Forexample,WeissandMehrotra(2001,Nr.21)argued:"Proponentsofpersonalizedpricingcontendthatpricesbasedonvalue,andnotcost,benefitnotonlycompanies,butalsothoseconsumerswhoareofferedrelativelylowerpricedgoodsandservices,sincethesecustomerspayonlyasmuchastheyvaluethegoodsorservices".Therearedoubts,however,thatthemajorityofconsumersregardsuchbehaviorasfairandacceptable(KrämerandKalka,2016).Attheenditisthedecisionofthecompany,whetherthestrategicfocusofthecompanyistobuildupcustomerrelationshipandloyalty(thisisachievedthroughahighcustomerbenefit,theso-called"valuetothecustomer")orwhetherthefocusisratheronashort-termmaximizationofcashflows("valueofthecustomer").Inthiscase,acompanyisaimingtoextractasmuchoftheconsumersurplusaspossible(BongaertsandKrämer,2014).Here,thefourpricingmodelspresentedabovehaveaverydifferentfocus.Inthetrade-offbetweenthe‘valuetothecustomer’andthe‘valueofthecustomer’decision,thepricingmodelforfreeisinfavoroftheconsumer(Figure2).Inthiscase,theproviderrequiresadifferentsourceofliquidity.Asiswidelyknown,Google’sdecisionwas(in2000)todefinerevenuefromadvertisingandanalytics,ase.g.fromtheB2BbusinessbasedonAdwords,astheeconomiccoreofitsbusinessmodel(BernasekandMongan,2015).

3.0 CaseStudy:DynamicpricingatAmazonThee-commercegiantAmazonisusedasacasestudyforthereviewpricingstrategiesintheDigitalAge.Thefirststepexplainsthespecialcharacteristics,whichmaketheAmazon’sbusinessmodelunique.Inthesecondstep,acoreelementofthebusinessmodelwillbeinvestigatedindetail:thecustomer-centricorientationofthecompany.BasedonanempiricalanalysisinGermany(onlinesurvey,Sep.2015)thecompetitiveedgeoftheInternetretailerisinvestigatedfromacustomerperspective.ThepricesofarandomsampleofproductsatAmazonareanalyzedbasedontypicalformsofpricediscriminationthatareusedinonlineretail.Finally,thecustomer'sperspective(reviewdifferentformsofpricevariationonAmazon)isintroduced.Figure2–Pricingmodelsofthedigitalageandcustomervalue

3.1 KeyelementsofAmazon’sbusinessmodelFoundedin1994,amazon.comisaleadinge-commercefirm,engagingintheretailsaleofconsumerproducts,sellingmerchandiseandcontentpurchasedforresalefromvendors,aswellasthoseofferedbythird-partysellersthroughretailwebsites,suchasamazon.com.Amazondidnotinventtheonlinestore,butthecompanyrecognizedthepotentialtotransformthewayconsumersshopbybuildingthenextgenerationplatformandinfrastructurethatgivescustomersunprecedentedchoice,scopeandvalue.Fromthebeginningthebusinessmodelwaspurelycustomer-centric.Bybuildingtheonlineshoppingplatform,Amazonradicallyreinventedthetraditionalretailbusinessmodelandthefundamentaldynamicsofhowconsumersshop.Whilethecompanystartedasabookseller,itlaterbeganmanufacturingandsellingelectronicdevices(includingKindlee-readers,Firetablets,FireTVs,andEcho,aswellasFirephones).Thecompanyiscontinuouslylookingforscale-effects.Therefore,Amazonactsasaresellerforhigh-demandproductsbutalsoasamulti-sidedplatformforlong-tail(lowdemand)products,whichareavailableonthesitefromindependentsellers.AnactivitylesserknowninthepubliceyeisthatAmazonoffersAmazonWebServicewhichencompassesfulfilment,publishing,digitalcontentsubscriptions,advertising,andco-brandedcreditcardagreementsservices.AWSindeedhasafirstmoveradvantage.Itwasbuiltfromthecompany’scoretechnologyinfrastructureandmakesweb-scalecloudcomputingcheaperandmoreaccessibleandturnedouttobeveryprofitable.Since2004AmazonhasoffereditsloyaltyprogramPrime,anannualmembershipprogramwithafeeof$99(U.S.)peryear($79in2005).Theloyaltyprogramprovidesfreeshippingofvariousitems;

Value-of-the-customer (B2C)

low

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e-to

-the

-cus

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er (B

2C)

high

high

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w

For free

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How profitable is the company across its customer base? How much does a provider exploit the willing-ness to pay of individual customers, thereby reducing the consumer surplus towards zero?

What is the perceived customer benefit, which is generated by the product and service of the provider? In case of a “No-charge” scenario the full economic surplus remains at the customer

Subscription

Typical posted price

accesstounlimitedstreamingofmoviesandTVepisodes;andotherservices.Itwasestimated,thatatthebeginningof2016,AmazonPrimehasreached54millionmembers.Primemembershipisanefficientgrowthtoolsinceittendstocausesubscriberstostopshoppinganywhereelse.ConsumerswhoknowAmazonareawarethatpricesindicatedontheplatformarecompetitive.WhencustomersdecidetobecomeaPrimemember,shippingcostsarenolongeranissue.SubscribersautomaticallydefertoshoppingatAmazonfirstbecausetheyknowshippingisfreeandfast,duetoexpressservice.AmazoncoversalltheshippingonPrimeorders.A2011investigationestimatedthattheaveragePrimememberused$55worthofshippingand$35indigitalcontentannually.Inotherwords:Amazonwas“losing”$11annuallybycollectingits$79membershipfee(Tuttle,2013).Butthisdidnotincludethemaintriggerofthecustomerrelationship.Amazon’sshareofthewalletisstronglyincreased,aswellascustomerloyaltyandthereby,futurecontributionmarginsacrossitscustomerbase.Foryears,Amazonhasbeenobsessedwithgrowth.Totalrevenuestripledfrom$34bn(2010)to$107bn(2015).Amazonmadecleardecisionlongagototradeoffshort-termprofitagainstlong-termcashflow.Itskeystrategyistobeabletocapturethelargestmarketshareandscalepossiblethatwillallowittodrivedowncostsandincreaseprofitabilityinthefuture.ThisisreflectedinAmazon’sfinancialperformanceindicators.In2012and2014,Amazongeneratedlosseswhileatthesametimerevenuesstronglyincreased.In2015thepriceearningsratioamountedtomorethan500,comparedto250forAlphabetand20forApple,themostvaluedfirmsintermsofbrandvalue(seeFigure3).Evenin2015whenAmazonprofitsaftertaxesraisedto$0.6bntheoverallreturnonsaleswasonly0.6%.RetailgiantWal-Martreached3.4%atthesametime(profitsof$16bnrelatedtorevenuesofapproximately$485bn).Figure3–Amazon.com:Financialperformanceindicators

3.2 BuildingcustomerequitybasedontrustandcustomercentricityAsSimons(2014)stated,Amazondevotesmaximumresourcestopleasingconsumers,evenifthatmeanssellersorcontentproviderssometimesfeelshort-changed(sellerswhosestore-frontsarehostedontheAmazonplatformhavebeenknowntosueAmazonformoreresources).ThisisasideeffectofcustomercentricityinnovationsuchasPrimefree-shipping,detailedproductreviews(includingnegativeones),look-inside-this-book,andthelistingoflower-pricedproductsfromonsite

Year Revenues ($bn )

Profits after taxes ($bn )

Profits in % of revenues

2010 34.2 1.152 3.4%

2011 48.1 0.631 1.3%

2012 61.1 -0.039 -0.1%

2013 74.5 0.274 0.4%

2014 89.0 -0.241 -0.3%

2015 107.0 0.596 0.6%

Price-Earnings Ratio of leading Internet Companies Amazon.com: Revenues and Profits (2010-15)

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Amazon.com

Alphabet

Apple

PE-ratio

competitors.Whilecompetitorshaveoftencriticizedthesepractices,Amazonhascontinuedtoimproveitscompetitivepositionandsuccessstoryduetounparalleledcustomerloyaltyandstratosphericstockvaluations.Primewasintroducedin2004,asaresultofAmazonsearchingfortherightloyaltyprogramformanyyears.AnAmazonsoftwareengineernamedCharlieWardfirstsuggestedtheideaofafree-shippingserviceviaasuggestionboxfeatureonAmazon’sinternalwebsite.OnedirecteffectthatcomeswiththePrimemembershipisanincreaseinspendingatAmazon.ConsumersshiftbudgetsfromotherretailerstoAmazon,leadingtoastrongsalesgrowth.ItisestimatedthatPrimemembersincreasetheirpurchasesonthesitebyabout150percentaftertheyjoinandmayberesponsibleforasmuchas20%ofAmazon’soverallsalesintheU.S.AccordingtoastudybyRBCCapitalMarket,39%ofPrimemembershadexpenditureofmorethan$200inthepast90daysandfor25%expenditurewasbetween$101and$200.Whilealmost67%ofprimemembersspentmorethan$100in90days,thecorrespondingfigurefornon-Prime-customerswas28%.AstudyconductedbytheauthorsreviewedinwhichelementscustomersseeAmazon´sperformancesuperiortoitscompetitors.Duringthesurvey500consumersfromanageof18yearswereinterviewedinGermany(OnlineStudy,September2015).FromtheperspectiveofAmazon’scustomersthemostimportantperformancecharacteristicsarethewideproductrange(85%)andfastdelivery(80%),followedbyaclearaccount(55%).Astonishingly,thefactor"lowprice"ranksonlyinfourthplaceinthetopperformancewith53%(Figure4).ThisreflectsthefactthatGermanconsumersarenotprimarilyfocusedongettingthelowestpossiblepriceonAmazon,butratherthatserviceelementsreceiveclearpreference.ParticularthecustomeraccountthatprovidestransparencywithrespecttoitspreviousordersisseenasbeneficialbyAmazoncustomers.Figure4–Amazon’sUniqueSellingProposition

ThesefindingscorrespondtotheresultsofastudythatcomparedAmazon’spricingwiththatofitsmaincompetitors(BoomerangCommerce2015)andshowthatAmazonisn'talwaysthecheapestplacetoshop.Thegiantonlineretailerusesitsvastcomputingresourcestomonitorandanalyzethepricesofmanythousandsofitemssoldbycompetitors.Popularitemsarequicklydiscounted,whileitemsthatarelessattractivemayactuallycostmorethantheydoonrivalsites.Inalmosttwothirdsofallobservedproductsinvestigatedinthestudy,Wal-Mart’sproductswereexactlythesameprice

Wide product range

Fast delivery

Clarity of account (My Amazon)

Cheap prices

Free Shipping

Good product information

Quick response to customer inquiries

Customer orientation (fairness)

Prime Services

Other

85%

80%

55%

53%

47%

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38%

34%

31%

3%

All Amazon customers USP´s of Amazon

1) What makes Amazon special / Where is Amazon superior to the competition?

84%

78%

53%

52%

41%

44%

34%

29%

19%

3%

Amazon customers without Prime

90%

89%

64%

54%

74%

50%

56%

58%

91%

3%

Amazon customers with Prime

asonAmazon.de;forproductsthatarecoretoAmazon,Wal-Martturnedouttobelesscompetitiveandviceversa.CustomerswithPrimestatusbasicallyshowasimilarpreferencestructure.However,resultsindicatethatPrimemembersparticularlyvalueservicessuchasfreedeliveryandotherprimefeaturesprovidedexclusivelyforthem.Inadditiontotheinformationprovidedtocustomersabouttheiraccounts,Amazonstillhasavarietyofcustomer-specificinformation.AsVillas-Boas(2014)pointsout,salesarerecorded,asarebrowsingand‘clickthrough’patternsforeachpersonalcomputeraccessingAmazon.com,whichenableAmazontounderstanddemandmuchbetterthanthecompetition.Amazondoesthisbytrackingnotonlywhatcustomersbought,butalsowhatelsetheylookedat;howtheynavigatedthroughthesite;howmuchtheywereinfluencedbypromotions,reviews,andpagelayouts;andsimilaritiesacrossindividualsandgroups.Sincethebusinessmodelwasfullydigitally-driven,customeranddataanalysishavebeencorecompetenciesofAmazonfromthebeginning,providingalltheinformationneededtopursueallkindsofpricediscrimination.Competitivepricingrequiresdata,intelligence,andstrategy,playedathighspeedandatahighlevel.3.3 ResearchonpricediscriminationatAmazon.deAccordingtoastudyconductedbypricemonitoringproviderMinderest,itwasfoundthatAmazonmademorethanonemillionpricechangesonValentine'sDayalone(Minderest,2015).Foreachproduct,pricesfluctuatedwithinafewhoursbyupto240%.Thereasonforthisvariationinthepriceisthealgorithmof"DynamicPricing",whichiscurrentlybeingdevelopedbyAmazon.Aspreviouslymentioned,thistoolwillmaximizeprofitsdependingonthemarketpriceandeconomicviability.Changescanbemadeinashortperiodoftimeinordertoincreasecompetitiveness.Todate,Amazonistheleaderinusingthisbusinessintelligencetool.Toillustratethiswithaclearexample-thecamera"NikonD610SLR"wastrulyremarkableasthepricefluctuatedbetweenEUR700andEUR1.687.ThismeantadifferenceofEUR987or240%.Thesesavingscouldhavebeenachieved,ifthecamerahadbeenorderedonFeb12at10:00am,insteadofonFeb13at9:26pm.WhetherpricesatAmazonvaryornot,howstronglytheydiffer,andwhatformsofpricedifferentiationareapplied,wasreviewedbasedonanexperimentalstudy.Here,pricesforselectedproductswererecordedonthewebsitesofAmazonandcompetitors,andcompared.Thiswasdonesimultaneouslybyusingdifferenttypesofdevices.Inthisway,itcouldbeexaminedwhether,forexample,customerswithiOSdeviceswereshownhigherpricesthanconsumersusingothertypesofdevices.Theinvestigationalsoincludedananalysisofmid-tolong-termpricedevelopments,whichwasexecutedusingthewebsitewww.mein-wunschpreis.com.Theresultsshowedsignificantfluctuationsinpriceinthelong-term,e.g.byupto300EURforthecamera(NikonD610)aswellasforthecoffeemachine(KrupsNespresso3006X).Incontrast,littlepricevariationswereevidentontheindividualconsumerlevel(Figure5).However,variationsinpricewereobserved,e.g.,ononedaythecoffeemachinewasofferedcheaperwhenrequestedviasmartphonewithoperatingsystemiOScomparedwithothertypesofdevices(includinglaptopwithiOS).3.4 CustomerperspectiveonAmazon’spricediscriminationWhilethepricemonitoringaimedtogenerateobjectiveresultsintermsofpricevariationsinonlineretailandtodetermineformsofpricedifferentiation,aconsumersurveyexaminedhowtheAmazoncustomersevaluatedifferentformsofpricediscrimination.First,duringthesurveyaformofdynamicpricingwaspresentedinwhichthesellerchangesthepriceofaproductaccordingtodemand.Consequently,pricesforoneandthesameproductmayvary,sometimesbeinghigher,sometimeslower.Inthiscasethecustomer’sperceptionwasratherindifferent,theshareofrespondentsthat

agreed(25%top-2ratingonascaleof1to6)wasovercompensatedbycustomerswithnegativeratings(34%).Although,onehastoappreciatethatthisignoresthefactthatacertainproportionofconsumerswillprobablynotnoticeanypricedifferencesinpractice.Only23%oftheAmazoncustomersagreedtothestatement“WhenIsearchonAmazon,Icanbesuretogetofferedthelowestpossibleprice”(12%ofnon-customers).Figure5–ResearchonAmazon’spricediscrimination

Secondly,anotherformofdynamicpricingwasdiscussed;describingascenariowheredifferentpricesareofferedtoAmazoncustomers,dependingonhowtheyareshoppingandwhichdevicetheyuse.44%oftheAmazoncustomersbelievethatAmazoncannotaffordtooffercustomersdifferentpricesdependingonwhetheraPCorasmart-phoneisused.Morethan50%thinkthiswouldbeareasonnottopurchaseonAmazoninthefuture.Figure6–ThecustomerperspectiveonpricediscriminationatAmazon(KrämerandKalka,2016)

coffee machine

camera

Price variation over time (coffee machine and camera) Price variation across individual consumers

I do not see any problems if the prices vary depending on the customer

I have personally experienced that the products prices have been changed for inquiries when different types of devices were used during a search

For the customer price security is a clear competitive advantage of Amazon

When I search on Amazon, I can be sure to get offered the lowest possible price

Amazon can not afford to offer customers different prices, depending on whether a PC or a Smartphone is used

If so, that would be a reason not to use Amazon for purchasing any longer

1)  In Internet blogs is discussed that Amazon customers get different prices displayed, depending on how you are looking for and from which device. Do you agree to the following statement or not?

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15%

47%

23%

44%

54%

25%

18%

35%

40%

29%

24%

63%

67%

18%

38%

27%

22%

Amazon-customers Amazon-Non-customers

Agreement(top-2) Disagreement(low-2)

15%

20%

34%

12%

39%

81%

15%

16%

36%

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8%

Agreement(top-2) Disagreement(low-2)

Statements regarding the price differentiation at Amazon1)

Astheanalysisshows,dynamicpricingbasedonrapidpriceadjustmentsovertimedependingondemand,islessproblematicfromthecustomer’sperspective.However,alargemajorityofAmazoncustomersfeeluncomfortableinthedynamicpricingworldbasedonthecustomerprofilesthatisifpricesvaryforindividualcustomers.Ifcustomerscomprehendthataretailermisusedtheirpersonaldatafora“better”pricing,customerconfidenceasoneofthebiggestcompanyassetsispotentiallyforfeited.Thenthedamageforthecompanycouldbeworsethanthebenefitsofaone-to-onepricing.4.0. Outlook:ChancesandlimitationsofpricinginadigitalworldDigitaldisruptionwithitsnewtechnicalpossibilities,BigData,changesincustomerbehaviorandcompetitivepressurehaveimplicationsforpositioningandthepricingstrategiesandmodelsofenterprises.Fourpricingmodelsarepredominatelyimplementedinthenewdigitalworld,whichhaveredefinedtherulesofthegameinpricing.Eachofthemfollowsotherobjectives,opportunitiesandrisks.Theuseandvaluedepends,ofcourse,onthespecificproductandcustomercharacteristics.Withreferencetothe“forfree”and“freemium”model,successfactorsaremainlytobeseeninthere-andcrossfinanceinstruments,whereasthe“subscription”modelfocusesonoptimizingcapacityutilizationwhilstkeepinganeyeonthevariablecosts.Thesethreemodelsaredrivenprincipallybytheobjectiveofquicklyacquiringnewcustomersandbuildinguployaltyamongusers.Incontrast,thefourthmodel“dynamicpricing”isnotopenlycommunicatedtothecustomersandtriestofullyexploitwhatthetargetgroupiswillingtopayfortheproductorservicesduetotime,behavior,customerprofile,useddevicesandsoon.Withthehelpofalgorithms,differentapproachescanbeusedinalmostrealtimetochangepricesinordertomaximizeprofits.Whilethefirstthreemodelscannotbecombinedwitheachother,itistheoreticallypossibletocombinethe“dynamicpricing”modelwiththe“freemiumaswellaswiththe“subscription”model,becauseanoffsettingeffectisnotforeseen.Nevertheless,psychologicaleffectsalwayshavetobeconsideredifthecompanywantstocreateavaluefororofthecustomer,especiallywithregardtotheone-to-onepricingpolicy,whichsomecompaniesseeasthebiggestopportunityforthefuturepricingonthebasisofbigdata.Whenevaluatingchancesandrisksofneworchangedpricemodels,keyelementsmustbetheperceptionandpsychologicalpriceevaluationbythecustomeraswellasthepotentialdamagetothebrandimage.Ifthecustomerfeelsunfairlytreated,themainrisksofallfourmodelsarecustomerdissatisfactionandcustomerchurn,bothleadingtonegativeeffectsforthecustomerlifetimevalue.5.0 ReferencesAriely,D.(2010).Predictablyirrational,revisedandexpandededition:Thehiddenforcesthatshapeourdecisions.NewYork,NY:HarperPerennial(GermanTranslation).

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Bertini,M.(2014).Pricewarsandthemanagerswhostartthem.BusinessStrategyReview,25(4),14–17.

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Krämer,A.(2015).PricinginaVUCAworld:Howtooptimizeprices,iftheeconomic,socialandlegalframeworkchangesrapidly.InO.Macketal.(Eds.),ManaginginaVUCAworld(pp.115–128).NewYork,NY:Springer.

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