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Notes
- 1.
The Big Mac index began as a comical way to compare the relative buying power of different currencies, but resonated so strongly (and has proved to be fairly accurate as a predictor of purchasing parity) that it is often quoted in financial journals and economics texts as a very real indicator of the strength of national economies around the world. This page describes how the index works and shows its value in the various regions on the global map (see http://www.economist.com/content/big-mac-index, Retrieved July 31, 2014).
- 2.
The slightly more ethical version of this happens at stores where everything seems to be perpetually on sale but in reality what they’ve done is introduce the product without fanfare for a high price simply to establish a reference price. After a couple of weeks, the new 50% off price tags are added with loud promotion.
- 3.
Interestingly, it doesn’t matter which of the three options is chosen—the presence of options helps the consumer feel confident in making a decision. Having established a reference price allows them to choose the low price to save money, the high price because they desire quality, exclusivity, or “the best,” or the mid-tier mainstream choice that the retailer prefers and that appears to offer the best value.
- 4.
Tversky, A. & Kahneman, D., (1974). Judgment Under Uncertainty: Heuristics and Biases. Science, Vol. 185, No. 4157, 1124–1131.
- 5.
Ariely, D., Predictably Irrational: The Hidden Forces That Shape Our Decisions (New York, NY: HarperCollins Publishers, 2008).
- 6.
The entire iPad keynote can be seen here: http://www.youtube.com/watch?v=_KN-5zmvjAo#t=4704. Accessed May 15, 2012. The summary and pricing discussion begins after the demo and runs from 1:14:02 to 1:15:50.
- 7.
Economic surplus is defined as the sum of consumer surplus and producer surplus. The consumer surplus is the monetary gain (or savings) captured by consumers when they can purchase a product for less than the maximum they are willing to pay. The producer surplus is the monetary gain captured by a producer when they sell for greater than the least that they would accept. Usually, the goal of both the consumer and the producer is to reduce the surplus of the other party to zero to capture the maximum economic surplus for themselves. In general, disruptive strategies attempt to minimize the total economic surplus to deny competitors opportunities to take market share and, in the long run, keep the majority of the market surplus. This is exactly the opposite of a value-based pricing approach.
- 8.
Are there exceptions to this rule? Of course. Certainly before we started to understand the dynamics of disruptive innovation, most disruptions that occurred historically were accidental, and accidental disruption still occurs because not everyone plans for it or understands how it works—that’s the reason for this book. There are also companies like Apple that have serially disrupted several markets while targeting to keep the maximum economic surplus for themselves. Accomplishing this is very difficult and rare, however, as it requires consistently innovating ahead of the market, delivering a nearly whole product and ecosystem on the first release that is easy to use and obviously better on several outcomes desired by customers. In other words, it requires exceptional understanding of the JTBD and exceptional execution on delivering to that, as well as visionary leadership. Since Steve Jobs’ passing, it appears that Apple has lost that edge. While it’s still innovative, it’s not the company that created the iPod, iTunes, iPad, and App Store.
- 9.
Chris Andersen explored how and why “free” has grown as an approach in his book, Free: How Today’s Smartest Businesses Profit by Giving Something For Nothing (New York, NY: Hyperion, 2009). If you are considering offering all or some of your product for free, I encourage you to read this book for more ideas and insights.
- 10.
The limited number of alternatives for carrier services has resulted in monopoly or oligopoly conditions in most markets that has been exploited to raise prices far beyond what a free market would support. In fact, as carriers have switched from 3G to faster 4G services, they have benefited from higher efficiency, which has reduced costs. Yet they are raising prices by as much as 50% and claiming a better service, according to technology news site ReadWrite.com. “Why Your Cell-Phone Bill Should Be Going Down—But Isn’t,” ReadWrite.com, May 9, 2014, http://readwrite.com/2014/05/09/4g-3g-smartphone-data-price-difference. Accessed June 5, 2014. This incumbent-style market exploitation has left the door wide open for disruptive outsiders such as Google to offer free WiFi services that will likely put a major disruptive dent in carrier revenues wherever they are available.
- 11.
This “launch” problem (often described as the “chicken and egg” problem) is the biggest issue multi-sided platforms usually face, since there is no value until the network exists. Although all participants benefit when the market is functioning, there isn’t sufficient motivation or incentive for one side to fully engage, or for the market to scale quickly, unless there is a subsidy. The example of Ethoca discussed in Chapter 4 is a multi-sided market that provides different benefits to different members of the network and strongly exhibited this “chicken and egg” syndrome until a few visionary card-issuing banks helped kick-start participation by providing data (a form of subsidy). Once off the ground, such markets tend to grow virally as the benefit increases as the number of participants grows, and often result in a single company “owning” the market (especially if the value decreases when there is more than one provider of the service).
- 12.
Evans, David S., Some Empirical Aspects of Multi-Sided Platform Industries. Review of Network Economics, Vol. 2, Issue 3, 191–209 (September 2003).
- 13.
Contrast Google’s approach of offering most of their software free, including the Android operating system on mobile devices, with the history of the payment card industry.
Evans (Ibid.) provides a case study describing how Diner’s Club created the modern credit card industry when it provided a single card that diners could use to buy meals on credit at a number of restaurants in New York. They charged 7% of the restaurant tab to restaurant owners and, after a short time offering free cards to users to get them on board, raised fees from cardholders in a series of steps up to $26/yr by the late 1950s. American Express saw an opportunity to leverage its travel industry reputation and experience to broaden the utility of a general-purpose credit card and quickly launched and grew a competitive service to Diner’s Club by charging lower fees to merchants (thus growing the number of places that accepted cards making them more attractive to consumers), while positioning as a more exclusive product with a higher membership fee to users. Later banking cooperatives such as Visa and MasterCard were able to enter the market by lowering merchant fees significantly and reducing cardholder fees to zero but introducing the idea of revolving credit at much higher interest rates than a traditional bank loan. Today, we have PayPal reducing the transaction cost to merchants and consumers even more for online payments. None of these subsequent market disruptions could have occurred without excessive economic surpluses that new competitors could attack with a different business model. Google’s market approach is better for consumers and better for Google in the long run.
- 14.
Mark wrote powerfully about this effect in his blog Both Sides of the Table, discussing why he likes to invest in companies that are able to leverage deflationary economics and how this notion has driven many of the greatest Internet companies’ growth. This highly recommended article reviews the types of companies it applies to, explains how you can apply it if it’s right for you, and provides examples of how a number of disruptors actually did it. Mark Suster, “The Amazing Power of Deflationary Economics for Startups,” December 22, 2011, http://www.bothsidesofthetable.com/2011/12/22/the-amazing-power-of-deflationary-economics-for-startups/ Accessed August 22, 2012.
- 15.
Figures come from IDC Research, reported in The Next Web (http://thenextweb.com/mobile/2014/08/14/idc-global-smartphone-shipments-pass-300m-q2-2014-android-84-7-ios-11-7-windows-phone-2-5/, Accessed August 18, 2014) and Business Insider (http://www.businessinsider.com/iphone-v-android-market-share-2014-5, Accessed August 18, 2014).
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© 2014 Paul Paetz
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Paetz, P. (2014). Pricing Strategy. In: Disruption by Design. Apress, Berkeley, CA. https://doi.org/10.1007/978-1-4302-4633-6_7
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