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Welcome to our exploration of digital pricing strategies!
In this learning bite, we'll delve into three-level approach around digital pricing, continue with the characteristics of digital goods and end with the building blocks of pricing strategies for digital goods.
Learning Objectives
After finishing the learning bite you will be able to:
Explain the three-level approach to digital pricing
Describe the pricing characteristics of digital goods and services
Identify building blocks of pricing strategies of digital goods & services and explain which pricing properties of digital goods are leveraged
Birds Eye on Digital Pricing
In Screen 4.8 you were already introduced to the Topic of "Pricing in the Digital World", covering the topics of Price Transparency, Usage-based pricing and Dynamic Pricing, which made you familiar with the pricing characteristics of the digital world. Digital Pricing on the other hand introduces a broader framework for pricing in the digital world.
Frohmann, 2023, describes Digital Pricing in the following way:
"Digital pricing is a systematic process for achieving strategic corporate goals and meeting new customer needs. The focus is on the customer and thus on the two central influencing factors of digital pricing: value to customer and value of customer"
He introduces a three-level approach to digital pricing, as price optimization (pricing process) is only one component of digital price management, preceded by definition of revenues sources (revenue model) and the definition of value to customer as a key part of the business model:
Figure 1: The three-level approach “digital pricing”, Source: Frohmann, 2023, Page 69
Lets have a look into the components and use Amazons eBook business ("Kindle") to illustrate their approach to digital pricing:
Business Model: Components of the business model are definition of target customers and value to customer; value creation architecture and the profit model. Digital business models often revolve around platforms, ecosystems, and marketplaces, where value creation and delivery mechanisms are fundamentally different from traditional models.
Amazon: “We don’t want to make money with the devices. We make profit after the device is sold. When customers buy books, MP3s, or movies!” Jeff Bezos. This can be summarized as: Content is the core of value to customer.
Revenue Model: In digital business models, the monetization strategies often extend beyond direct transactions. Customers can pay with non-monetary components such as attention or data.
Amazon: Amazon splits its revenue model into two parts:
Hardware: Selling the Kindle at the break-even price or at a loss to encourage purchases. This increases the user base for digital content.
Content: The sale of content is highly profitable and supplemented by subscription services like Kindle Unlimited. It subsidizes the low margins on the hardware.
Pricing Process: The digital context allows for dynamic pricing, price differentiation, and the use of advanced data analytics for price optimization. Unlike traditional models, digital pricing can be highly personalized and flexible, adjusting in real-time based on user behavior, market demand and competitive dynamics.
Amazon employs Dynamic Pricing in combination with data-driven decisions to match customers willingness to pay most accurately and to respond to competitor behavior.
Figure 2: The three-level approach “digital pricing”: example Amazon; Source: Frohmann, 2023, Page 70
The thee-level approach ensures that all aspects of the business are aligned, from value creation to monetization and pricing strategy. The better they are integrated with eachother and match customer requirements, the greater the market success.
According to Simon & Fassnacht, 2019, the most important aspect of price management is “value to customer”. Therefore digital pricing must necessarily start with the business model, incorporating the revenue model and ending with the pricing process. This process is not a one way street:
An innovative pricing strategy can not only help to monetize (“value capture”), but also drive value for the customer (“value generation”). Therefore we will look in the following section into the pricing process.
Deep Dive: Pricing Process of Digital Goods
In this deep dive we want to focus on the pricing process as the last component of the three-level approach to digital pricing, especially on characteristics and pricing strategies for digital goods.
Pricing Characteristics of Digital Goods
Digital goods and offerings (such as eBooks, newspapers, software, online music and video games) have some unique properties in terms of pricing (Frohmann, 2023, pp. 27-29):
Indestructibility, reproducibility and convertibility
Indestructibility: Digital goods do not age. (Yet, there might be a loss of value over time perceived by the customer.)
Reproducibility: Digital services can be duplicated without loss of quality and at low cost.
Convertibility: New versions can be created with little effort - think about license-enabled features in software.
Network effects
The topic of network effects was covered in several courses. I recommend the slide set in the "Economics for Digital Business" course for revision.
In short: network effects ocur when the value of product or service increases as more people us it - think about social media, where each new user makes the network more valuable to all existing users.
Lock-in effects
If you ever emerged in the Apple ecosystem, you have noticed how high the (virtual) burdens ("switching costs") are to switch to another platform e.g. Android.
Same holds true for Cloud Computing: Switching from Amazon Web Services to another Cloud Computing Provider (e. g. Google Compute Platform) results in massive efforts to adjust to new Interfaces.
Relatively high fixed costs
When comparing the variable costs to supply a Music CD vs streaming music it is obvious: The digitized product has nearly zero marginal costs for additional units, while there are variable costs for production, logistics and distribution for the Music CD.
Same holds true for other media: If the infrastructure is available (fixed costs), the marginal costs for additional units are very low.
Uncertain quality assessment before purchase
Digital offerings are usually "experience goods": the quality and value can only be assessed post-purchase.
Therefore customers rely on price as a significant indicator of quality before buying.
Combined with price intransparency among suppliers, this enhances the pricing power of firms.
Building blocks of pricing strategies for digital goods
Leveraging the properties mentioned above, several techniques developed, which might be used solo or combined to maximize profits:
Versioning
Leveraging the flexibility of digital goods, versioning helps to segment and meet different customer needs or willingness to pay.
Googles Productivity Suite Workspace offers a variety of different versions to cater for different needs. Netflix does the same: 5€/month for 1080p with ads, 14€/month for 1080p without ads and 20€/month for 4K+HDR and more simultaneous streams.
This optional reading on Medium.com provides further information on versioning, as well as this additional optional reading of Harvard Business Review: Shapiro, Varian. "Versioning: The Smart Way to Sell Information".
Price Discrimination
Digital goods enable personalized offers and regional pricing adjustments to charge different prices to different groups based on their willingness to pay.
YouTube Premium in Germany is priced at 12.99€/month in Germany, while customers in India will pay 129₹ (Indian rupees)/month - around 1.50€, reflecting the different willingness' to pay in these markets.
Bundling
Multiple digital products or services are offered together at a discount. This can increase the perceived value and encourage customers to purchase more than they initially intended.
The travel platform Klook offers "passes" for multiple attractions in destinations around asia with discounts, see e.g. Klook Pass Greater Tokyo with up to 39 different attractions with discounts up to 48% compared to purchase of single tickets for each attraction.
Usage-Based Pricing
This is the standard pricing model for cloud-based services: Charging based on the amount of use or the extent of services consumed.
Cloud Costs are such a big topic, that a new term was coined. FinOps: A mix of DevOps paradigm (development and operations cooperation in software development) and "finance" to manage costs of cloud computing. KMPG offers more insights in this optional reading.
Freemium Model
A free version with basic features is offered, while premium features are charged. Effective in software, games and online services, where marginal cost of additional users is low.
A prominent example of this strategy is Spotify. Free users can listen to music, but ads are played between the songs. Depending on the device users might only be able to play music in shuffle mode. Switching to a paid model removes all these restrictions.
In the video game industry, where usually even the base version is paid, this model is often called "Pay to Win", because players are able to gain a competitive advantage by spending (additional) money.
📖 Supplementary Readings
📰 The Washington Post: "Diablo is about how anything is corruptible. Enter ‘Diablo Immortal.’"
📰 Forbes: "‘Escape From Tarkov’ Fans Are Outraged At New $250 Pay-To-Win Edition"
Dynamic Pricing
Algorithm-based adjustments of prices in real-time based on demand, competition, market conditions and customer behavior.
This strategy came into focus when superstars like Taylor Swift used the ticketing platform "Ticketmaster" to sell concert tickets using dynamic pricing to adjust pricing to demand.
🖥️ Supplementary Video
📺 CNBC: How The Taylor Swift Debacle Fueled The Ticketmaster Monopoly Debate (17:56)
📖 Supplementary Reading
📰 The Economist: "If Ticketmaster is a greedy capitalist, so is Taylor Swift"
Penetration Pricing
This strategy involves setting a low initial price to quickly attract a large number of customers and establish significant market share.
This approach is especially effective in markets with strong network effects, where the product's value increases as more people use it.
Initially low prices help build a large user base, which can later be monetized through higher prices, upgrades, or additional services (Buxmann et al., 2008).
Subscription Models
Instead of providing a product or service for a one-time fee, digital goods are often offered for a recurring fee, providing continuous value over time.
For the supplier it offers a steady revenue stream and can build customer loyalty. Streaming wouldn't be imaginable without.
Did you know: To watch all German First League (1. Bundesliga) Soccer matches online, you need to spend 60€ per Month: 30€ for Sky Wow and 30€ for DAZN.
Figure 3: Digital pricing strategies are using price differentiation (multiple prices) to optimize for profit by capturing different willingness to pay; Source: Frohmann, 2023, page 154
Now it is your turn to think about which of the pricing strategy blocks leverage which pricing properties of digital goods.
Contribute your thoughts by adding an entry or liking existing entries in the following padlet. Scroll down inside the padlet to see all strategies.
🖥️ Supplementary Video
Watch the video (03:19) to see how Disney implemented penetration pricing when launching their streaming service, Disney+.
Now it is time to test your knowledge in the following Quiz.
Quiz
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