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Introduction
Info-Rule #1
Info-Rule #3
Info-Rule #4
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By Hal Varian
and Carl Shapiro:

Information Rules
Information Rules
at Amazon.com
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Spacer Image Hal Varian Hal Varian
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Hal R. Varian is the Dean of the School of Information Management and Systems at UC Berkeley. He also holds joint appointments in the Haas School of Business and the Department of Economics and occupies the Class of 1944 University Professorship. He received his S.B. degree from MIT in 1969 and his MA and Ph.D. from UC Berkeley in 1973. Professor Varian has published numerous papers in economic theory, econometrics, industrial organization, public finance, and the economics of information technology.


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» Versioning: The Smart Way to Sell Information on the Harvard Business Review.

» The Web Gets Ugly by Paul Krugman, from the New York Times Magazine.

» The Information Economy a Web site compiled by Dean Hal Varian.

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Also by Hal Varian:
Intermediate Microeconomics
Intermediate
Microeconomics

at Amazon.com
By Marty Lucas, marty@mappa.mundi.net Trip-M Archives »



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Copyrights
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economics

Information products have high fixed costs but low marginal costs. Creating the first copy of an information product is expensive, but copying it is inexpensive. If the information's producer can copy the product inexpensively, so can others, and in most cases the only protection the producer has against unauthorized copying is the law of copyrights. Shapiro and Varian say the best strategy for management of intellectual property is to "choose the terms and conditions that copyright maximize the value of your intellectual property, not the terms and conditions that maximize the protection" from unauthorized copying.

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Info-Rule 3:

Information is costly to produce but cheap to reproduce.

       Producing information products is a scary business because most of the costs of an information good are "sunk" before it hits the market. The authors of Information Rules say that because of this, pricing your information product on the basis of allocation of the cost of production is irrelevant, unwise, and unlikely to succeed. Perhaps the most interesting and certainly the most practically useful passages of the book describe some counter-intuitive strategies for turning this aspect of the information economy to your advantage, including versioning and personal pricing.

IR-3.1 Pricing Strategies - Versioning.

       "Design your product line to capture the greatest profit from the information you are selling." In Chapter 3 of Information Rules Shapiro and Varian argue persuasively that most information products can generate more revenue for their producer if they are offered to the public in multiple versions.

       "Versioning," says Varian, "is where you take your information good and you create a product line. You segment the market with high value users buying the full featured, fast, convenient version, and people with lower value buy the less convenient version." Feature richness is a familiar approach to versioning, and not just in the information market, as any new car buyer can attest. But what makes versioning in the information market potentially controversial is that often the lower priced versions in the product line are created by disabling features, a practice that does not actually make them cheaper to produce. In fact, sometimes the producer incurs an additional cost to bring a less valuable information good into its product line.

       "Sometimes you do this by delay," says Varian. "The movie comes out on the big screen first and then six months later it comes out in video. Sometimes you do it by the user interface. Dialogue does that with DialogueWeb and DataStar where one is targeted towards professionals and the other towards casual users. You can get the fifty-dollar version of Quicken, with all the bells and whistles and portfolio analysis, or you can get the twenty-dollar version, which basically balances your checkbook. I think it's a strategy we're going to see more and more in the information market."

       Information Rules cites, as an example of versioning, the IBM LaserPrinter Series E, a consumer model that printed five pages per minute, half the rate of IBM's commercial model LaserPrinter. A consumer testing lab found that "the difference in speed was due to a chip that inserted wait states to slow down the [consumer model] printer."

       "They had an office version of this printer that was producing ten pages a minute," says Varian. "And they came out with a version for the home or small office. And given that they'd already had the manufacturing line set up for the high-end version, it was the easiest way to produce that. Just put in this little chip to slow down the version for the home users."

       Is cripple-ware, while a profit maximizing strategy for the corporation, liable to alienate the consumer? Varian maintains the practice is not necessarily contrary to consumer interests. "If they could only produce one of those printers, they would have sold to the office market because people are willing to pay much more at the high end of the market," says Varian, "So what I would say as a consumer is 'don't worry too much about the design of the product line.' What you want as a consumer is a competitive environment. Because, if there's somebody else producing an eight page per minute printer and selling it to you at a bargain price, then the company can't slow it down very much. The discipline doesn't come from legislation or consumer backlash it really comes from the competition."

IR-3.2 Pricing Strategies-Personal Pricing.

       "The more you pay, the more it's worth" goes the ironic old saying. But when Shapiro and Varian argue the benefits of personal pricing, they turn the old saying on its head and it becomes "the more it's worth to you, the more you should pay." Personal pricing is a practice where the information product vendor makes an offer to the prospective purchaser based upon a calculation of what the vendor believes the prospective purchaser is willing to pay.

       For example, I'm a subscriber to some of the online legal research products offered by Lexus-Nexus, who make quotes based on a personal pricing system. When I want to subscribe to a service I call them on the telephone and tell them what I want. They look at the number of users who will access their services from my office, my geographical location, and whatever other dirt they can find about me and offer a price. (I must admit, I felt the price they offered was fair and accepted it).

       So that's personal pricing in action. But my question to Hal Varian was, "should consumers like personal pricing? Why?"

       It's the wrong question, Varian asserts. "You have to ask what would happen if they didn't use personal pricing. Some people always think that they'd get the low price, but suppose there's a high price and a low price. If you don't have the personalized pricing, would everybody face a high price or would everybody face a low price? My own opinion is that in most cases you'd see the high price reigning if there was a single price rather than the low price."

       "Let's take everybody's favorite (or least favorite) example, airline pricing," says Varian. "You can fly from here to New York on a full fare basis, it's two thousand bucks. If you stay overnight on a Saturday and purchase with a two-week advance notice then it's maybe four hundred bucks. So now you have to ask yourself, if they could only charge one fare, which would it be. Would it be closer to two thousand or closer to four hundred? And I say it would be closer to two thousand because of the business traffic: business people who have to go! They're the ones with the inelastic demand. What's happening is the airlines are reaching out and offering this deal to fill up the empty seats. My claim would be that people are better off because airlines have engaged in that price differentiation."

IR-3.3 The Dangers to Open Source-Fragmentation and Cost Recovery.

       How does the advice that the best intellectual property management strategy maximizes information value relate to the open source movement, and the apparent success of Perl, Unix, and Linux?

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Uncertain Future?
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Linux Penguin HAL VARIAN: "Open source has been successful up until now because typically there hasn't been an economic incentive in producing open source software. But as more firms get in and try to make money off of it, I think the model becomes more fragile. I'm not saying it will destroy it, but the tension between maximizing the size of the network [IR-4.1] and trying to grab the whole network for yourself comes into play. There's a tension between producing the most value versus producing the most profit. We'll see if the open source movement can work through that and survive."

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       Varian says he uses Linux and Perl and other open source software. He says, "The good part is that they do provide a standard, they do provide a mechanism for managing the growth of that standard."

       How does the open source movement need to adapt if it is to survive? Varian thinks that application of the pricing strategies championed in Information Rules can help open source software in the same way it can help any other information product. Offering an entry-level product at low (or no) cost, and then a "supported product with extra bells and whistles and nice add-ons, interfaces, and easy installation" is a good strategy, according to Varian. "So even if the product is available for free, to get the product with the extra goodies costs something." Even an open source information product costs money to produce, and therefore it can't survive without an adequate cost recovery model. Through versioning the open source community can maintain access to the basic technology at a very low cost.

       But can't versions quickly become competing and destructively incompatible? Varian observes that successful open source products have a gatekeeper "who manages the fragmentation problem, and decides what is in the kernel and what isn't in the kernel, what's in the Perl distribution and what isn't part of the Perl distribution." The gatekeeper's role is to define what the product is (and is not) and "keep it pure, in the sense of defining the standard." Beyond the open source example, standards bodies like the IEEE or the International Telecommunications Union or the National Bureau of Standards have as their goal defining what a particular product is. "An example I like to use," says Varian, "is which side of the road do you drive on? It doesn't matter too much, as long as we all do it the same. So that's the role of the standards keeper. And it doesn't matter a whole heckuvalot whether this particular library is in or out of the Linux distribution, but people who write code to that distribution would like to know whether or not it is there."

       The standards gatekeeper need not have a proprietary interest in the economic sense, but there must be a sense of who is in charge, says Varian. There's no one right way to make a gatekeeper; Varian says the control could be established "by respect, by mutual agreement, by law, or by international treaty."



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