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December 12, 2003

Product crimping and price discrimination

Price discrimination is the practice of charging different customers different prices for the same good. One strategy for implementing this is to produce two distinct qualities of product - a high-quality product and a damaged or crimped version. In addition to providing a justification for the price differential, this strategy also prevents arbitrage that might erode the gains from price discrimination in the first place.

Here are a few examples of product crimping (culled from Preston McAfee's excellent 'Competitive Solutions'):

* In May 1990 IBM introduced the LaserPrinter E, an inexpensive alternative to its very popular and successful LaserPrinter. The LaserPrinter E was virtually identical to the original LaserPrinter, except that the E model printed text at 5 pages per minute (ppm), while the LaserPrinter could reach 10ppm. The slower performance of the LaserPrinter E was accomplished by adding five chips to the E model. According to Mitt Jones (PC Magazine): "... IBM has gone to some expense to slow the LaserPrinter in firmware so that it can market it at a lower price." The LaserPrinter E sold for about 60% of the price of the original LaserPrinter... IBM has reduced the incentive of high-end customers to buy the low-end device by slowing down the low-end device.
* The Sony MiniDisc is like a compact disc in performance, but it is the size of a 3 1/2-inch floppy disc... Sony makes two sizes of minidisc, a 60-minute and a 74-minute version. The difference in the 60-minute version is a code written on the disc itself, which tells the player/recorder not to use a portion of the disc. these instructions are embedded in a non-rewritable area so that aftermarket resellers cannot overwrite the instructions. At the time of this writing, 74-minute minidiscs sell for around $4.50, while the 60-minute versions sell for $3.00.
* It has been alleged that an overnight delivery service deliberately holds back second-day air packages for delivery on the second day to insure that next-day air is significantly better. This policy insures that many of the next-day air customers do not percceive second-day air to be a "usually next-day air" product.
* Intel produced the early version of the 80486SX processor by disabling the math coprocessor in its regular 80486 chip.
* A very subtle form of product crimping allegedly is employed by American airlines. On flights with a high proportion of full-fare passengers, American improves the quality of the meal service, thereby rewarding the full-fare passengers and injuring, on average, discount flyers.

Posted by Narasimha Chari at 07:16 PM in marketing, Product Management | Permalink

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Comments

The essence of this technique is "value extraction". The seller is trying to avoid leaving profit on the table by extracting a price which reflects the value attributed to the product (or service) by the buyer.

When a buyer needs all of the features of a product then he will perceive a higher value. When a buyer could use a high value problem to solve a problem but really only needs a few features then he is unlikely to be willing to pay the asking price for the full product.

First example. I am not a graphic designer. I do not "value" all the features in Photoshop and I am unwilling to pay the asking price. However, my wife owns a digital camera and has requirements to touch up and edit photos. Hence, the manufacturer bundles a cut-down version of Photosohop with the product.

I then used that "free" Photoshop to create graphics for my website. I gained some free utility where I could not justify the price of a full Photoshop license. I could not justify it because I am not a full time graphic designer and it is priced to reflect the value attributed by such people.

Adobe could realize more value if they could sell Photoshop in other ways. For example, I design a new website about once every two years. It takes me about 1 month - working part-time. If I could rent Photoshop full featured for say $20 for 1 month then I may be tempted to do so. The same would be true for a number of other products I use in one off website creation.

Second Example. Togethersoft and Intelli/J. Together Control Center is a high end IDE and modeling tool acquired by Borland. A TCC license sells for about $7K and it is well worth the money for software architects and analysts who do modeling and design work.

However, a wider market for developers, who do not architect, model, analyze or design in any formal way, exists. Those developers valued only a subset of the features in Together and were unwilling to pay the $7K asking price. The value they perceived was more like $700, i.e. 10%.

Togethersoft (and Rational) had established a pricing umbrella and were unwilling to risk commoditizing their product and cannabilizing the high value market segment. So Togethersoft ignored the low-end market.

The result was that a number of Togethersoft staff left the company and created Intelli/J. This product is now significantly eating into the potential market for Together.

Had Togethersoft been willing to entertain forms of price discrimination then they could have avoided the Intelli/J defection. The added revenuw and market share this would have brought them would have resulted in a much higher price when Borland eventually acquired them.

Some in the industry believe that Togethersoft would have acquired Borland had Intelli/J remained in its product portfolio.

David

Posted by: David Anderson | Dec 12, 2003 9:48:55 PM

David,

Thanks for your thoughtful comments.

In general, when faced with different classes of customers who have (a) different performance requirements, (b) differing willingnesses to pay, it makes sense to somehow segment the product offering and price differently across the customer segments to capture the most value. Price discrimination and product crimping as a subset are both special cases of this broader strategy.

As you also point out, by introducing a low-end product with only a subset of the features of the high-end product, you can avoid cannibalizing the higher-end offering. The lesson from your Togethersoft and Intelli/J example is that if you hold back from product segmentation/price discrimination for fear of cannibalizing your product, you leave the door open for competitors who will capture the value that you're leaving behind.

Furthermore, low-cost disruptions can pursue a trajectory of performance improvements that, over time, leads to their capturing more and more of the higher-end customers while maintaining their cost advantage. This ties into Clayton Christensen's ideas about performance oversupply and low-cost disruptions that I'd reviewed a while ago (see http://techtrends.blogs.com/blog/2003/08/performance_ove.html ).

-Chari.

Posted by: Chari | Dec 13, 2003 12:40:44 PM

Sorry for too many comments today, but there is a great paper by Odlyzko about pricing in particular about airlines. http://www.dtc.umn.edu/~odlyzko/doc/privacy.economics.pdf

Posted by: TJ | Dec 15, 2003 1:52:16 PM

Just a comment on David's comment about Adobe. They have actually offered several lower-end alternatives to Photoshop over the years, such as Photoshop LE that was often included with scanners or digital cameras. Their latest attempt, Photoshop Elements 2.0, is a solid entry-level editing package for a low ($99?) price. As far as I can tell it's the full-blown version of Photoshop with many advanced features simply turned off.

Neil

Posted by: Neil | Jan 4, 2004 8:44:06 PM

Do you have a link and/or evidence showing the claim you made about American Airlines? I'm just curious because it sounds like one of those rumors that becomes truth by repetition.

Posted by: Tobin Coziahr | Jan 5, 2004 5:25:17 PM

Sorry, upon re-reading that, it sounds like I'm accusing you. I realize that you were quoting McAfee, I was more curious what evidence he had presented, since I don't have the book available to me.

Posted by: Tobin Coziahr | Jan 5, 2004 5:28:10 PM

Tobin,

I got the example from Preston McAfee's book (verbatim). What I quoted is pretty much all he has to say on the AA issue.

I don't know how true the allegation is - my intent was more to show examples of ways in which pricing can be used as a tool to segment and differentially serve the customer base (which may consist of different constituencies with different price elasticities of demand).

Judging by some of the responses, perhaps I should have exercised more caution in quoting the AA example. Hope this clarifies.

-Chari.

Posted by: Chari | Jan 5, 2004 5:52:53 PM

i am very interested in most points raised in the entire website, and would appreciate it if you could send me any regular updates to definitions or facts on any part of the site, especially on discrimination pricing

yours sincearly - Mr. Taylor
(MP-Labor)

Posted by: Charles Taylor | Jan 20, 2004 1:41:40 PM

That example from American Airlines was given on ABC Morning News, July 11, 2000. The book actually says allegedly (and gives the citation) because I was unable to find a second cite to the practice.

Please consider posting a review of Competitive Solutions on Amazon.

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"One strategy for implementing this is to produce two distinct qualities of product - a high-quality product and a damaged or crimped version. In addition to providing a justification for the price differential, this strategy also prevents arbitrage that might erode the gains from price discrimination in the first place."

This is so true. I hope they don't discriminate on the prices.

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