Impact of the Internet on Pricing

Pricing is how a company transforms the benefits that it provides to consumers into the profits that it receives. Let's take a look at the key pricing concepts.

Standard Pricing

The general goal of pricing a product is to set prices to maximize profits. The price of the product includes fixed cost and variable cost along with a profit margin. The company maximizing profits wants to find the price that just makes marginal revenue equal to marginal cost. Marginal revenue is the revenue it receives from the additional unit it sells and marginal cost is the incremental cost of the additional unit. The balance between marginal cost and marginal revenue gives the company its highest profit.

Price Sensitivity

A fundamental issue facing all firms is the impact of the Internet on a customer's price sensitivity. Price sensitivity is the relationship of a change in product choice due to a change in price. When a small change in price leads to a change in choice of product we refer to it as a highly price-sensitive product. On the other hand, if the choice of product does not change even after a higher change in price it would be a low price-sensitive product or price insensitive.

A common perception is that the Internet will always raise consumer price sensitivity. For many companies, this will be true. However, some companies will be able to get higher prices and companies that understand the reason/s due to which price-sensitivity is increased by the Internet, can take steps to adjust to this new world. Next, we take a closer look at the determinants of price-sensitivity. They are as follows (Nagel, 1983; Nagle et al., 2002):

Unique Value Effect

The most important determinant of price sensitivity is the unique value of the product. Unique features and benefits lower the price sensitivity of consumers and raise consumers' willingness to pay. The value a customer receives can be judged by the benefit the product provides the consumer and the price. To lower the price sensitivity, the perceived benefits should be greater than the price thereby, increasing the value.

The Internet will reward those companies offering true value and lower price sensitivity for companies that provide consumer benefits. However convincing customers that a product or service is superior and worth a premium price can be difficult on the net.

To be able to convince customers of the value of a product and hence the reason to pay more is to provide hard facts, solid testimonials and hands-on trial use. The Internet can be used to convince customers of the benefits.

Providing information to customers can be difficult when third party comparisons are made. There are plenty of websites like www.strongnumbers.com that provide comparison of products based solely on price. They do not provide additional information of safety, styling or quality elements that might justify a higher price.

The Substitute Product/Service Awareness Effect

A product/service can be price insensitive if it has a monopoly in the market. However, due to competition most products have high price sensitivity. Since the Internet offers a wide range of products and gives the customer greater choice, the price sensitivity for products/services on the Internet increases. Increasing information of competitors' products may lead to less willingness to pay.

Yet again the competition becomes even more intense when sites offering price comparison increase. Certain sites offer price comparison for low price goods like books and CDs/DVDs, also compare shipping, delivery and add-on prices to accurately reflect the total price. The ability to make price comparisons boosts price sensitivity. Virtual value activities have a direct effect on price sensitivity. For example, a website in India that offers product comparisons is www.ebuyguru.com. It lists different categories within which a customer can search for a particular type of product that best suits his/her needs. The website also educates the surfer regarding the product category.

Total Expenditure Effect

As customers spend a larger part of their budget on a product or service, they naturally pay more attention to shopping for the best price. For example, if a major part of the household budget includes consumer electronics (including personal computers) then a website such as www.mysimon.com would be helpful to the customer to slice and dice the information from a variety of vendors on various attributes that may be significant to the purchase decision. If a customer wants to purchase a car, he/she will definitely look for the dealer that would offer the lowest price for the same car. However, the customer may not be inclined to spend a lot of time searching the Internet for a CD/DVD. The cost of time and effort (opportunity cost) should not be greater than the savings cost.

Shared Cost Effect

The shared cost effect states that markets in which there is a split between a person choosing a product and the person paying for a product will be less price sensitive than if the same person chooses and pays. Websites must decide which of the two markets they are targeting, i.e., the decision-maker or the payer. If the target is the decision-maker, stress should be placed on reasonable prices and value added amenities. If the target is the payer, cost-effectiveness will be important. For example, an executive staying at a hotel on a business trip will not be the payer but he/she would decide the hotel depending on the availability and amenities available there. Hence, he/she will be less price sensitive as compared to a vacation trip where he/she would be the payer. For example, www.travelnow.com caters to the decision-maker by searching for an available hotel in the city of your choice and displays information regarding the amenities and rates; whereas www.priceline.com caters to the buyer by allowing you to bid a lower price than the advertised rate by the airline/hotel.

Price-Quality Effect

When consumers first confront a new company, product, or service, they usually judge the quality with respect to the price charged. In the real world it is easy to judge the quality of the physical product. On the net, due to the lack of interaction, the quality of the product is judged by the price charged. It is generally believed that high quality products are more expensive and vice versa.

Difficulty in judging the quality may lower the price sensitivity of consumers. Low price outlets need to build on the confidence and trust of the customer. Well-known brands generally perform better on the net as they have brand equity which can then be related to quality. Thus, price-quality effect can work to the advantage of well-established brands in the face of aggressive price competition by start-ups.

Inventory Effect

The inventory effect states that price sensitivity is less on items that are nonperishable and can be stored easily. The prices of perishable items are harder to use to stimulate demand because there has to be a closer match between the time or purchase and consumption. Lowering the price of a product as it approaches its due date of consumption may not be able to attract customers. Prices of such products generally decrease over a period of time.