The Wall Street Journal has an opinion piece by Frank Luby and Frank Bilstein giving software firms pricing advice from drug firms. Both industries face similar problems -- they have high fixed and low marginal costs and hence the pricing strategy is not self-evident. More than that, it's damned tough to figure out how to price in such a market.

The article emphasizes paying attention to the demand-side in setting prices -- what prices meet the customers' needs and expectations best? This means a host of ephemeral factors must be taken into account, in addition to things like perceived "fairness" of the price and a degree of cost certainty for the consumer. They also discuss how habits and expectations form. Large enterprise software consumers are apparently aware of the promiscuous discounting that goes on, and exploit it accordingly. But such practices make it dreadful to be software supplier, needless to say. Just ask the recording industry how unfortunate it is for consumers to begin believing a product is "free."

These pricing conundrums are everywhere in digital industries and the economists have no good answer. As Jim has noted, the economists' marginal cost pricing prescription is useless, if not dangerous here. The economists' more sophisticated suggestions for high fixed, low marginal cost industries -- Ramsay pricing -- either offend consumers' sense of fairness (ask a business airline traveler) or reek of "blackboard economics" that gives the right answer in theory but is useless in practice.

In the end, my feeble take is that pricing in such industries is really, super, mega-hard; that theory provides little guidance; and that regulators, academics and theorists can accomplish only mischief by trying to interfere here.

posted by Ray Gifford @ 1:17 PM | General

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