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Cost transparency is the new reality, and companies won't be able to avoid it. That doesn't mean, however, that companies should automatically cut their prices to the bone. They can take several steps to mitigate the effects brought about by the Net's trove of information.
For example, companies can pursue pricing options that go beyond just cutting their prices. One strategy involves "price lining," which is also called tiered pricing or versioning. Price lining is the well-known practice of offering different products or services at various price points to meet different customers' needs.
For example, America Online offers many plans at different prices for its customers worldwide. For its U.S. members alone, AOL has five options with rates that vary according to the level of subscriber usage. (For more on this strategy, see Carl Shapiro and Hal R. Varian's "Versioning: The Smart Way to Sell Information," HBR November-December 1998.)
Companies may also implement dynamic, or "smart," pricing — in which the prices they charge vary from one market to another, depending on market conditions, differences in the costs of serving individual buyers, and variations in the way consumers value the offering. That is what Staples is trying to do with geographic segments by forcing shoppers to enter their zip codes before they can view prices. Companies that can pull off this approach can earn higher profits than those that have only one price for every market they serve. Major airlines, auto dealers, and car rental companies have long practiced dynamic pricing. Lately, the strategy has been touted as a pricing panacea for e-commerce businesses, but managers need to be aware of its pitfalls and risks. (See "Is 'Smart' Pricing Really Smart?")
As a better solution, companies should look toward improving the benefits that their products or services offer. There's no substitute for quality, of course, and brand leaders can continue to enhance their offerings and then see to it that their superior quality is communicated to the public. Even in an era of cost transparency, the better products and services will still command higher premiums. (Companies that try to base claims about quality on image rather than fact, however, will be in trouble.)
Bundling—packaging a product with other goods and services—can make it difficult for buyers to see through the costs of any single item within the bundle. It focuses buyers on the benefits of the overall package rather than the costs of each piece. Some computer manufacturers, such as Gateway, are bundling their own Internet services with their machines as a way to mitigate the problem of free-falling computer prices. In the e-commerce world, Charles Schwab has kept its head above the crowd by using this strategy. It bundles value-added items such as better research tools and access to preferred IPOs with the option of talking to brokers by phone or at branch offices. As a result, it has been able to successfully justify its somewhat higher commissions to customers.
But the optimal way of counteracting cost transparency is through innovation. Consumers will reward makers of new and distinctive products that improve their lives. AOL, for example, combines innovation with bundling. It offers distinctive services such as instant messaging, proprietary e-mail and chat rooms, easy-to-surf "channels," parental controls over children's access, and novel ways to share photographs. AOL also has agreements with 3Com and Seagram that will give its subscribers greater access to its services; users of 3Com's PalmPilot will be able to read their AOL e-mail on their handheld sets, and visitors to Seagram's Universal Studios will be able to access their AOL accounts at special kiosks.
Likewise, Yahoo!, the Internet's number one site based on the number of unique visits it receives, has also been the Web's preeminent innovator and has thus maintained its lead over other online portals. Yahoo!'s latest catalog of features consists of well-organized and updated links, country-specific lists, free Web-based e-mail service, yellow pages and classified ads, e-commerce sites for small businesses, and a broad range of informative financial sites including the Net's most popular chat groups on stock trading. The lesson for traditional companies, like the large bookstore chains whose bricks-and-mortar superstores increasingly look like white elephants, is that they, too, will have to innovate and create new experiences for customers to differentiate them from their online competition.
Better-quality products, creative pricing strategies, imaginative bundling, and innovative thinking can all help keep cost transparency from overwhelming a seller's ability to maintain brand loyalty and obtain relatively high profit margins. But contending with the Internet's vast reach and power will not be an easy fight. Those managers who best understand the dynamics of cost transparency on the Net will be most prepared for the challenge.
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Is "Smart" Pricing Really Smart?
If one were to believe the business press, smart, or dynamic, pricing—the practice of charging different buyers different prices for the same item—is the way of the future in e-commerce. Marketers seem to view the popularity of auction sites on the Web as proof that buyers enjoy online haggling. And online auctions do represent companies' ultimate dream of collecting the highest amount that each individual buyer is willing to pay at a certain point in time, a practice that in theory would allow them to extract the maximum possible profit from the market. Smart pricing is also popular because today's technology makes it easy to do. Even small and midsize businesses can make multiple price changes per day as market conditions and valuations shift. On the level of the individual, consider that when a shopper visits a site, a "cookie" (or small data file) is embedded on his computer. When that shopper returns to the site, the company can customize the prices he sees based on his previous buying behavior.
But the proponents of smart pricing appear to have overlooked its most obvious pitfalls. Because the Internet allows customers to easily share information with one another, smart pricing is likely to create widespread perceptions of unfairness that may prove devastating to businesses in the long run. Consumers will be unhappy if they believe they have paid more for a product than someone who was more persistent, more adept at bargaining, or just plain lucky.
Companies should tread carefully when thinking about smart pricing. For most consumers, fixed prices are a security blanket that helps them feel they are being treated fairly—or at least no worse than the next customer. Some companies have understood this well—think of Saturn with its no-haggling policy and Wal-Mart with its everyday low pricing. And a lesson from history may be instructive: In the seventeenth century, Hachirobei, founder of the House of Mitsui, instituted fixed prices as a way to resolve Japanese consumers' frustration over having to bargain to buy everyday household items. That action contributed heavily to Mitsui's rise as one of Japan's most successful industrial conglomerates.