Tuesday, May 19, 2015

An Invisible Handshake for The Digital Wealth of Nations

It is time to replace the venerable "invisible hand" of Adam Smith with something new and more suited to the strange and challenging nature of digital products. Think instead of an "invisible handshake," that draws producers and consumers into a more cooperative, balanced, and productive relationship. It takes a handshake, because digital is a post-scarcity economics. What matters here is not a balance of demand and finite supply over a population of producers and consumers in a single market -- but a compatible understanding of value between individual pairs of producers and consumers who can act without that producer constraint.

Let's indulge in some armchair economics to explore some big-picture ideas derived from previous posts.  This draws especially on the prior post -- about my thought experiment of an all-knowing economic demon, that leads to the idea of an invisible handshake, as replacing the invisible hand.

(This sequel is best understood after reading that.)

I suggest a kinder, gentler kind of scarcity. Some scarcity is unavoidable, so our solution is not the extreme peer-to-peer "economics of abundance" that some now advocate -- with its limited ability to motivate and sustain serious production of value.  The solution is to re-imagine the socio-economic contract between consumers and the producers that create value for them, to ensure a business model for producers. To maximize the value produced, and the entrepreneurial creativity, we need to motivate organizations that are selfishly driven by a desire for profit. I suggest a new kind of market that rewards the production of intangible stuff, based on a this new socio-economic contract -- neither the limited motivational power of pure altruism, nor the deadweight loss of artificial scarcity. And I suggest that this new economy can evolve from where we are, starting now, with the FairPay architecture outlined in this blog.

Allocating scarce resources with the invisible hand

The beauty of the Smith's invisible hand is that it set prices in a way that worked not only at a micro level, but also as a basis for an allocation of resources for society at large. The whole edifice of market economics has been based upon this.

But now the digital world creates strange new rules, at least in that special portion of our markets.  So then, for the digital domain, what now?
  • We now have freemium and other new models, but do they have any real economic rationale? Do they tell us how to allocate resources in a way that is good and efficient for individual producers and consumers, and across society? 
  • Many producers have rely on some form of artificial scarcity as a way to sustain revenues, but put the accent on artificial -- this has no fundamental basis, and creates no balance or fairness in resource allocation,  "The inefficiency associated with artificial scarcity is formally known as a deadweight loss" (Wikipedia article on artificial scarcity),  This may help keep producers solvent, but is fundamentally very hit or miss.
  • We also have the sharing economy, that recognizes digital abundance with its emphasis on collaboration and open-source, but with questions of efficiency, effectiveness, and sustainability at scale. 
Can we do better?
The core challenge of the economics of real goods and services is the allocation of limited resources: physical resources, labor, and capital. As Adam Smith said in 1776 in The Wealth of Nations, "...price...is regulated by the proportion between the quantity...brought to market, and the demand of those...willing to pay...." Smith went on to describe how "...he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. ...By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it."  So in the face of scarcity across a market, prices are set by the invisible hand to allocate the supply where it is most wanted. Hayek expanded on Smith to argue that an economy needs prices as the only effective way to signal how resources should be allocated. Debate on how well this works for society continues, but it is widely recognized that it works to build wealth. Is there something to replace that in the digital world?

An invisible handshake -- allocating share of wallet in a post-scarcity digital economy

I propose doing allocation in digital markets with an invisible handshake, because the game changes without scarcity of supply. What matters is no longer a dance of a market as a whole at a given point in timebut a dance of each consumer with each producer over time. So what should determine price?
  • Each producer can provide as much as is desired by each consumer. There is no inherent supply constraint -- all that matters is whether the compensation from that consumer satisfies that producer. 
  • Prices for different consumers need not bear any relationship. What does it matter if some pay more and some pay less? Maybe that depends on how much they want to use, what value they get, and how able they are to pay. We are conditioned to think price discrimination is unfair (and sometimes illegal), but that is true only when unilaterally enforced by excess producer power, not if done for reasons acceptable to consumers. 
The new allocation is not one of supply, but of share of wallet. If each consumer deals with a market full of suppliers for all of their digital products and services, the relevant scarcity is of their wallet -- how much can I spend on all of my digital desires, and how do I split that among my providers?
  • If I negotiate over time, in "dialogs about value," to share the economic surplus of my digital purchases, I am forced to allocate my spending within some digital budget, across all of my suppliers. I can do that any way I wish (to the extent that each supplier agrees to permit).
  • If all consumers do that, then all suppliers get their fair share of all of the wallets for all of their consumers.  They sell as much as their aggregate market population desires, at a sum of prices that is the maximum each market particpant is comfortable allocating.  
  • Given a scarcity of nothing but wallet, what works for each individual pair in the market leads to a result for all pairs that approximates a market-wide optimum.* 
So, like the invisible hand, the invisible handshakes between each of the individual pairs leads indirectly to a socially beneficial allocation. Like the invisible hand, it refers to an emergent process that by seeking local solutions, leads to globally optimal solutions.
  • The invisible hand applies external market-wide forces (supply vs. demand) to producers and consumers at a given point in time (actually a short interval), It pushes them together to a market price. That pricing process indirectly leads to an approximately optimal distribution of scarce supply resources.
  • The invisible handshake is driven by an agreement between individual consumers and producers to seek a mutually beneficial relationship. That binds them in an emergent process that generates prices over the course of the relationship, and indirectly allocates the wallet share of each participating consumer to demand as much digital wealth as each is willing to pay for -- at prices that work for each of them individually -- to compensate producers for producing as much as each one -- and thus the total population -- values. 
Thus the handshake is essentially a moral contract between the individual parties. That may sound utopian, but as outlined in the prior post and elsewhere in this blog, it is a moral contract with teeth. There are strong practical incentives to adhere -- and data that can be applied to help verify adherence. (This is the process I call FairPay, as described throughout this blog -- see sidebar.)
  • Digital products and services can be instrumented to generate detailed usage data that correlates to the actual value received.
  • Both parties participate in ongoing dialogs about value, which add subjective insight, but still can be partially validated by the usage data.
  • Based on these dialogs, the producer extends pricing "credit" to the consumer. If the consumer abuses this credit, they get less credit, and lose some or all of the ongoing privileges of the handshake.
  • This process generates consumer reputation ratings for fairness with each producer.  Since a good reputation rating has benefits (much like a credit rating), consumers will seek to maintain it.
It is this balance of forces -- the subject of the handshake -- that governs the allocation of wallet (in an approximation of the wisdom of the pricing demon).** Different producers can manage their own policies to make their handshakes very strict and demanding, or more loose and forgiving. Different segments of the population may play the game more or less fairly and honestly. But the process will adapt, and find workable relationships for most segments of the market. (And conventional pricing can be applied for those segments that fail the handshake.)

This provides the basis for a post-scarcity economy, at least for digital -- and perhaps more broadly. The digital goods and services are not scarce, but the willingness of consumers to sustain producers is scarce. The invisible handshake governs an allocation of that willingness to sustain. To/from each consumer according to his willingness and ability to pay. To/from each producer according to their ability to create realized and recognized value.

As noted in the prior post, this handshake enables a kind of first degree price discrimination. Conventional economics views first degree price discrimination as economically efficient, but not feasible. But what emerges from the handshake is a new kind of first degree price discrimination that is feasible and agreed to by each consumer.

A kinder, gentler -- and more sustainable -- market

This enables a broader sense of economic value than is generally addressable in conventional markets.
  • The invisible hand allocates supply and demand for particular items at particular times, thus narrowing consideration, in ways that ignore sustainability and other aspects of social value ("externalities"). Many have sought to broaden the focus of producers with notions of "Creating Shared Value" (CSV) and triple or quadruple bottom lines, that factor in financial, environmental, and social (and other) dimensions.
  • The invisible handshake creates prices that reflect not just financial value, but whatever dimensions of social value the producer-consumer pair want to reflect in the dialogs about value. There is no need for added bottom lines, or separate CSV objectives -- CSV is integral to the handshake
This handshake is not on a transaction price, but on a continuing relationship. As a result, it fundamentally changes the our economics from working across markets without regard to past or future, to taking a longer term view:
  • It is the lack of past and future that create many of the problems in conventional market economics. We balance supply and demand in the short term, with no direct way to factor in long-term consequences for the individual parties, or society as a whole. Addressing those "externalities" by bolting on special measures (taxes, subsidies, etc.) is artificial and very problematic.
  • With the invisible handshake, the whole focus is on a relationship over time.  Value shares may fluctuate in the short term, but move toward a desirable sharing over the life of the relationship. Sustainability can factor in directly.
Instead of trying to find a price, we need to find a broader kind of agreement. Instead of agreeing on price. we price out of agreement.  That agreement will naturally vary from person to person and from time to time. The effect of this "invisible handshake" is to draw producers and consumers into a more cooperative, balanced, and productive relationship.

Now that our digital market has been shattered to bits...

Moving from here to there will take learning and adjustment by all market participants. But digital has already shattered the market for content to bits -- shouldn't we take advantage of this opportunity?

Ah, Love! could you and I with Him conspire
To grasp this sorry Scheme of Things Entire!
Would not we shatter it to bits--and then
Re-mold it nearer to the Heart's Desire!

-- Rubaiyat of Omar Khayyam, Edward FitzGerald translation


*There is of course the important case of ad-supported digital services that take no share of wallet. It seems clear that this is not sufficient to support all digital services but it will remain an important contributor. The handshake process can factor in the value of ad viewing as one part of the compensation that offsets any monetary price, and thus takes less share of wallet. In fact, any aspect of value (attention paid to ads, personal information made available for sale, referrals, etc.) can be factored in as credits into these dialogs about value.

**Of course conventional set prices (or any pricing scheme at all) will also effect some kind of allocation of wallet. But is there any economically sound rationale? -- it is arbitrary, crude, and not personalized (as the pricing demon would suggest), and thus results in significant deadweight losses (notably the value not provided to those who would benefit from and pay fairly for it).

Monday, May 4, 2015

Harnessing the Demons of The Digital Economy

The dynamics of networked commerce combined with the essentially free replication of digital offerings has created devilish problems that our current economics has yet to tame.  Sellers have no clear rationale for setting prices and consumers feel they should not have to pay anything at all.

One way to step back and re-think this is to do a "thought experiment," as has proven valuable in the development of science. Some notable thought experiments involve imagining benevolent "demons" with special powers and/or knowledge: Laplace's demon, with its perfect knowledge of the state of the universe and all its natural laws, and Maxwell's Demon, with its ability to individually sort hot from cold molecules.* Maybe we cannot build such demons, but thinking about them can clarify concepts and possibly point to approximations that can be built, or can suggest directions for looking outside the box.

The demon I propose is one that can power a system of commerce.  Imagine a demon that has perfect ability to read the minds of buyers and sellers to determine individualized "value-in-use" -- the actual value perceived and realized by each buyer, at each stage of using a product or service -- such as songs or articles or e-books, either in a subscription or item-by-item context.
  • The demon knows how each buyer uses the service, how much they like it, what value it provides them, and how that relates to their larger objectives and willingness/ability to pay. It understands the ever-changing attributes of current context, where the value of a given item can depend on when and how it is experienced.
  • Furthermore, this demon can determine the economic value surplus of the offering -- how much value it generates beyond the cost to produce and deliver it.
  • The demon can go even farther, to act as an arbiter of how the economic surplus can be shared fairly between the producer and the consumer. How much of the surplus should go to the consumer, as a value gain over the price paid, and how much of the surplus should go the producer, as a profit over the cost of production and delivery.
This commerce demon could thus serve as the brains of a system that sets prices that are adaptive and personalized -- to set a price for each person, at each time, that is fair to both the producer and the consumer.

Imagine we could build an e-commerce system, with advanced programming and data that worked as an artificial intelligence version of this demon. We could build services like Amazon, iTunes, Netflix, or a newspaper subscription that were priced by the demon. Prices would not be pre-set by the seller, but would be set by the demon at levels that would be fair and acceptable to both the buyer and seller.

(This takes us in a direction very different from the ideas from the early days of e-commerce of "bots" that would negotiate prices for us. The demon is in some ways analogous to a bot, but instead of negotiating a single transaction, it works at a higher level that centers on value, not just negotiating power.)

With such a demon setting prices, we could reap the cornucopia of goods and services that the infinite replication of digital offerings promise ("information wants to be free") while still providing fair profits to the producers ("information wants to be expensive"). Every consumer who is willing to pay more than the marginal cost of production would be able to buy, while those who get and can pay for significant value would pay appropriately higher prices.

This may sound pointlessly fanciful, but thinking about it can suggest new approaches that are practical.

One such approach, the FairPay architecture I have been describing in this blog, works very much like an approximation of this demon. Not perfect, but still workable as an emergent process that uses simple procedures and dialogs to approach what this demon knows. Details are in other posts and the sidebar, but some basic points:
  • FairPay shifts our perspective from individual transactions to a series of transactions over time in a relationship.
  • Instead of the invisible hand of supply and demand pushing from outside, it brings an invisible handshake in which the buyer and seller agree to cooperate to find a fair basis to exchange value.  This can inform a new balance of powers, based on "dialogs about value." 
  • The buyer's power is to set prices for a current transaction -- "fair pay what you want" -- with the understanding that he agrees to be fair, and that this is a temporary privilege that the seller will continue only as long as he agrees the prices set by that buyer are usually fair.
  • The seller's power is to decide whether to continue these attractive offers, or not. That gives the buyer full buy-in on all prices, but motivates him to keep up his end of the bargain.
  • Additional data feeds in to the process, including the seller's suggested price to each buyer, the buyer's reasons for pricing higher or lower, and all of the increasingly rich individual details that digital system instrumentation can make available about usage levels, patterns, and contexts, to inform and validate these dialogs.
  • Based on all of that, the seller tracks each buyer's reputation, much like a credit rating. Consumers will warm to the idea of this pricing privilege, and will seek to protect their fairness rating just as they do for credit ratings.
The result is an emergent process that seeks to discover the price, just as the demon understands it. The approximation may start out being quite crude, but digital sellers can afford some unprofitable cycles in the early stages of each relationship, if that soon leads toward convergence on fair prices. As experience is gained, this will become a science of Big Data and predictive analytics -- one that works to serve both the buyer and the seller.

So this FairPay process acts as an engine that approximates what the demon knows. It draws out the knowledge of the buyer, encourages truth-telling, nudges that with the views of the seller, and provides a context for the dialogs about value that lead to a fair split between the producer and consumer surplus. Such a process can totally change the game of selling digital stuff, for more profit, and more value to society.

*Expanding on these demons, and the two well-known examples...
  • Laplace's Demon, has been influential in philosophy and physics, as one who has perfect knowledge of both the current state of the entire universe, and all the laws of nature. Thus Laplace's demon can look forward or backward to derive the exact state of the world at any past or future time. This is relevant to questions of free will versus determinism, and to quantum uncertainty.
  • Maxwell's Demon, has been influential in thermodynamics, as a gatekeeper in a box with two chambers separated by a small hole with a door. The demon can control the door to allow high speed molecules to go from left to right only and low speed molecules to go from right to left only, thus making the left side get colder while the right side gets hotter. This would violate the second law of thermodynamics.
(There are reasons why both are infeasible, but thinking about them sheds light on why that is.)

Adam Smith's invisible hand can be thought of as a similar demon that helps balance supply and demand in a market at a given point in time. As we know, Smith's demon actually works fairly well for many markets.

Economics has generally ignored my demon, but it has been lurking in the background. First degree price discrimination was defined by Pigot as applying this kind of information in idealized monopoly situations -- but has been viewed as not realistic for reasons such as arbitrage (those who bought cheaply could resell to others so they did not have to pay the full amount they would be willing to pay).

I propose that the workings of FairPay enable something much like first degree price discrimination, but instead of all the surplus going to the monopoly, my demon shares it fairly between producer and consumer.  And since resale of digital services can often be made impractical, the arbitrage problem generally does not apply.

Thursday, March 19, 2015

Beyond the Deadweight Loss of "All You Can Eat" Subscriptions

In the continuing conundrum of pricing digital content, "all you can eat" unlimited subscriptions have become the latest thing to try/hate. We see it in music, with the Taylor Swift withdrawal from Spotify, and in e-books, with angst over Amazon Unlimited and other subscription services.

At a most basic level, isn't it clearly perverse that:
  • I pay the same for Spotify whether I listen for 2 hrs/mo or 12 hr/day?
  • I pay the same for Amazon Unlimited whether I read 1 book/mo or 1/day?
  • I pay the same for Netflix whether I watch 2 hrs/mo or 12 hrs/day?
  • I pay the same for NYTimes.com whether I read 20 stories/mo or 50/day? 
The problem is obvious on the surface, but the fix has not been at all clear.
  • All you can eat (AYCE) encourages wasted resources ( a "deadweight loss" as economists say*), and this is especially painful to the creators of content (musicians and authors) who find themselves getting pennies for their hard-earned work. 
  • But all the conventional set-price alternatives are also very problematic -- especially for digital content, which can be replicated at near-zero cost, to economically serve almost anyone who sees value in it.  
The problem is that we have had no efficient way to price for a value that varies from person to person and from time to time.  For example:
  • AYCE under-prices to heavy users, and overprices to light users. 
  • Set-prices of any kind underprice to those who most value an item or are most able to afford it, and overprice to those who find limited value or have limited means.  
This results in a deadweight loss to our economy -- a loss to society -- because the set price excludes the large numbers of potential consumers who would gladly pay less, and thus would (1) obtain value and (2) generate a profit to the seller.

This is partly a matter of usage volume.  Pricing for usage has always been a problem (think of long distance phone bills, and now cellular data), but now it is far more widespread and problematic for products and services that involve significant costs of human creation but low cost of replication. Many have identified the need** to find new business models, but with little clear direction as to how.

I suggest that this derives from an underlying blind-spot -- we are stuck in our habit of thinking that prices should be set by sellers, rather than embracing the new dynamics of networked e-commerce that make it practical to dynamically set individualized prices (see my earlier post, "So Last Century...").  The new FairPay pricing architecture promises to move us to a new economics, by setting prices that correspond to a particular individual's usage context and value received. This has long been an economic ideal (perfect price discrimination), but FairPay shows how the digital world offers a new way to approach this ideal.

Pricing for value

When you think about what is economically efficient, and what is fair to both parties, it is clear that prices should correspond the the value of the experience. Value is not just how much you eat, of what and when, but how good is it -- a particular and ever-changing mix of how tasty, exciting, nutritious, timely, sustaining, ...and how costly to provide.

Businesses can exploit other models, but that is often unfair to consumers, and wasteful to society as a whole. But pricing for value is challenging, and so is rarely done for consumer services. Let's look at some of the commonly used options, all of which are good for some of the people, some of the time -- but not for others.
  • All You Can Eat subscriptions (AYCE at a set price -- all the items you want, time-limited to a meal, a month or whatever) -- This is simple and easy, but has all of the unfairness and inefficiency noted above. (These and variants are often referred to as paywalls.)
  • Usage-related subscriptions (set prices for units of usage, a form of a la carte) -- This can correlate well to usage as one important aspect of value, and thus be much more efficient and fair, but it is very unforgiving, and so consumers rightly shy away from it, especially if they are price sensitive. We all know of the old horror stories of teenagers getting surprised by cell phone bills for thousands of dollars, and are always very conscious of "the ticking meter," Many variations on this have been applied, with mixed results, One variation is set prices for different tiers of usage (common with cellular data and previously for voice, but little used for content).  This avoids surprises within one tier of usage, but confronts the user with a cutoff, after which they suddenly must jump a high price hurdle to the next tier for one more unit, or stop until the next cycle. An improvement on that adds "rollover minutes" in which unused usage credits are carried over into later periods (a doggie bag). These are workable and moderately efficient with regard to usage, but get complex, and still present the consumer with set-prices (and potential surprises) that may or may not match to the value to that user. (FairPay draws on aspects of these models in a more forgiving form.)
  • Unit purchases of items (essentially AYCE at a set price, of a single reusable item, forever) -- This is also simple and easy, and good for those who want to make full use of a given item (song, book, video, app, etc.) but tends to make it prohibitive to use very many items.
  • Freemium subscriptions (AYCE at a set price, split between a free tier of items/services, and a paid tier) -- This is just a variant version of AYCE that serves two customer segments, but only obtains fees from one. This has become very popular as perhaps the best solution readily available for many digital services, such as for Spotify, newspapers (metered or "soft" paywalls), and many others. But freemium is still a form of AYCE, with all its inefficiency, and it still has a set price, so the challenge of what price, at what level, remains (see post "Beyond Freemium..."). Multi-tier freemium models also exist, and add the efficiency of usage tiers or feature tiers to the basic idea of free+paid options. But still the tiers and prices are pre-set, and still do not adapt to the fact that value varies in many dimensions other than just quantity of usage. As to deadweight loss, freemium reduces some of that, by providing some value to consumers of the free tier -- but it fails to provide the incremental value of the full service, or the revenue that many of those free tier users would be willing to pay. (FairPay offers similar benefits to freemium, in a more flexible and potentially efficient form.)
There are also many variants and other pricing strategies that deserve consideration, but have yet to prove widely effective for consumer markets. These may apply to items or subscriptions, and some involve a shared platform supporting multiple vendors.  (Of course many other models exist -- including other combinations of these techniques.)
  • Micropayments (small set prices for each small unit of content) -- This variant of usage-related subscriptions has a long history of conceptual appeal, but has the same problems of being unforgiving, with the nagging fear of the "ticking meter." (To ease the logistics of handling small payments to many vendors, this is often applied across multiple vendors with a common payment platform, such as in app stores and in multi-publication subscription services.) 
  • Pay What You Want (PWYW) (AYCE of a single item, forever, but the consumer sets the price) -- This gained fame after Radiohead offered a PWYW album, and has proven successful in some markets such as indie music, games, and e-books (see post "...Still Crazy..."). While it has been well established that most people will pay, and many will pay fairly or even generously, it is still very iffy as a sustainable business model. Its success so far has been greatest in special promotions, such as Radiohead, or Humble Bundle. (A limiting factor has been that most PWYW offers are in a single transaction setting -- FairPay shifts this the setting to that of an ongoing relationship.)
  • Pay What You Want "post-pricing" (PWYW, where the consumer sets the price after experiencing the items) -- This "post-pricing" has been little used so far, but has a big advantage in that it let's the user set a more generous price because they have confidence that they will not be disappointed -- and it signals greater trust and confidence from the seller, to further encourage generous pricing. (One established form of post-pricing is shareware, but with only the choice between a set price or zero. Again a limiting factor has been the single transaction setting, unlike the ongoing relationship setting that is central to FairPay.)
  • Tip-jars or Microdonations (blending PWYW with micropayments) -- These have gained limited traction as a way for small sellers to pool voluntary payments using a common payment platform, such as for blogs. (Again, while pooled, this is purely voluntary, and not wrapped into a relationship-building structure as FairPay is.)
  • Value-based or Performance-based pricing (collaborative post-pricing based on actual results of use) -- Near the ideal of pricing for value with perfect price discrimination.  As currently done, this has been generally impractical in consumer markets, but it has proven very effective and efficient for big-ticket industrial items or services, where the parties can agree on how to measure value and share in the value surplus that the product/service creates, and can do the analysis that takes. The advent of Big Data is making this more feasible and effective in a wider variety of businesses. (As explained below, FairPay provides a way to extend this to mass-customized consumer markets.)
What is fair to me is not fair to the next guy

While the deadweight loss of All You Can Eat is a big problem, usage pricing can only solve part of the problem of pricing digital, even if it could be done perfectly. Even at the same usage level, a price that is fair to me may not be fair to the next guy. What if I get great value from x number of items because they contribute significantly to my business, investments, health, hobbies, social life, cultural interests or whatever, but someone else may find some value in them, but not as much? Alternatively, what if the perceived value is the same (such as for health, or to a sports fan), but I am affluent and can easily pay a high price for that value, but someone else is a student, retired, or disadvantaged?

Simply charging based on units of usage still has the problem of the Long Tail of Prices. A number of consumers (the short "head") who get high value or have high ability to pay could potentially be enticed pay more, and should do so to help support the creation of this value (much as patrons of cultural creation do). The "long tail" of very many consumers who would get less value or have less ability to pay, and so do not buy, might happily pay a lower price, and thus contribute added profit to the creator of that value. It is well know in economics that it is most efficient to sell to everyone who will pay a price greater than the marginal cost of production (which for digital products is nearly zero) -- if you can get those willing to pay more to do so.

Units of usage are just not an adequate measure of value. (Why is it that very expensive gourmet restaurants serve very small portions with few complaints, while mass-market restaurants feature large portions -- and, of course, "all you can eat" buffets?)

The efficiency of FairPay

Essentially FairPay takes the principles of the value-based and performance-based pricing that work increasingly well in B2B markets, and applies them in a lightweight and intuitive form to consumer markets. In doing this, it can flexibly blend features of many of the models described above in a new paradigm. Post-pricing is used in combination with aspects of freemium and PWYW, along with post-pricing, in a new way that gives buyers and sellers evenly balanced power to collaborate over time to set individualized fair prices in "dialogs about value" that can consider all of the relevant dimensions of value and fairness.

For more specifics of how FairPay changes the game to enable personalized pricing based on individual value see the other posts on this blog, and the FairPay Web site.

  • The previous post digs into the specific example of music, providing a good example of the subtleties that FairPay can address, but music is a hard business to change because of the role of entrenched labels and other intermediaries that make it difficult for those selling music to experiment with new pricing models (especially after Steve Jobs got them to buy into iTunes!).
  • Very much the same analysis can be done for other industries that have fewer structural constraints. For example, journalism, such as newspapers and magazines, may be much more amenable to FairPay in that there are no powerful middlemen to stand in the way of pricing innovation. Several prior posts address that (such as those relating to NYTimes, NYTimes Premier, Bezos and the Post, and Omidyar, and I expect more to follow). Briefly, there are the same issues of widely varying value propositions, and the need to get readers to pay a fair price to support the expense of high-quality journalism.
  • Much the same applies to many other businesses, including e-books, video, apps, games, and other digital services. One post explores the rich nuance that FairPay can offer in dealing with the widely varying value of Travel Guides.

Of course it does no good to set individualized prices if those asked to pay more than others will not agree to do so. That is why perfect price discrimination has been so elusive. What is different about FairPay is how it nudges those who can and should pay more to agree that it is fair that they do so. That is addressed in the examples just referenced, and more fully in posts on Seller Control and on Making People Want to Pay You.

Isn't it time to move beyond our deadweight losses and try a pricing model that addresses the dynamics and context-dependency of digital so that as many people as possible pay a fair price? ...A model that enables a product or service to by provided to everyone who is willing to pay more than the very little that it costs -- and enables the provider to gain a fair profit from all of them?

*Not being expert in economic theory, I am not sure if all of the economic inefficiencies described here are strictly considered deadweight losses (and wonder how well economic theory addresses the new varieties of exchange enabled by digital) -- but it is such a great term!  My point is they are inefficiencies (in theory and in practice) -- and that many sales that would create an economic surplus for both buyers and sellers do not happen because of these kinds of pricing inefficiencies.

Two interesting items on this theme are:
...And don't start me on why I have to pay $4 per month for ESPN even though I never watch it!

**The music business has been one of the hardest hit by this and most outspoken about the need for new business models (as addressed in the prior post). For example, see recent pleas for new business models for music in Harvard Business Review, from an ex-Rhapsody exec, and in Music Industry Blog posts here and just earlier.

Tuesday, February 10, 2015

The Future of the Music Business -- The Artist is King with FairPay

The economics of the music business continues to be highly problematic.  The revenue pie for recorded music is a fraction of what it once was, and artists/creators complain that they are seeing only crumbs. At the same time music is more available - and artists are closer to their fans - than ever.

As this dilemma motivated the upcoming MIT Enterprise Forum Think Tank session on The Future of Music: Where is the Money? (which I will co-lead on April 16 in NYC), this seemed a good time to explore how the new FairPay monetization strategy bears on this. This post is my take on Where the Money Should Be, and how FairPay can enable that.

The crisis of Napsterization has eased a bit, as first iTunes and later subscription services like Pandora and Spotify are getting many people to pay something, but business models remain besieged. At the same time, artists/creators have gained a direct path to their fans and seek to exert more power. The recent spotlight on this business as Taylor Swift pulled her music from Spotify (and Spotify's response) has shed some light on the economics, and the recent move of YouTube to add a paid service adds to the momentum toward paid subscriptions.

But the size of the pie remains shrunken, and the size of the slice that passes to the performing artists and songwriters* often seems disproportionately small.  More radical models of disintermediation, with artists/creators going directly to fans and even selling on a pay-what-you-want basis, as done most famously by Radiohead, and more sustainably by Amanda Parker, have shown that we are ripe for new ideas, but none have yet proven broadly workable. [See Update below.]

Revisiting the economics of the size of the pie - and the portion of the pie

The core problem is that the value and economically proper price for recorded music is not well captured by any conventional model. Primary criteria are:
  1. A fair price to the listener
  2. A fair portion to the artists/creators* (performing artists and songwriters)
  3. A fair portion for distribution
  4. A fair portion to other services such as A&R development support and marketing, whether done through labels or special services hired by the artists/creators.* 
Consider first #1 and 2, revenue in to the distributor, and then passing through to the artists (via whatever convoluted path through labels and rights organizations):

Sales of albums, and now album or track downloads ($1 or $10 for unlimited play), had been the mainstay of the business, but the flaw in their economics is clear, now that alternatives are more available.
  • Buying music is a good value for the user only if they play it many times. Lightly played albums are very expensive per play.  Conversely, heavily played albums are a huge bargain (one that the the artist does not fully share in). 
  • The payment to the artists/creators (via whatever path) is roughly tied to sales, and so depends on how many people buy, not how much value they got (measured by how often they play it and other factors). That disproportionately favors production of pop hits over more subtle kinds of value.
"All you can eat" subscriptions (typically $5-10 per month) to unlimited numbers of plays per month are now gaining market share, but this too has perverse economics:
  • Flat rate subscriptions have a one-size-fits-all price that actually fits very few. Ultimately the price must be set to earn the distributor a reasonable margin on average over a widely varying user base. Some will play many hours per day, resulting in little revenue pass through per track -- or a net loss if the distributor pays rights holders a set fee per track. Others will be in a range that generates reasonable profit. Some will pay full price for light usage (for a nice profit), but many will refuse to pay the monthly fee at all, and stick with less profitable advertising-supported free versions (or piracy). For light users, the standard monthly price will rightly seem exorbitant. The irony here is that distributors earn little (or even lose money) on the dedicated music fans who should be their best customers
  • Depending on the subscription service, the payment to the artists/creators (via whatever path) may be based on revenue (e.g.: "streaming services" like Spotify, Rhapsody, Deezer, and MOG), or on tracks played (e.g.: "webcasters" like Pandora). If on revenue, the usage-related inefficiency passes directly to the artists/creators. If on tracks, the artist/creator is not harmed by heavy users, but still loses out on those who opt out, or makes less on "free" versions with ads. Overall, this results in a licensing structure in which per track fees to rights holders must be very low because of this economic inefficiency.  They may get paid per track, but as they say, the payments are woefully small - not because the distributors are exploiting them, but because the distributors are caught in the middle with an inefficient pricing model.

Neither of these current pricing models produce an economically sound result in which users pay at a level that corresponds to the value they receive. From an economic perspective, it would be far more efficient and fairer to all if users paid based on usage (with some volume discount). But usage-dependent pricing models have generally been unpopular because users fear unpredictable billing levels and nasty surprises. (A future post is planned to discuss this issue further, but consider the examples of voice and data communications services that have been oscillating between usage tiers and unlimited.) The next section will explain how FairPay can change this.

But first, what about the portion of the pie that goes to the artists? This is the other critical issue. Historically, the record labels held a lock on distribution, and used that to exert control and extract high fees, giving relatively small shares to the artists. The Internet has been a great leveler, turning distribution into a utility service, enabling musicians to sell directly to their fans, cutting out or reducing the role of the middleman (see my post on indie music). Some have been very clever and successful at this, but many artists want or need help developing themselves and their market. This argues for a flexible unbundling, where the A&R (artists and repetoire) and marketing services of a label (or specialized service) are priced and bought by the artist separately from distribution services. The openness of the Internet suggests it will increasingly be the artists who decide what services to outsource, at what cost, depending on what level of help they want and need, and that labels will move to the side, morphing into support services to artists.*

A better value proposition with FairPay

FairPay promises to change the game --  primarily, by making the revenue pie bigger -- and secondarily, by making the artists/creators share of the pie bigger as well.

How FairPay works for music is outlined in an early post on the basics and a later one on how it can work disruptively for indies, The essence is that it enables prices to be individually set to match the value exchanged.  Instead of a flat price for (a) an unlimited number of plays of a purchased track or album forever, or (b) for an unlimited number of plays of any music in the catalog per month, FairPay can track to the amount of music played in any month, and can also factor in other aspects of value, including very subjective factors.

Our current models are historical accidents, caused by the limitations of distributing physical recordings for which usage was not trackable, and the limitations of mass marketing and its need for a uniform set-price per record or CD.  That world has changed radically, but our pricing models not so much.

With FairPay, users are given usage reports and suggested prices for their monthly listening, and get to decide what they think is fair -- and give their reasons why. Distributors let them continue to do that as long as they generally pay an amount that seems fair enough to the distributor, given their individual context.  Thus a light user might, in fairness, pay less than the $5-10 per month now charged, and a heavy user might be convinced that it is only fair that he should pay $15 or even $20 per month. This expands the total revenue base, bringing in many more paying subscribers, some paying less and some paying more than the current fixed price.**

This usage sensitivity alone can help the artists/creators, since they can now get paid for more plays, and by more people. But FairPay can go farther, since it enlists patrons in "dialogs about value" that center on the fairness of the price, and that fairness includes factors like how much of the price goes to the artists/creators. Daniel Ek of Spotify speaks of the need to increase transparency in this obscure area (as does the Copyright Office), and FairPay can greatly leverage the power of that.
  • Distributors (or their artists) can disclose their algorithms for passing through revenue to rights holders, so that customers can choose to use services that most generously sustain the artists/creators who produce the music.
  • FairPay can go further by enabling bonus payments to favorite artists, either by explicit direction of the user, or by indirect metrics of value such as "thumbs up," inclusions in playlists, or frequency of play.  Such adjustments might come out of base pricing, or out of special patron bonus payments that pass through 100% to rights holders.*
All of this can enable a more direct linkage between fans and artists, and a more direct exchange of value in which fans more fully take on the role of "patrons" -- to sustain the artists that produce the music they care about. Amanda Parker said:
I see everybody arguing about what the value of music should be instead of what I think the bigger conversation is, which is that music has value, it's subjective and we're moving to a new era where the audience is taking more responsibility for supporting artists at whatever level.
The core of FairPay is a systematic process for building individualized relationships in which creators/suppliers are rewarded by patrons for providing value that meets their individual needs. This can work through multiple levels of the value chain, to enable artists to most effectively tune and position their work to appeal to the audience that values and patronizes them.

Making it happen will take work, and experimentation -- and the entrenched powers of the labels and the licensing system and rights organizations will adapt slowly -- but there is no reason why this can't be made to work far better than our current inefficient models. This may start most easily with the indies (with their simpler business model infrastructure), and then migrate to the major labels (to the extent they remain relevant).

When it is clear that most of the price goes to the artist (and the people they chose to help them produce and distribute the music), and not just into the coffers of some faceless corporation, listeners will be more willing to pay a fair price for their music. FairPay can provide a process for working with each patron to jointly find a fair price. With such a direct linkage between value creation and monetary reward, the artist can become king.

*For simplicity, I refer to both the performing artists and the songwriters as "artists/creators" (or sometimes just "artists") in that both (sometimes the same persons) are creators of the music, and ultimately the ones listeners most want to compensate to sustain their creation. The industry structure treats these roles very differently, and pays them through different paths and under different rules, often through labels and publishers (who may handle most of the rate negotiations) and through a web of Global Music Rights Organizations (GMROs). I gloss over these details here, but of course applying FairPay or any other new monetization strategy will require accommodating (or changing) this industry infrastructure.  I also focus on the distributors and labels as the main competitors with artists/creators for a portion of the pie, ignoring the role of GMROs as a secondary issue, but one that is still essential to getting revenue to the artists/creators.

**This process can be simplified once a pattern is developed, so that a customized pricing pattern can continue automatically, with the user intervening to change it only when desired.

(My thanks to Daniel Susla for helpful comments to clarify my understanding of this complex industry)

Update: See these pleas for new business models for music in Harvard Business Review, from an ex-Rhapsody exec, and in Music Industry Blog posts here and just earlier.

Tuesday, December 2, 2014

So Last Century! - It's Time to End the Tyranny of Set Prices

We think we know what a price is, but new kinds of markets require new kinds of prices. A price has a function, and that function has changed.

We recognize that electronic markets and digital products have created a new age, but we seem to not recognize that these markets and products need a radically new approach to pricing. FairPay is a new concept of what a price is for these new markets.

Expanding on ideas on the Harvard Business Review Blog, Marco Bertini and I have co-authored an article, "A Novel Architecture to Monetize Digital Goods," that has been submitted to a leading management journal for publication.

Conventional thinking about prices is blinded by a mind-set that we all grew up with and take for granted -- but that is actually a historical oddity. As we observe in the article:
Throughout most of the history of commerce, price was the outcome of a negotiation between individual sellers and buyers. Different buyers achieved different prices depending on their current situation, needs, and bargaining power. In other words, prices were very personal.
Starting in the 1850s, however, the shift to mass retail shoved this tradition aside. Shoppers no longer bought from individuals, but from organizations interested in standardization and scale. Indeed, the price tag gained popularity in the early 1860s with the arrival of the department store—John Wanamaker, the trailblazing American merchant and religious leader, opined that if everyone is equal before God, then everyone should also be equal before price. The company dictated terms, with prices set to maximize profit or some other objective and offered to the market on a take-it-or-leave-it basis.
Now that commerce is shifting back to personalization, it is interesting that one of its central ingredients, price, lags behind. Businesspeople appreciate that prices should be fitted to people’s personal valuations as they once were, but there is no real agreement on how this comes about.
Our suggestion seeks to undo the tyranny of fixed prices while retaining the efficiency inherent to institutionalized commerce...
Specifics of how and why to do that are explained in the article (preliminary version online at SSRN). Additional background is in other posts on this blog.

To be clear, our answer is not to try to somehow go backward to automate traditional negotiation. Instead we need to go forward with new ways to build relationships based on human values in a world of electronic markets and digital experiences. What we need is a totally new concept of what a price is, how it is arrived at, and why.

Article abstract:    
The shift of commerce to the digital domain has forced many organizations to rethink their attitude to value creation, at times backtracking to the very question of what “value” actually means. Electronic commerce facilitates and thrives on social interaction, yet the way companies convert digital anything into cash they can bank seems to be stuck in time, obeying rules and practices that may have worked for physical goods but make far less sense today. We believe that earning revenue in the digital age needs a fresh approach. This short article seeks to lay the foundations for such an approach and proposes FairPay as one viable alternative.

Wednesday, November 12, 2014

Better than Groupon! -- A FairPay Coupon/Trials Service

Trial coupons (like from Groupon) can be a very effective way to attract new customers, but as generally done, this process tends to attract bargain-hunters who may not be the ones a business really wants to attract. FairPay promises to enable a better way to attract your real target market.

The idea for FairPay (Fair Pay What You Want) came from thinking about the problems with digital offers and how to solve them, but it also has significant potential for use with real products and services, especially for experience goods, where the true value is only apparent after having the experience.* I suggest a Groupon-like service that similarly offers "coupons" for trial offers, such as for restaurants, service establishments, and the like, but based on FairPay pricing. Think "Groupon What You Want" or "PriceMeNot."**

FairPay is based on taking the risk of low payment on some product offers, in order to seek to build a profitable relationship with a prospect. The prospect is told that they can set their price as they think fair (possibly within limits), but that such offers will continue in the future only if the seller(s) agree the buyer's price is fair (based on individualized criteria). Unlike conventional coupon offers, which offers a pre-set discount, FairPay lets the buyer set their own discount, higher or lower, after they try the product or service. If the esperience was good, the discount is smaller, but if it was bad, the discount can be higher (possibly even 100%).

This is attractive to those seeking fair value, by eliminating their risk of buyer's remorse. It makes trying new places nearly risk free (at least as to cost), and offers a fair discount for taking the risk of a bad experience, but can be selective enough to exclude those who just want a bargain and will never be good customers.

In the case of a coupon aggregator (like Groupon), the aggregator would collect feedback from the buyer on why they set the price they did, and from the seller on whether the price seems fair, given those reasons and given other data about the buyer's values, demographics, and ability to pay. The aggregator can explain that they will develop a reputation for the buyer, and use that to target other offers (or not). Thus the buyer has a strong incentive to be reasonably fair.

For example, for the case of a restaurant (which has significant marginal costs), the offers may be framed so that the buyer is told they can pay any price they want, but if not at least a target percentage (maybe 50%, maybe more), must explain why they think it is fair (with a few multiple choice questions that are easily scored automatically). They might also be told that a suggested fair price should be between 25% and 75% of the normal billed price. This reflects the objective of providing a discount for the risk of a disappointing meal, but with the idea that even a disappointing meal is usually worth something (say 25% of full price), and a very good meal deserves a good price, even as a trial (say 75% of full price). The buyer might be free to pay zero, but only in truly rare cases (such as for buyers that usually pay well) would that not be taken as a black mark on their reputation score that might exclude them from most or all future offers. This pricing might be set directly with the aggregator right after the meal (such as in a mobile app), who would then settle with the restaurant privately. Other kinds of service establishments could use a similar process.

By doing this over a series of offers, the aggregator can characterize each buyer with a FairPay reputation, maintain that in a database (along with rich, transaction-level detail on what they pay well for and what they do not -- and why), and use that reputation data to target additional offers. Merchants most eager to attract customers will make offers to a wide range of prospects (with correspondingly high risk), while other, more successful or selective merchants might limit offers to those who have already gained a reputation for paying fairly (thus taking relatively low risk, and from more valuable customers). The aggregator can also limit the number of offers that a particular merchant makes to untested buyers with unknown fairness reputation, to limit the risk even for marginal merchants.

The benefit to buyers is that those who are willing to pay fairly when they get value can be given trial offers for quality establishments that they may be likely to revisit.  It can be made clear that buyers who price at above the suggested value can generally expect to become eligible for more attractive offers, and those who price below that value will generally get less valuable offers. Some will price for quality and style, and some will price for the biggest discounts they can get (if they do not squeeze too hard). Offer flow will vary accordingly.

The benefit to merchants is that they can target the prospects most likely to appreciate what they offer, in a way that calibrates their risk. Some will seek new customers at relatively high risk, while others we be selective, and take little risk.

The benefit to the aggregator is not only a more effective coupon business, and a new broader range of consumers participating, but a valuable new database of very fine-grained data on buyer value perceptions and willingness to pay.  Much like a credit rating database, this FairPay reputation database can become a very valuable asset in itself. (And the aggregator can maintain the privacy of the customer data by not revealing the data to the merchants, but just using it internally to manage the offer process based on merchant-specified criteria, much as many ad-targeting services do.)

*As a well-tested reference point in the non-digital world, consider the experience of many restaurants, theaters, hotels, and other businesses who have tried pay-what-you-want offers.  These do not include any of the reputation tracking controls that FairPay applies to limit free-riding, but even with that limitation, PWYW has proven effective in many such situations.  See, for example, references cited in my Resource Guide to Pricing , such as the one that studied the restaurant Kish. For a more widespread example, check out Panera Cares.

**[Update] This can also apply to services analogous to Priceline's, especially for products like hotel rooms that have a high experience good aspect. A number of hotels already do PWYW offers at off times, so FairPay is a clearly attractive alternative. (Note that the "Name Your Price" feature of Priceline is very different from the Fair PWYW approach of FairPay, since with Priceline the seller can and will reject your price if it is lower than his secret minimum price. With FairPay your price is never rejected -- you just won't be allowed to continue setting unfairly low prices more than very rarely.)

Monday, October 13, 2014

Making Customers Want to Pay You -- Research on How FairPay Changes the Game

Wouldn't it be nice if buyers volunteered to pay businesses a fair price for what they are offered? Seems like a silly idea! But recent business experiences and research suggest we may just be stuck in the mind-set of the last century.

"Modern" mass-market commerce is a race to the bottom that assumes and appeals to the worst in people. Sellers set prices as high as they think they can to maximize total profit -- so buyers' only option is to take it, or bargain-hunt. What we have here is what behavioral economists call an exchange relationship norm. Exchange norms are zero-sum, quid-pro-quo. As described in other posts, FairPay seeks to find a better way.

Insight into how and why a very different model can work emerges from a growing body of research and real business success with Pay What You Want (PWYW) pricing (which has proven to be not quite as as foolish as it might first seem.)  FairPay builds well beyond this -- it promises to be significantly more effective than conventional PWYW -- and sustainably profitable for large-scale business -- by applying feedback and tracking in ongoing buyer-seller relationships, not just one-time sales. (Some background on PWYW.)

How to understand the power of FairPay was made a bit clearer to me in a very interesting research paper by Santana and Morwitz, "We’re In This Together: How Sellers, Social Values, and Relationship Norms Influence Consumer Payments in Pay-What-You-Want Contexts." That paper suggests an interesting two dimensional behavior model, which I interpret as follows.

The two dimensions of behavior are:
  • Social Value Orientation (SVO), essentially pro-social versus pro-self, as individual traits. 
  • Economic/Exchange Relationship Norms versus Communal Relationship Norms, as situational variables in a relationship. 
These are more fully explained in some excerpts from the paper below, but the bottom line is to clarify the motivation for the two dimensional strategy that FairPay seeks to apply to getting buyers to willingly pay a fair price:
  1. Segment customers based on their Social Value Orientation traits -- are they receptive to and driven by social values, or not? Tactics for managing the FairPay process will be a bit different for high, medium, and low SVO trait segments.
  2. Nudge all customers toward Communal Relationship Norms, in ways tuned to each segment -- to seek to bring out their Social Value Orientation to the fullest extent possible.  
Based on this, the FairPay process diagram can be understood to work for each segment, but with rather different control parameters applied to each. In all cases the objective is to foster a situation that favors Communal Relationship Norms, and that draws out whatever level of Social Value Orientation can be elicited.
  • The sweet spot is targeting high Social Value Orientation (pro-social) customers, and moving them toward Communal Relationship Norms. They are the ones who will respond best to the pricing privilege that the seller grants to the buyer in FairPay -- to price in a way that considers fairness to the seller -- and who will be least inclined to abuse that privilege.  Managing that for these buyers will be mostly carrot, and not much stick. 
  • The secondary focus is on moving medium-to-low Social Value Orientation (more pro-self) customers toward Communal Relationship Norms. They will need more nudging to emphasize the carrot (why the seller is deserving of communal norms), while keeping the stick in sight (why it is in their best interest to price fairly). Those who do not respond with at least minimum levels of fairness (uncooperatively pro-self) can be treated as a third segment -- to be excluded from FairPay (at least until they seem ready to behave more sociably), and be left to buy on the conventional set-price terms that routinely work for pure Exchange Relationships.
Businesses can seek to maximize profits with a mix of FairPay and conventional set-pricing by doing the following:
  • Position themselves as deserving of Communal Relationship Norms. This can cover the whole spectrum of corporate citizenship, customer relations, quality, style, artistry, craftsmanship, service, and support. (A number of posts expand on this.) 
  • Sustain that positioning throughout their customer relationships. This is deeply embedded in the FairPay processes.
  • Seek to market to high SVO (pro-social) customers as the preferred market segment. This is the segment that will be most willing to pay you generously for your product or service (if you position yourself as deserving, and ask in the right way).
  • Manage the segmentation throughout the business processes to appeal in the right way to the right people. FairPay provides an architecture that supports this. In contrast, freemium has been very popular because of its crude segmentation between those who pay and those who don't, but has been found to be limited in managing to optimize and up-sell that.
A further insight from this study is to reinforce that the nudging of buyers in the adaptive control process of FairPay is best done with a gentle hand. Communal Relationship Norms are a delicate thing. There is an inherent quid-pro-quo in FairPay -- in the future, those who do not pay well will get fewer and less generous offers than those who do pay well. But this should be managed with enough flexibility and forgiveness of minor lapses to not poison the effort to nudge toward Communal Relationship Norms.

This research helps to clarify the behavioral principles that underlie FairPay, and reinforce expectations that it can work very effectively over a wide range of customers and product types. It provides a perspective to better understand my other posts on the motivations, mechanics, and benefits of FairPay.

Some detail on these behaviors from the paper:
  • Social Value Orientation, as individual traits (p. 9-10): 
"People who are motivated to maximize their own gain irrespective of others’ gain are labeled as individualistic. Those who are motivated to maximize the relative difference between their own gain and that of others are said to be competitive. Those who seek to maximize joint gains for self and others are labeled as cooperative, and those who are motivated to maximize gains for others are said to be altruistic....SVO research tends to focus on cooperative, individualistic, and competitive orientations or the more general distinction between pro-social (i.e., cooperative and altruistic) and pro-self (i.e., individualistic and competitive) orientations...We argue that pro-socials will be more likely to take the seller’s welfare into consideration than pro-selves. However, we expect this payment behavior to vary according to the salience of relationship norms between the buyer and the seller when the pricing decision is made..."
  • Economic/exchange relationship norms versus communal relationship norms, as situational variables in a relationship (p.10-12):
"Consumers can form relationships with brands that mimic social relationships with other people...As such, these brand relationships are guided by norms in the same way as individual relationships...Perhaps the most common distinction among relationship norms is the exchange / communal norm distinction...Exchange norms are typically based on economic factors, while communal norms are based more on social factors. In general, exchange relationships are guided by norms of quid-pro-quo, where partners provide benefits either in response to benefits given or with the expectation of getting similar benefits returned in the near future. Conversely, communal relationships are governed more by norms of conferring benefits to the partner...Keeping track of inputs and outputs, comparable benefits, and repayment behavior are all hallmarks of exchange relationships; while helping others, keeping track of others’ needs, and responding to others’ emotional needs are all hallmarks of communal relationships. Business partners and acquaintances are typically guided by exchange norms, whereas friends and family are typically guided by communal norms."
"...These findings demonstrate that relationship norms affect consumer behavior, and although commercial relationships are typically governed by exchange norms, that buyer-seller communal norms are possible. We extend these findings to the PWYW context by suggesting that relationship norms can affect how much individuals pay in such settings. Specifically, when an exchange norm is salient versus a communal norm, consumers will be less likely to consider social factors in generating their purchase price, resulting in lower payments and a lower likelihood of overpayment."

Monday, June 23, 2014

Interview: FairPay -- Making Pay-What-You-Want Profitable and Sustainable for the Mainstream

Tom Morkes, author of "The Complete Guide to Pay What You Want Pricing," interviewed me about FairPay, as a bonus for readers of his excellent how-to guide.  FairPay draws on the increasingly popular PWYW pricing model and makes it "ready for prime time." FairPay builds on key aspects of PWYW in a way that can be highly profitable for mainstream businesses, not just a fringe strategy for Long Tail content or special promotions. The audio of the interview was recently make available for download separately, as well. Both are available from Tom (on a PWYW basis, of course!) at the links here:
Tom's e-book and related bonuses offer a rich and useful guide to using PWYW, and are full of insights and experience on best practices for making it work.  PWYW draws on subtleties in human behavior -- it can be very powerful, but there is nuance to framing such offers, and making it profitable on a sustained basis is often difficult.

My interview focuses on FairPay, and how it builds on the core benefits of PWYW, and goes far beyond conventional approaches, to make it more sustainable and profitable, and scalable to large businesses.  Most uses of basic PWYW are for limited promotions. FairPay adapts it to be more predictable and workable for ongoing use -- whether on small scale, or for seller who aggregate items or offer ongoing subscriptions, even to the scale of Amazon or the iTunes Store.

Using Tom's PWYW Checklist as a nice starting point, I clarify how FaiPay adds a process that builds an ongoing relationship based on dialogs about value. Tom lists 11 steps to making a PWYW offer work.  I group Tom's list as follows, and add one more:

#1-4 are prerequisites to using these methods, both PWYW and FairPay:

1.  Identify a Competitive Marketplace
2.  Identify and Target a Demographic with Fair-Minded Customers
3.  Determine a Product with Low Marginal Cost
4.  Create a Product that can be Sold Credibly at a Wide Range of Prices
...And #5-11 enhance the process of using these methods, also relevant to PWYW and FairPay:
5.  Establish a Strong Relationship with Your Customer
6.  Clarify the Offer
7.  Show the Customer You’re Human*
8.  Appeal to Idealism
9.  Anchor the Price
10. Steer the Customer to the Right Choice
11. Remind Your Audience to Contribute

...To which, FairPay adds a new 12th step, to make it an ongoing, adaptive, individualized process:

12. Repeat offers contingent on fairness -- build continuing relationship and dialog

Doing that involves a number of component steps, as described in the interview and elsewhere on this blog.  (An earlier post provides some diagrams that may be helpful while listening.)  The interview also expands on the rationale for how FairPay applies to various business contexts, and the behavioral economics that show how it can be effective.

I hope you will enjoy this material, and will want to use FairPay to take your business to the next level.  Comments are welcome, and I offer free consulting to those with a serious interest in considering FairPay.

[*Added note:  Even large corporations can emphasize their human values and the people behind them.]

Friday, June 6, 2014

Times Premier? -- What is it really worth? ...FairPay can tell

The recently introduced Times Premier premium subscription service provides a nice case study of the problems with conventional pricing models for digital content, and how the more adaptive model of FairPay promises to do much better.

"For those with a curiosity that matches our own," the Times' pitch reads, but what I am most curious about is whether and how I would value it. ...And whether the value to me would be consistent, or highly variable and hard to predict.

The Times' metered paywall has been working better than many feared, but is obviously leaving money on the table from loyal, engaged readers who can and would pay more for Times' journalism and extras.

Premier attempts to capture that value, but, like the old "Godfather"-inspired joke, they have made me an offer I cannot understand.
  • It offers me a combination of new features, some in specific quantities.
  • I don't know what these are, have never seen many of them, have no idea if I will like them. And, even if I do like some of them, how many will I want in any given 4-week cycle?
  • Some sound interesting, and some not at all
  • Even after I have tried them, I expect my desire and opportunity to enjoy them will vary and might decrease over time
  • I may want more than the included number of some features, while having no interest in others
I can afford the extra $10 per 4 weeks cost,* but have no confidence I will value the service.
  • Maybe I might try it and, if not too disappointed, just continue to pay the $10 without much thought (as the Times might hope) -- but profiting from my inattention leaves me feeling exploited.
  • Alternatively I might try it for a while, then cancel -- even if I would be willing to pay something for the occasional feature -- leaving both me and the Times losers.
  • In any case, I feel little temptation to even bother -- again leaving both me and the Times losers.
The core problem is a rigid, one-size-fits-all pricing scheme for a time- and quantity-varying experience good that is offered to diverse buyers with different and time-varying needs.

I had previously suggested to the Times that FairPay offers a new adaptive strategy that is far more promising. As explained further elsewhere in this blog, this is how it might work:
  • The Times identifies me as a current digital and print subscriber, and offers to let me try Premier on a FairPay basis, as a "patron" of their quality journalism.
  • They "bill" me in arrears on a pay what you want basis, telling me for the past 4 weeks how much of each Premier feature I used, and advising me of a suggested price based on that usage and my history. The suggested price may reflect volume discounts and a maximum for "unlimited" use, and may have adjustements for students, disadvantaged, or affluent patrons.
  • They try to nudge me to pay well by reminding me of their quality journalism, telling me that others are paying much as they suggest, and offering added incentives.
  • I decide whether I think it is fair to pay as suggested, higher, or lower, and check off possible reasons for that. 
  • The Times weighs the reasons, considers my history, demographics, and usage, and decides how fair my price seems -- on an individualized basis.
  • After a period of probation, the Times decides whether to continue as is, bump me up to more privileged offers, or drop me from FairPay pricing and require that I pay the standard $10 per cycle if I want to continue Premier.
  • This dynamic adapation continues indefinitely, as the product and the relationship change and evolve.
This has a number of benefits to both me and the Times:
  • It builds a true patronship relationship where I feel empowered, participate in real dialog about what I do or do not value, and build on my experience with the Times and my reputation for fairness.
  • It encourages me to recognize the value of what I get from the Times, and to reward them accordingly.
  • It lets me try Premier at no risk, but (optionally for the Times) with the understanding I am expected to pay, even for the first 4 weeks, if I find value in it.
  • Each cycle, I can pay as suggested based on my usage -- or more or less -- as I wish. 
  • If I have an occasional heavy usage cycle, I can apply whatever "volume discount" I like to avoid an unduly high charge, as long as I don't abuse that privilege.
  • If I thought the features were especially good that cycle, I can pay a bit more, and increase my fairness rating to show my "patronship" -- and earn more priviliges.
  • If I thought the features less good that cycle, I can pay less, and only harm my reputation and privilges if I make a habit of devaluing the product.
Some of the key benefits to The Times
  • They can get far more people to try Premier, and retain far more, for wider market reach and greater profit. Many may pay less than the standard $10, but some may pay more, generally in line with the value they receive.  The net profit can be higher, with a lower average price, but from more patrons.
  • Since Premier is a new offering, they would not risk cannibalizing existing revenues.  Even after it is new, an added FairPay option could extend its reach down-market, and add more premium revenue up-market.
  • They can build a deeper relationship with their patroms, based on this deeper empowerment, dialog, and experience. 
  • That can shift the relationship with the Times from quid-pro-quo business exchange norms to cooperative, communal norms, and fosters social values of fairness and reciprocity, both of which increase willingness to pay.
  • They can learn far more about what their patrons value and why.
  • They can justify different prices to patrons with different value propositions and abilities to pay.
  • They can start with fairly simple decision rules and liberal continuation criteria, and gradually add more nuance and discrimination as they and their patrons gain experience with the process.
Trying a radically new approach like FairPay has risks, and takes some effort, but I suggest that a FairPay version of Times Premier offers far more profit potential and far better relationships with the Times' patrons than the conventional version. Time will tell.

*My print insert offer says $10, but the Web page says $11.25. The print insert offers a free 4 week trial, but the Web page asks for $0.99.  Seller pricing manipulations that are hardly endearing to patrons!

Monday, April 21, 2014

Beyond Freemium -- Free? Paid? Freemium?... Finding Whatever Works

Pricing for digital offerings continues to be a fundamental challenge, and the debates over free, paid and freemium rage on.

"Making 'Freemium' Work" by Vineet Kumar in Harvard Business Review (5/14), nicely sheds light on companies' real world experience with freemium, highlights the challenges of making it work, and suggests how companies can tune it to get good results.

Here, I expand on my online comment on that article that refers to the HBR Blog post I did with Marco Bertini, introducing FairPay to HBR readers. Excerpting most of my comment on Kumar's article:
...a new strategy beyond freemium that addresses the same business needs, and exploits the attraction of "free," in a way that promises to be more powerful and flexible. We motivate this as moving the exchange between seller and buyer from the transactional to the relational, based on three pillars of relationship: empowerment, dialog, and experience/reputation. The six questions raised here are important to this new strategy as well. 
Freemium has offered a good start to dealing with new economics of digital offerings, but this new strategy, called FairPay, takes the driving objective of freemium - exploiting "free" to move toward a profitable relationship over time - and makes that the driver of a variable boundary between free and paid tiers. FairPay moves the strategic question of what to exchange at what price from a pre-set seller decision to an emergent, dynamic process that balances the interests of the seller and different individual buyers. That provides more nuance and flexibility than freemium's gross segmentation into just two (or a very few) set tiers (free or paid). 
We suggest the more individually adaptive techniques of FairPay can be applied to get better market reach and profit, and to build deeper and more profitable long-term relationships. The six questions identified in this article remain important: FairPay provides a systematic method for (1) adapting (and softening) the boundary between free and paid, focusing on (2) customer understanding and (3) conversion rates, (4) evolving over adoption life-cycles, (5) encouraging referral incentives and communications, and (6) guiding ongoing innovation. With both freemium and FairPay, we see an opportunity to move beyond the debate over free vs. fee, to focus on empowering and communicating with customers and finding ways to reward those who opt to pay.
How FairPay does this is more fully explained elsewhere in this blog and related Web site (see sidebar), but here are some comments specific to Kumar's six questions.
  1. What should be free?  With freemium, this is a very visible static parameter that is hard to guess right, and hard to change. With FairPay, the boundary is soft and dynamically individualized. The buyer sets it for each transaction, always getting a price he considers fair, but the seller controls future offers, thus providing a balancing force to drive the buyer to price in a way that both sides consider fair, over the course of a series of transactions that build toward a profitable relationship.  The seller need not shoot in the dark to set a rigid boundary that is inevitably too high or too low for many buyers. Instead of upwards of 95% of customers paying nothing, a majority can be driven to pay some workable amount -- and some to pay very well. (But the buyer is always free to pay nothing, at any time he feels that the product is not satisfactory.)
  2. Do customers fully understand the premium offer?  FairPay is built around a structured dialog about offers and value received, and lets customers in good standing try both regular and premium offers whenever they want, and then determine the value they see in it. The seller highlights the value, based on their individual usage patterns, and if a buyer does not value it enough to satisfy the seller, that buyer's trial of a premium service can end (but it can be extended long emough and often enough to be a proper test -- at any stage of the relationship). The basic process is structured, but lightweight, informal, dynamic, and intuitive.
  3. What is your target conversion rate?  Freemium centers on a single all-or-nothing boundary between free and paid that make it costly to guess wrong, and either miss much of the market or leave money on the table (by undercharging good customers). (See my "Long Tail of Prices" post for more on this.) With FairPay, "free" users are permitted to pay 0% of suggested price, while paying users can pay 10%, 80%, 120%, 200% or whatever -- the conversion process is one of nudging customers up the pricing curve, and getting them to try (and pay for) more valuable features. This multivariate dynamic optimization process is more complex, but even simple heurisics can offer far more nuance and flexibility than the hard boundary of freemium.  (Adding additional premium tiers to freemium can add a bit more nuance there, but still in a static way that is not easily changed.)
  4. Are you prepared for the conversion life cycle?  As Kumar observes, early adopters are less price-sensitive than others, and are often people for whom the value proposition is unusually compelling.  Freemium has no way to adapt to such variations over time, except to move the boundary for everyone. The core process of FairPay is driven by ongoing dynamic adaptation to different price-sensitivities and value perceptions, so identifying and dealing with such individual behavior is baked in to the process. 
  5. Are users becoming evangelists? Free users can have value as evangelists (as Kumar notes) and also as a target for advertising (a key revenue source for many services), and viral marketing can be very important. FairPay can accommodate whatever value factors the seller and buyer choose to consider: Free users can claim credit for evangelism and receiving and acting on ads, and viral offers can draw on the same process to offer FairPay "trials" that suggest pricing with a trial discount that encourages those new users who do see value to start paying something immediately or very soon (while still letting those who try it but do not acknowledge any value pay nothing).
  6. Are you committed to ongoing innovation? Freemium is very focused on customer acquisition, but FairPay is designed to do its adaptive work throughout the life cycle, as usage and understanding of the product matures and changes over time.  Because it is based on an adaptive value discovery engine that always sets prices in accord with current perceived value, it works throughout product and customer life-cycles, and continually drives the seller to make more desirable offers, based on detailed, real-world customer preference data. FairPay offers the potential to not only serve as a pricing engine, but also to serve as an engine for partly automating product innovation, as well. Detailed value perception data can be used to drive offer bundling and product development. So, once you get FairPayworking adaptively to set near optimal individualized prices, why would you drop it for a less adaptive alternative? If things are stable it works near optimally, and if things are changing, it is a nealry ideal tool to identify and adapt to the changes.
Kumar's article provides a nice framework for understanding both freemium and FairPay. Pricing is the heart of commerce, and is never simple. Debates over free versus paid tend to oversimplify and overgeneralize.  One post specific to the free vs. paid debate is "Free AND Paid! -- To Each His Own Price." Other commentary on why and how I think FairPay will provide an architecture for better pricing that subsumes both free and paid are throughout this blog and the FairPay Web site