Price Discrimination for the Good!

"Higher prices in an affluent area help bring healthier meals to a poor neighborhood" reads the teaser for an interesting NYTimes article, which goes on to report on a 2:1 difference in prices between two Everytable restaurants only two miles apart in LA:

The big price difference represents an unusual experiment to address the persistent issue of limited food choices in poorer neighborhoods around the country. The higher prices at the downtown store are effectively meant to offset smaller profits at the other location, making the lower-priced restaurant more economically viable.

The article includes comments from advisory firm partner Michael Kaufman:

To make it work, he said people would need to understand why prices are higher in one neighborhood than in another. ...“I think the key to it will be how they tell their story” 

FairPay applies similar logic -- in a more dynamically adaptive, emergent process -- to set prices based on an individual "invisible handshake" that applies a balance of powers to learn what value customers receive, and factor in their ability to pay to determine the fair share they should contribute the the profits that sustain a business. This was explained in my earlier post Price Discrimination Can Be Good!, which was triggered by the equally interesting, if less noble, example of Uber surge pricing.

One key point is that price discrimination is not inherently evil, as it is often viewed. It depends on how and why it is done:

• When price discrimination is done unilaterally by sellers, to extract maximum profit with no buy-in from customers it can be bad -- especially if done secretly in a way that is exploitative.
• When it is done with transparency and customer buy-in, based equitably on differentials in ability to pay and value received, it can be laudable, and customers can feel good about it.  

What matters is the openness and fairness of the process. As Kaufman said, "the key to it will be how they tell their story.”

This relates to the broader issue of the growing call for a more socially conscious capitalism, a "fairness economy." We want the efficiency of free markets, but with an awareness of social values and bottom lines that factor in people and planet. Many are seeking ways to to achieve that. FairPay points to a new and more powerful solution.

FairPay's invisible handshake is not just a feel-good image, but an operational process based on a specific balance of powers that shapes the "story" -- a process of dialog that gives pricing power to customers, but only as long as they use it in a way the seller agrees is fair. FairPay can be applied in a wide range of contexts, from those that today lack much social context (like TV), through those that have stronger social context (like journalism and indie music), to those with dominating social context (like non-profits and charities).

Engaging customers, telling the story, and building long-term relationships based on this invisible handshake promises to increase Lifetime Customer Value, to offer more profit, greater market share -- and more total value to society.

For a full introduction to FairPay see the Overview and the sidebar on How FairPay Works (just to the right, if reading this at FairPayZone.com). There is also a guide to More Details (including links to a video).

New Video on FairPay -- Reisman Presentation to ISSIP 10/14/15

Video is now online at ISSIP from my 10/14/15 presentation on FairPay. ISSIP is the International Society of Service Innovation Professionals, "a professional association co-founded by IBM, Cisco, HP and several Universities with a mission to promote Service Innovation for our interconnected world."

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Video Details:  This is about 24 minutes of presentation, plus some Q&A, with a very interesting and interested audience. A full slide set (including some supplementary slides not on the video) is also online. (Should there be any difficulty with those links, there are alternative locations for video and slides, and future updates of presentation slides will also be online.)
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I was introduced to ISSIP when I met Jim Spohrer of IBM, one of its founding board members, at the Naples Forum on Service in June. Jim immediately saw the appeal of FairPay, and how it embodies many of the principles ISSIP is helping to illuminate. He has been very supportive in introducing me to the ISSIP community. That led to this presentation, which was facilitated by Haluk Demirkan of the University of Washington.

As my still-formative and inexpert encapsulation of how FairPay fits with service science and Service-Dominant Logic (S-D-L), these teachings suggest that much of our conventional thinking relates to "Goods-Dominant Logic" that developed over the past centuries -- "yesterday's logic." But now we are in a service economy, and are beginning to recognize that goods matter only in enabling a service -- for example, a nail has little value in itself -- its value is in how it provides the service of fastening, in a particular use and context. The value of a service is understood to be "co-created" by the provider and the consumer in its particular use-context.

From this perspective, FairPay is a form of co-pricing, in which buyer and seller agree on a process to seek a win-win value exchange over the life of their relationship. That opens a whole new dimension in customer relationships that can deeply alter how we do business. (Details of how are in the video, and other pages here.)

One perspective on this might be thought of as Value-Dominant Logic (V-D-L) as opposed to our current Price-Dominant Logic (P-D-L). FairPay offers a process for seeking fair value, in which price becomes emergent from buyer and seller's interactions over time. Thus price remains the metric of net value-in-exchange, but now price tracks directly to value-in-context instead of being pre-set in ways that track poorly to value. The processes of FairPay -- as embodied in cycles of customer journeys -- dynamically set prices to approximate value. This not only can transform business, but makes a better economics, because prices that track to value make the economy more efficient and productive. (Some insight into this stems from my thought experiments relating to an all-knowing economic demon.)

The idea is very simple: P=V. Price = Value (in context). Price should at least seek to approximate value over time. Doing that would make our economy work better for all of us. FairPay suggests a way to adaptively seek P=V. (I plan to expand a bit on this in a separate post.)

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On the video, after the talk, is a few minutes of Q&A, with some very interesting questions.

(To add one clarification, I should have given a fuller answer on the first question in the Q&A. The question was about crowdfunding and crowdsourcing. I neglected the second part, and would add this: Crowdsourcing fits very nicely into the FairPay logic, since it is just another form of value, which flows in reverse, from consumer to provider, and just one more dimension of value to be mutually considered and netted out in the "dialogs about value," Just as value from the provider can be measured and then valued, so can value from the consumer.)

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 in Harvard Business Review, Marco Bertini and I have co-authored an article, "A Novel Architecture to Monetize Digital Offerings" that has been submitted to a leading journal for publication [now published in the Journal of Revenue and Pricing Management*].

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.

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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.

*The text here may not reflect final edits in the published article.

[Update:] Short NPR Video: The History of the Price Tag
This is worth watching as an amusing perspective on how the price tag was introduced and took hold. It emphasizes how haggling became impractical as commerce scaled with department stores, but glosses over the human dimension that was lost with this "take it or leave it" solution.

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More about FairPay

For a full introduction to FairPay see the Overview and the sidebar on How FairPay Works (just to the right, if reading this at FairPayZone.com). There is also a guide to More Details (including links to a video). 

Even better, read my highly praised new book: FairPay: Adaptively Win-Win Customer Relationships.

(FairPay is an open architecture, in the public domain.)  

(My work on FairPay is pro-bono. I offer free consultation to those interested in evaluating and applying FairPay, and am happy to address questions.)

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.

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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."

Turning the Invisible Hand to Create Shared Value -- The FairPay Strategy

"Creating Shared Value," the influential 2011 HBR article by Michael Porter and Mark Kramer, points to the need to reinvent capitalism with broader ideas about value creation that will unleash a wave of innovation and growth. They propose that "creating shared value represents a broader conception of Adam Smith's invisible hand."

I suggest that the FairPay revenue model provides a new market regime that reorients the invisible hand toward shared value, one that can be operationalized in business today, to offer an entirely new micro-economics for profit-seeking business transactions.

Porter and Kramer nicely draw the big picture for shared value, noting that, unlike calls for "Corporate Social Responsibility" that are at odds with profit motivations,

Shared value focuses companies on the right kind of profits - profits that create societal benefits rather than diminish them. ...

The moment for an expanded view of value creation has come. A host of factors, such as the growing social awareness of employees and citizens and the increased scarcity of natural resources, will drive unprecedented opportunities to create shared value.

We need a more sophisticated form of capitalism, one imbued with a social purpose.

They suggest what we need is not "a redistribution approach," but one for "expanding the total pool of economic and social value.

FairPay takes this CSV big picture and provides methods for "doing business as business" that support that vision. These methods can be applied now, in a wide range of businesses, and will point the way to applying similar new thinking more generally. (FairPay was designed for, and clearly applies now, in markets in which marginal costs are low, such as for digital products or services. Digital markets, especially for content, are widely recognized as being markets in which traditional capitalism has been unable to adapt effectively to the new digital economy, and new business models are urgently needed.)

FairPay turns the force of the invisible hand to span ongoing relationships. It guides pricing to create shared value between customers and businesses over long-term relationships (in which customers have a say in the creation of shared value). It looks beyond one-time transactions, to ongoing dialogs about value.

• Adam Smith's invisible hand works at a transaction level:  it optimizes the balance of  supply and demand in terms of prices for large numbers of individual transactions.  Transaction prices drive supply and demand into balance, by shifting supply or demand until balance is achieved. This invisible hand does not know or care about repeat business or shared value (except as it affects demand in aggregate).
• FaiPay turns the invisible hand on its side, to work over time, at the relationship level: it optimizes the balance of supply and demand in terms of prices over time, with respect to individual customers. Relationship pricing is balanced through an ongoing series of pricing conversations, to achieve an agreed upon level of shared value in each of a multitude of ongoing buyer-seller relationships. Shared value is integral to these pricing conversations.

The invisible hand of FairPay creates a new kind of balance that emerges over a series of transactions, with a simple balancing dynamic:

• For each transaction, the buyer is given the full power to set prices based on the value actually received (Fair Pay What You Want). This is done retrospectively, when the value is known to the buyer.
• The seller must accept the buyer's price for that transaction, but the seller holds the power to decide if the buyer's pricing is fair enough to want to extend the relationship by continuing to make FairPay offers for future transactions (considering what has been learned about the buyer's pricing behavior and reasons).

This leads to an ongoing balancing process based on longer-term considerations of shared value:

• Buyers have full freedom regarding the pricing of single transactions, but have the incentive to be fair to sellers and divide the shared value surplus in a way that is fair to the seller. They are also invited to give reasons for their pricing that indicate why they think their perception of shared value is more or less than the seller has suggested. Based on guidance from the seller on suggested prices, costs, usage, social norms, and the buyer's reasons, both sides can learn whether and how they can agree over time on criteria for fair pricing that creates the maximum shared value (even if they do not agree on each transaction).
• Sellers yield power over a limited number of individual transactions, but gain new power to truly understand the value they provide to individual sellers in each transaction, and to engage in a substantive dialog with their customers about that value and how they should share in it. Sellers manage the "choice architecture" that frames the value proposition and the factors to be considered, and can signal what buyer pricing behaviors they accept as fair or unfair. The seller learns how loosely or rigidly to manage each customer relationship to create profit and grow its share of the pie.

The new invisible hand of Fairpay emerges from this balancing mechanism for discovery and maximization of shared value between buyers and sellers over time.

• FairPay pricing can be used in combination with conventional pricing as a back-stop, and positioned as a privilege offered to those who desire a relationship based on shared value and respect for the obligations of fairness that entails. 
• Sellers can manage the "choice architecture" by using premium tiers and perks as rewards, and the threat of withdrawal of such premiums as penalties, to nudge buyers to price at the highest levels the buyers consider justifiable.  Sellers also hold the threat of complete withdrawal of future Fairpay privileges (returning an "unfair" buyer to fixed pricing for future transactions) as a powerful incentive to deter abuse. 

The essence of Fairpay is that buyers and sellers engage in a continuing individualized dialog about shared value--both at a personal and a social level--as actually realized in every transaction. 

• FairPay seeks maximum shared value for each customer, by being specific to the value sought and received by that consumer, at that time, in that context. 
• It reflects individual variations in need, value perception, willingness to pay, ability to pay, and all relevant criteria. It provides sellers with fine-grained, in-context "market" data for segments of one, that enable the sellers to fully understand market needs, and learn new ways to meet them, and to delight their customers, one by one. 
• It naturally reflects broader considerations of shared social value beyond the individual customer, by sharing responsibility with the customer for the social valuation process. Buyers are free to consider whether a seller is socially responsible in the larger sense, and to factor that into their willingness to pay (to whatever extent they desire). What might have been an externality to the seller may be internalized by the buyer, so that the seller must internalize it as well. Social values shift from external constraints at odds with profit maximization to natural subjects of the value dialog with the buyer.
• It changes the equation from a zero-sum game of buyers shopping around for the lowest prices and sellers seeking to be the low-cost provider, to a win-win collaboration for achieving shared value. 
• Instead of consumers seeing profits as coming at their expense, profits are framed as a valid and deserved sharing of their value surplus with a company that is a respected partner in value creation. This gives a new legitimacy to profit-seeking, as integral to collaborative creation of shared value.

Traditional transaction-level pricing models foster a purely price-based race to the bottom, which makes it hard for a company to see at a micro-economic level how social responsibility to their customers and the larger public can benefit their bottom line, well intentioned as they may be. We can talk of shifting the view to long term profit maximization, but how do we do that? The ongoing, relationship-based structure of FairPay micro-economics directly considers shared value, at both the individual and larger level, in a way that removes the conflict.  It aligns profit maximization for the firm with maximization of social value (at least as perceived by individual buyers). Thus Fairpay provides a new micro-economic mechanism to seek long-term profit maximization in ways that directly align with social value maximization.

Where and when can FairPay fit in? It is most clearly applicable to businesses in which marginal costs are low. A major segment is in markets for digital products and services. Such markets already make extensive use of free trials, freemium models, and even pay what you want promotions. These markets already exploit the low incremental cost of producing additional (marginal) items, to give away some product in order to sell more in the future. FairPay can be introduced immediately, to do this in a much more economically efficient way. Some controlled level of zero-revenue transactions are accepted as a market learning cost, in order to discover what buyers are willing to pay and whether they are good partners. With FairPay, instead of "free" offers, the offers are value-based (but are similarly risk-free to the buyer). Similar immediate opportunities for FairPay arise in markets where physical goods and services are perishable (such as those currently addressed by Priceline's "name your price" model). As businesses and consumers get used to FairPay, opportunities to exploit it will expand.

Turning the invisible hand to the broader aspects of shared value. FairPay naturally guides better economic efficiency, while significantly reflecting the broader context of shared value. When this new turn of the invisible hand gives consumers a say in pricing, social values will be served as just another corporate profit opportunity, not a "Corporate Social Responsibility" cost.

• Price efficiency and legitimacy:  FairPay provides a structure for pricing that is dependent on buyer acceptance in a way that legitimizes differential pricing - to efficiently address varying value perceptions, usage patterns, and abilities to pay. Price "discrimination" becomes an equitable method for maximizing shared value when the buyer participates in the discrimination and accepts the rationale for paying more or less than other buyers. This can enable usage-based and other value-based pricing in ways that buyers can agree to and temper as desired (such as paying little extra for an unintended and atypical overage in usage). Many current markets are very inefficient because of consumer aversion to metering and other rate discrimination. "All you can eat" pricing plans have popular appeal to narrow customer interests, but their wastefulness and inequity will become very apparent when customers participate in pricing decisions.
• Disadvantaged markets: This buyer acceptance of "fair and reasonable price discrimination " also enables new ways to efficiently address low-income and disadvantaged markets at a profit (and social benefit).  For example, it becomes clear that those who can afford to pay more than others should do so. Information and digital services that may expensive in high-value/high-ability-to-pay markets can fairly be offered far more cheaply in disadvantaged markets without cannibalizing the markets where buyers know they can and should fairly share their large value surplus. When treated as partners in shared value pricing decisions, consumers will recognize that companies should be able to profit more (and recover more of their costs) from those who can afford it than from those who cannot, and companies will be able to expand and differentiate their markets accordingly.  
• Innovation and productivity: FairPay's individual dialogs about value give companies both the incentive and the market information needed to innovate to better serve existing and potential customers, and to communicate how they offer value to different customers. FairPay pricing dialogs will capture rich and detailed transaction level data on individual buyer value perceptions, needs, and desires. They can re-conceive products and markets, identify new needs, create efficiency, and expand markets, in a natural partnership with their customers.   

All of this can start now in markets that Fairpay is particularly well suited to:  those in which marginal costs are low, such as for digital products and services, and for perishables. As such uses of FairPay develop, our concept of how to think and talk about pricing will change, and our understanding of business as a game of relationships, not just transactions, will grow.

From there we can learn how extend the principals underlying FairPay to other markets, and perhaps develop similar models of relationships and of dialog about value that can work even for products and services where marginal costs are not low. We will enter a new era in capitalism as a way to collaboratively create shared value, guided by a new and broader sweep of the invisible hand.