Efficient Pricing of Geomarketing Internet Services Essay

Abstract Geomarketing information is information which enables the user to take better and faster decisions about marketing and sales activities. The main source of information are geographic, demographic, and statistic data. These data are usually collected and maintained by several institutions and come in a variety of forms and formats. The final integrators acquire datasets, sort, filter and organize them, and offer in advance defined analyses. In this paper we focus on geomarketing services offered on the Internet where usually no physical good is exchanged. The subject of trade is geomarketing information the user is able to extract from the datasets. The main issue is how to set a Pareto efficient price for geomarketing information. The situation is Pareto efficient when the sum of user’s and service provider’s surplus is maximized. We investigate nonlinear pricing strategies and their efficiency to serve mass markets and attract users with different willingness to pay. Nonlinear pricing is used in a broader sense to include the practice of selling the same information product on various vertical markets at prices that are not in proportion to the differences in marginal cost. The market research for the GISMO project (Krek et al. 2000) showed that the US market differs substantially from the European. It has characteristics of a commodity market, where providers offer very similar or equal products at similar prices. This is feasible only if the prices for raw datasets, which represent the main barrier to enter the market, are low or zero. Competition among service providers drives prices down and enables them to successfully serve a mass market. The European approach is mostly determined by the high prices of datasets and restrictions on the copyright forced by the National Mapping Agencies. This prevents further production and creation of information products and serves only a narrow group of users with high willingness to pay. We list the most i mportant conditions for Pareto efficient nonlinear pricing of geoinformation services. 1 Introduction Price is a very important element of trade. It can only be discussed in relation to what is offered, how much value the potential user attaches to the product and how much he is willing to pay for it. A geomarketing service in this paper serves as an example for a geoinformation service in general where a Geoinformation product is traded. A Geoinformation product is defined as a specific piece of geoinformation which provides an answer to a particular user’s question. The provider of a geoinformation service has to select the medium of delivery and the price for the service. We concentrate on geomarketing services provided online through the Internet. The service is mostly done automatically, and not by a human. Usually no physical good is exchanged. Gathering information about the product, placing the order, and payment is done over electronic network. In the sections 5 and 6 we analyze different pricing strategies for geographic information and their Pareto efficiency. The s ituation is called to be Pareto efficient when the user’s and service provider’s surplus is maximized. We review marginal cost and nonlinear pricing and explain in which cases they conform to the Pareto efficiency. Setting a price equal to marginal cost is not economically viable since such a price does not cover fixed cost. Some examples of nonlinear pricing, such as quantity discounts, term-volume commitments, and list of price options satisfy the Pareto efficiency requirement if certain conditions are satisfied. We conclude with the list of the most important conditions for the Pareto efficient pricing of geomarketing service. They can be applied to geoinformation services in general. 2 Geomarketing Services A geomarketing service is a service of providing geomarketing information to the user. Geomarketing information is information which enables the user to take better and faster decisions about marketing and sales activities. This information can be delivered to the user in a different form, format and through different media. Geomarketing information is gathered from internal company’s data, which are combined with external demographic, statistic and geographic data. A geoinformation that satisfies a particular information need in a specific decision making situation is called a Geoinformation product. 2.1 Geomarketing Data Geomarketing data consists of internal company’s data and external data. Internal data (the rate of sale, current customers profiles, etc.) is collected and maintained by the company itself. External data comes in a variety of formats and forms, as a collection of numbers, reports, maps, etc., and is gathered by different institutions. Demographic and statistic data is collected and maintained by Statistical Offices and aggregated to a certain extent. Geographic data is provided in Europe mostly by National Mapping Agencies, in USA by the US Geological Survey (USGS). Because of this broad variety of data, their structure, content and formats, they cannot be easily integrated and are not straightforward usable by a non-technical user. 2.2. Geomarketing Information: a Product The source of geomarketing information is geomarketing data. Specialized companies collect the data from different sources, combine them, sort and filter them. For example, the statistical and demographic data have spatial dimension, which is usually given by the street name and house number. This data has to be geocoded in order to link the attributes (purchasing power, age, educational structure, etc.) with geographic data. The providers identify dimensions of data that are valuable for a certain group of users, package them and offer them as a Geoinformation product. A Geoinformation product is a specific piece of geoinformation which provides an answer to a particular user’s question. The answer to the question can come in many different forms; as a selected dataset, combination of datasets, a report, a map, etc. To make the geomarketing service feasible, some in advance designed steps and analyses are offered to the user. The most common are customer profile, site selection, and market penetration. 3 Internet as a Medium of Delivery The Internet changes the way transactions are done. User and seller can enter an electronic relationship without personal contact. The buyer can place an order any time (from the seat at home, late in the evening) and can take as much time as he wants or needs to take the decision about the purchase. Searching for the right product over e-network, he can get comparable information about similar products from other companies, their characteristics and prices. Cooperation with potential and current users of geoinformation services is important. In the Internet world, the gap between service-consumers and services-providers blurs. â€Å"Consumers become involved in the actual production process, their ideas, knowledge, information become part of the product specification process† (Tapscott 1996). In a geomarketing service, usually no physical good is exchanged. The user gets o the result of nly the analysis, the answer to his question. Even more advanced geomarketing services offer the possibility of uploading the data of the user on the provider’s server and combining these data with the collection of the data on the server. A service offered via Internet involves less administration, paper work, and less human resources, which reduces transaction costs. Direct connection to the computer accounting system can provide systematic and efficient registration of the transactions. Security and protection mechanisms enable the service provider to follow and control transactions. Selecting a proper pricing policy in order to attract widespread use of the service is of great importance. In the next sections, we review marginal cost and nonlinear pricing, and analyze their Pareto efficiency. 4 Pareto Efficiency The situation is Pareto efficient if there is no way to make both the user and the service provider better off. The sum of the user’s and provider’s surplus is maximized. It can be a understood lso as maximizing the difference between economic benefits and costs which appear on the user’s as well as on the provider’s side. The economic benefits are the benefits of using the product on the product has to him with his willingness to pay for the marginal unit of the product. If he expects high benefits, he will be willing to pay a high price for the product. Cost incurred on the provider side is mostly high fixed cost of designing and creating the Geoinformation product and enabling the service, and low marginal cost of providing an incremental unit of the product. The user’s cost is the price he pays for the product, the transaction cost and the cost associated with acquiring the information about the product. 5 Marginal Cost Pricing and Pareto Efficiency Marginal cost pricing is pricing where the price equals the marginal cost. The cost of an economic good is an important determinant of how much the producer will be willing to produce. The concept of â€Å"marginal† or â€Å"extra† cost is crucial for the situation on the market of economic goods. It has an important role in appraising how efficient or inefficient any particular price and production pattern is (Samuelson 1967). This observation is valuable for the standard economic good where the total cost of producing the product depends on the quantity produced. The cost structure a Geoinformation product substantially differs from the cost structure of the standard economic good. The total cost of producing the product is mostly a high fixed cost of collecting the data and designing the product, and is not recoverable if the production is halted (sunk cost). The marginal cost of producing t e second and each additional copy of the product is h very low or zero, mostly the cost of disseminating the product. The share of the marginal cost in the total cost of production is negligible. Marginal cost pricing of a Geoinformation product would according to the marginal cost pricing scheme imply very low or zero price. â€Å"Pricing at marginal cost may or may not be efficient: it depends on how the consumers’ total willingness to pay relates to the total cost of providing the good† (Varian 1999). At the first stage of the production, the datasets have low value to most users and they have low willingness to pay for them. The high cost of producing the datasets cannot be recovered. M arginal cost pricing does not imply efficiency because it does not cover the total costs of producing a Geoinformation product. 6 Nonlinear Pricing and Pareto Efficiency Pricing is nonlinear when it is not strictly proportional to the quantity purchas ed. Different prices are charged to different groups of buyers or the same product. Nonlinear pricing is also used in a f broader sense to include the practice of selling the same product on different markets at prices that are not in proportion to the differences in marginal cost. Good examples are phone rates, frequent flyer programs, and electricity (Wilson 1993). The first notion about charging different users differently for the same product was called price discrimination (Pigou 1920) and distinguished among three different forms of discrimination. 6.1 Price Discrimination Pigou (Pigou 1920) first used the term price discrimination and he described the following forms of nonlinear pricing: †¢ First-degree price discrimination The first-degree price discrimination is sometimes known as perfect price discrimination. The producer sells different units of output at different prices and these prices may differ from buyer to buyer. The buyer pays the maximum price that he is willing to pay, irrespective of the cost of production and supply. Usually it is difficult to determine what is the maximum price someone is willing to pay for the product. †¢ Second-degree price discrimination The producer sells different units of output at different prices, but every individual who buys t e h same amount of the good pays the same price. Second-degree price discrimination is much more common in practice. Good examples of this discrimination are volume discounts and coupons. †¢ Third-degree price discrimination The producer sells the output to different people at different prices, but every unit of output sold to a given person sells at the same price. Customers are divided into more groups, which have different demand curves and different price elasticity. The highest price is charged to the groups with the lowest elasticity. Examples of this discrimination are student discounts. 6.2 Two-part Tariff Two-part tariff is an example of a nonlinear pricing and consists of two parts. The first part of the tariff usually comes in the form of a membership, an annual or monthly license and is supposed to cover fixed cost. The second part of the tariff is related to the usage (number of reports transferred, number of bits, layers, etc.) and covers the incremental cost. This pricing scheme is often used in telecommunication. Users are charged for the connection to the network and additionally for the usage. Two-part tariff pricing scheme can be very naturally applied to a geomarketing service. The first part of the tariff represents a membership fee, an annual or monthly licence for access to the data, reports and maps; the second part is a n additional fee usually based on the volume transferred. Price P for a geoinformation service is then P = p0 + p v.q where p0 pv q fixed fee (annual, monthly, membership, etc.) price set for a volume transferred quantity transferred. The revenue collected from the first part of the tariff (p0 ) is supposed to cover the fixed cost of producing the first copy of the Geoinformation product. The price of u sage (pv ) should cover the incremental cost and the cost of transaction. The combination of the membership and usage constructed for the predicted demand is set so that the company’s total cost is recovered. How high the fixed fee and the price of usage s hould be is an important question. Availability of the raw data at low price will change the nature of the market. The price for both parts of the tariff (p0 and pv ) will form according to the equilibrium rules of supply and demand. 6.3 Pareto Efficiency of the Two-part Tariff Two-part tariff can disadvantage a certain segment of the users. Imagine a geomarketing service company offering geographic data over the Internet. For the simplicity of reasoning, imagine there exist two segments of users; those who use data on a regular basis and have a high willingness to pay (governmental institutions, ministries, utilities, etc.), and those who seldom need data (students, individuals, small and medium companies, etc.) and have low willingness to pay. In this case, a high fixed fee excludes the users with low willingness to pay, occasional users who need only a small volume of the data and are not willing to pay an annual membership fee or a license. The necessary condition for Pareto efficiency is not satisfied. 6.4 Quantity Discounts Quantity discounts are a form of a nonlinear price where the provider charges a lower price for a higher volume purchased. The opportunity of selling high volumes at a low price is often neglected in geoinformation business. Increased revenue from the higher volume at lower price enables the provider to improve the service and reduce prices for all users. The quantity discounts are usually designed in order to stimulate sales, but can complicate the billing and accounting system. Pareto efficiency of quantity discounts depends on the volume-price categories offered by the service provider. This pricing strategy might disadvantage users with low willingness to pay, not being able to pay nor interested in purchasing higher volumes. 6.5 Term-Volume Commitments According to this strategy the user agrees with the service provider to pay a certain amount of money for the service in advance. The payment is set according to the predicted demand for the service. This kind of agreement usually involves some discounts, because the whole payment is done at once and at the beginning of the period. Short-term contracts involve lower reduction in price than longer contracts. This strategy reduces billing and accounting cost and is often used by Internet providers. For example, â€Å"a one-year-term commitment to spend $2000/month obtains a discount of 18%â€Å" (Gong and Srinagesh 1998), for the 5 -year contracts the Internet providers use up to 60% discount. Term-volume commitments satisfy the Pareto efficiency requirement if the user can choose among different schemes and are designed indiscriminately. 6.6 List of Price Options Different pricing options can be combined and offered as a list of price options. In geomarketing services, the two-part tariff is often combined with an additional pricing option, the uniform pricing scheme. Under the uniform pricing scheme, the user pays the price (p2 ), which is proportional to the data transferred. Usually the tariff per volume purchased (p2 ) is higher in the uniform pricing scheme than the price (p1 ) proposed in the two-part tariff scheme, but the user need not pay an annual membership fee or license. The user profits if he is an occasional user, who needs a small volume of data. The sum he is willing to pay in this case is lower than the annual membership or license fee plus the cost of the data transferred.