title: Rational pricing

Rational pricing

By: Scott Bradner

I will admit to being totally baffled by many of the pricing decisions corporations make these days. Clearly some of the prices are enabled by constrained markets, but in many cases it is hard to determine just what thought process was followed to get to the final price.

I'm not an economist, but, like anyone buying gasoline these days, have some real world understanding of the effects of supply and demand on pricing. (In the case of gas, it is more the effects of rumors of supply problems rather that actual supply for raising prices and the half-life of the universe for reducing prices.)

Of course, there is the third factor of patents and being able to block others from selling competing products that can have a major impact (take a look at the pharmaceutical industry for a very clear example -- it does help if the alternative to your product is pain or death).

But even if you had a complete understanding of the above factors some recent pricing decisions might not make sense to you. In retrospect, Apple's pricing of the iPhone makes a lot of sense but I can not see a way to look at the fees proposed to be charged to Internet radio for streaming music that could make any sense.

The pundits had a field day when Apple first announced the price for the iPhone. A not quite unanimous view was that the device was far too expensive for the function and that it was going to be a flop because only Apple zealots would buy a geek toy phone at that price. You might recall that this was also the common view when Apple first announced the iPod. This seems to have been another case where the pundits refused to learn from history. We will not know for another week but it looks like Apple has already sold as many as a million iPhones to date. A USA Today survey showed that the iPhone was the first Apple product for 30% of the iPhone buyers. (http://www.usatoday.com/tech/wireless/phones/2007-07-12-iphone_N.htm#uslPageReturn) The same survey showed that 90% of the buyers were extremely or very satisfied with the phone they bought (and, it follows, with the price they paid). So Apple was right in how they set their price, even though it was more than twice the parts cost (http://www.engadgetmobile.com/2007/07/02/teardown-reveals-iphone-parts-cost-two-bills/) and even though it did not appear so to many people beforehand.

A while ago I wrote about a US Government board deciding that the music industry's proposed prices for the streaming of music over the Internet were so perfect that the board could adopt them without changing anything significant. ("The copyright industry's royalty board" http://www.networkworld.com/columnists/2007/031207bradner.html). Since it was clear that only some large Internet radio stations with very strong finances could continue to exist under these prices I simply do not understand what logic the industry used to come up with them. They only conclusion I can reach is that the industry felt that 1 radio station paying a big fee made them more money than thousands of stations paying one or 2 percent of the same fee. That is a level of math I can not follow. It is timely to write about this now because the fees go into effect on the day that I'm writing this column.

Maybe scared of Congress, SoundExchange, (http://www.soundexchange.com) the industry's voice on these fees, is now talking accommodation and reduced fees - so far not low enough for many of the smaller players to survive -- but reduced in any case. (http://www.wired.com/entertainment/music/news/2007/07/webcasters_face_music)

Apple priced the iPhone logically to maximize a market, this clearly can not be said for the music industry.

disclaimer: I have no idea who at Harvard decides prices (I do know there are significant subsidies for those who can't afford the not insignificant price) so I did not ask the university about the above meanderings and they are mine alone.