Partners, not Suckers -- From Price Discrimination to Value Discrimination

"How Online Shopping Makes Suckers of Us All" is a very nice analysis of how "standard prices and simple discounts are giving way to far more exotic strategies, designed to extract every last dollar from the consumer."

This article by Jerry Useem in The Atlantic provides a big-picture view of the growing use of dynamic pricing to seek perfect price discrimination -- how companies "are comparison shopping us."  It highlights the current race to the bottom in e-commerce. It also points to the emergence of more positive approaches like Everlane's efforts at "radical transparency" that seek a more cooperative approach.

A recent WSJ article on algorithmic pricing for gas stations gives related background, but observes how there a glimmer of a win-win aspect to dynamic pricing: "This is not a matter of stealing more money from your customer. It’s about making margin on people who don’t care, and giving away margin to people who do care."

I say we can make business far more win-win (at least for many kinds of services) -- all we need is a shift in perspective.

Value Discrimination

This blog explores how both profit-seeking companies, and value-seeking consumers can benefit from refocusing their efforts (especially for digital products/services):

• From optimizing for price discrimination in transactions
• To optimizing for value discrimination in relationships .

There are three reasons:

1. Price discrimination is largely a zero-sum game at the transaction level, but win-win games become more powerful when commerce shifts to a relationship level. Amazon Prime is a clear example of how building a relationship focus shifts consumers from bargain hunting to value-seeking. Prime members value the convenience and the trust that their value proposition is "good enough" at a transaction level -- even if they do not get an optimal price for each transaction, they optimize value at a relationship level.
2. Digital products/services are "experience goods" -- their value is hard to know until after they are used. Furthermore, their value is very personal and context-dependent, and thus hard to estimate without feedback from the customer. Transaction pricing remains a conundrum. Relationships build trust and limit risk, and average out the noise of transaction-level pricing.
3. Digital products/services have essentially no scarcity or marginal cost, so cost-based pricing and demand-based pricing (related to allocation of scarce goods, the invisible hand) no longer apply. The only reason to pay is the desire (or duty) to sustain future supply.

Thus for digital goods there is no cost-basis for pricing -- it is entirely based on value and willingness to pay. But that provides new kinds of learning opportunities (freemium being just a crude first step) to really find out what people value and are willing to pay for, and to find new ways to be fair about what customers should contribute to fund production of the services that they really want.

The bottom line is that for digital products/services, a relationship-focused, cooperative, transparent approach can be far more effective. No one has yet put all the pieces together, but my work on FairPay points the way. It all revolves around a shift in mind-set toward

• a transparent, cooperative process  
• value over price 
• personalized services rather than standard products. 

We see elements of this emerging in a variety of partial steps, such as these:

• Everlane's limited "Choose What You Pay" variant of pay what you want pricing (PWYW) lets the buyer participate cooperatively in price-setting by choosing any one of three prices. Everlane is "radically transparent" in explaining how much each option sustains the seller's ability to provide service. Here customers know they are paying at least "at cost" for clearance items, and 13% of them willingly pay more than the "at cost" price to help sustain a business they feel offers desired services (even though they are not required to do that). (Details are in the Atlantic, and my prior post).
• Amazon Prime's focus on relationships rather than one-off transactions (as well as its Subscribe and Save discount offerings). Jeff Bezos may be hard-headed, but he is certainly not short-sighted.
• "The Subscription Economy" more broadly, with its focus on relationships driven by value-in-use -- the idea that value really derives from the service we get from "goods" as services, not from the goods (products) in themselves. 
• Membership models (a more value-focused variation on subscriptions), which are being increasingly viewed as the future of journalism -- as I explored a few years ago, and is now the focus of the Membership Puzzle Project.
• "Value-based pricing," which shifts from cost-based and competition-based pricing rationales to the more win-win idea that price should correspond to the value the customer gets from using the product or service. Another post explains how all pricing can be viewed as being on a "ladder of value." Going up the ladder moves from prices pre-set based on predicted average value to prices set after usage based on value-in-use as measured in terms of performance or outcomes as obtained by individual customers. This is becoming best-practice in many B2B markets, and it applies for B2C, as well.
• Crowdfunding patronship approaches to funding ongoing creation, such as offered by Patreon and IndieGoGo, in which consumers willingly pay to sustain creators they want to support.
• Similar PWYW models, especially those that draw on human values for motivation, such as those offered by Humble Bundle and One World Everybody Eats.

Back to the future

The Atlantic article gives a nice perspective on the commercial drive toward price discrimination, and how what we see now is the result of over a century of mass marketing that has driven both sides to a zero-sum transaction mentality.

• We are so used to this model, with its resulting race to the bottom bargain hunting, that we forget that it is not the natural behavior of human commerce. Humans can play the bargain hunting game, and some even learned to enjoy it, but it is neither natural nor productive. As the Atlantic article observes, people are tired of wasting their time at it, and reach "a shut off point." 
• Traditionally, commerce was driven by human relationships -- while prices considered costs and competition, they were ultimately based on value (as I explored previously.). 
• Value based pricing in B2B markets shows how a return to those values can work, but not how to make that simple and scalable enough for mass consumer marketing. 

FairPay shows how our digital environment enables us to return to those values by shifting our ideas about commercial relationships -- from haggling about transaction prices to cooperating to set prices in a relationship, based on "dialogs about value" aimed at gaining a shared understanding of the value of the relationship. That is simpler, less adversarial, and more effective (and that is what works in advanced forms of B2B value-based pricing), and it is not so hard to do with computer support. I call the "social contract" that drives this new kind of cooperative process an "invisible handshake." It shifts commerce from a series of zero-sum single-transaction games to a repeated game of relationship that encourages cooperation. 

FairPay's repeated game revolves around these "dialogs about value" that make this process explicit and transparent. It seeks to approximate a deeper economic idea of perfection, as I describe in a thought experiment that provides an underlying model for thinking about pricing and relationships. 

FairPay creates a mass-customized process for seeking "value discrimination." As those articles explain, marketers and economists traditionally think about "price discrimination" as a way to be efficient in getting the most revenue from each customer. But in recurring relationships, what we really seek is value discrimination -- finding the optimal value proposition for each customer. We seek  to maximize not only Customer Lifetime Value (what the vendor cares about), but also Vendor Lifetime Value (what the customer cares about). 

Value discrimination involves optimizing not only the prices obtained, but also the product/service package value that is offered and delivered at those prices, to that customer. Not only does this make the process more win-win with regard to both price and value, but it provides a direct operational map for guiding the business to provide the greatest possible value to each interested customer. Over the lifetime of the relationship, it is both the right price and the right product/service package that guide the path to maximum profit -- and maximum value to customers and society. When done with transparency and fairness, discrimination can be good!

Climbing this ladder of value and making the behavioral changes that refocus all parties on value will take time -- and can occur over each of multiple dimensions of pricing, packaging, and product design. It can happen very quickly for some customer segments in some markets. It will take longer for some customers (those who thrill at the competitive nature of the zero-sum bargain hunting game and are less appreciative the broader aspects of service value) -- and in businesses that are constrained by scarcity, and/or are unable or unwilling to offer services that differentiate themselves. A full spectrum of approaches will coexist for some time.

But it seems clear that value discrimination is the path for the future. Most of us consumers want to be the ones to decide, in transparency, when we want to be generous -- instead of being manipulated in the dark to be "suckers." Even when the result is beneficial -- "making margin on people who don’t care, and giving away margin to people who do care" -- we consumers want to have transparency and choice. Instead of the invisible hand that pushes us around at a transaction level, we can build win-win relationships on this more transparent and cooperative (not so invisible) handshake.

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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.