Versioning: The Smart Way to Sell Information

Positioning and pricing strategies become all the more important when the marginal cost of your product is zero.

by Carl Shapiro and Hal R. Varian

In 1986, Nynex issued the first electronic phone book, a compact disc containing all the telephone listings for the New York area. Charging $10,000 a copy, the company sold the CDs to the FBI, the IRS, and other large commercial and governmental organizations. Sensing a great business opportunity, the Nynex executive in charge of the project, James Bryant, left to set up his own company, Pro CD. His goal was to produce an electronic directory covering the entire United States.

The phone companies, fearing an attack on their lucrative yellow pages businesses, refused to license digital copies of their listings to Pro CD. But that didn’t stop Bryant. He went to Beijing and hired Chinese workers—at $3.50 a day—to type into computers every listing from every U.S. telephone book. The resulting database, containing more than 70 million phone numbers, was used to create a master disc, which in turn was used to create hundreds of thousands of copies. The CDs, which cost well under a dollar each to produce, sold for hundreds of dollars, yielding a tidy profit for Pro CD.

But the CD-phone-book boom was short-lived. Attracted by the seemingly strong profit potential, competitors such as Digital Directory Assistance and American Business Information rushed to launch competing products containing essentially the same information. Because their products were indistinguishable, the companies were forced to compete on price alone. Not surprisingly, prices plunged. Soon, CD phone directories were selling for a few dollars in discount software bins. A high-priced, high-margin product just months before, the CD phone book had become a cheap commodity.

The rapid rise, and even more rapid fall, of CD telephone directories stands as a cautionary tale for the purveyors of information products, particularly those sold in digital form. It reveals that the so-called new economy is still subject to the old laws of economics. In a free market, once several companies have sunk the costs necessary to create an undifferentiated product, competitive forces will usually move the product’s price toward its marginal cost—the cost of manufacturing an additional copy. And because the marginal cost of reproducing information tends to be very low, the price of an information product, if left to the marketplace, will tend to be low as well. What makes information products economically attractive—their low reproduction cost—also makes them economically dangerous.

Many information producers make the mistake of assuming that their products are exempt from the economic laws that govern more tangible goods. But, as Pro CD found out, that’s just not so. Although information goods have unusual production economics, they are nevertheless subject to the same market and competitive forces that govern the fate of any product. And their success, too, hinges on traditional product-management skills: gaining a clear understanding of customer needs, achieving genuine differentiation, and developing and executing an astute positioning and pricing strategy.
Information’s Dangerous Economics

To forge a winning strategy for an information product, you need to understand the economics of information production. Information goods, which we define as goods capable of being distributed in digital form, have always been characterized by a distinctive cost structure: producing the first copy is often very expensive, but producing subsequent copies is very cheap. A book publisher, for example, may spend hundreds of thousands of dollars to acquire, edit, and design a manuscript, but once the first copy of the book has been printed, the cost of printing another is usually only a few dollars. To get a movie made, a producer may spend a hundred million dollars on cast, crew, script, and sets, but making a print of the final cut will cost only a few hundred dollars. The fixed costs of producing information are large, in other words, but the variable costs of reproducing it are small.

The sharp skew toward fixed costs is not the only thing distinctive about the cost structure of information goods. The fixed costs and the variable costs themselves have unusual characteristics. The fixed costs tend to be dominated by sunk costs—costs that are not recoverable if production is halted. If you invest in a new office building or factory and later decide you don’t need it, you can recover part of your fixed costs by selling the facility. But if your film flops, you probably won’t be able to sell off the script or the sets, and if your CD is a dud, it ends up in the cut-out racks at $4.95.

The variable costs of producing information also have a unique feature: the unit cost of creating an additional copy of an information product typically does not increase even if a great many copies are made. Information producers, in other words, have few capacity constraints, which is quite a different situation from that faced by most manufacturers. If sales of microchips grow, for example, Intel will at some point need to build an expensive new fabrication facility to meet the added demand. And if sales of airplanes increase, Boeing will have to invest heavily in new plants, machinery, and people. When these and other traditional manufacturers reach the limit of their existing capacity, the cost of producing an additional unit goes way up. That doesn’t happen with most information products, which can be reproduced with a high degree of automation at very low cost. If you can make one copy, you can make a million copies, or ten million copies, at roughly the same unit cost.