Jeff Jarvis, the popular media blogger, has long ridiculed newspapers for trying to find innovative ways to charge for the stories they publish online. True to form, he had a kneejerk reaction to the New York Times’s plan to ask frequent readers of its digital content to buy a subscription. Jarvis argues that in seeking to charge its “best customers,” the Times is guilty of “cockeyed economics”:
So why charge your best customers? Why single them out? Why risk driving them away? The logic eludes me. So do the economics.
But it’s Jarvis, not the Times, whose economics, and logic, are askew. Jarvis might want to spend some time reading about the fundamentals of pricing, particularly Hal Varian’s classic work on the “versioning” of digital goods. Varian is a distinguished economist who teaches at Berkeley and is also now Google’s chief economist. Here’s a little of what he says about “versioning information goods,” which is extremely pertinent to the Times’s strategy as well as the news and media business in general:
One prominent feature of information goods is that they have large fixed costs of production, and small variable costs of reproduction. Cost-based pricing makes little sense in this context; value-based pricing is much more appropriate. Different consumers may have radically different values for a particular information good, so techniques for differential pricing become very important … [One] particular aspect of differential pricing [is] known as quality discrimination or versioning … The point of versioning is to get the consumers to sort themselves into different groups according to their willingness to pay. Consumers with high willingness to pay choose one version, while consumers with lower willingnesses to pay choose a different version. The producer chooses the versions so as to induce the consumers to “self select” into appropriate categories …
[Consider the case] in which the seller knows something about the distribution of willingness to pay [WTP] in the population, but cannot identify the willingness to pay of a given consumer. In this case the seller cannot base its price on an exogenous observable characteristic such as membership in some group, but can base its price on an endogenous characteristic such as the quality of the choice the consumer purchases. The appropriate strategy for the seller in this situation is to choose two qualities and associated prices and offer them to the consumers. Each of the different consumer types will [select] one of the two quality/price pairs. The seller wants to choose the qualities and prices of the packages offered so as to maximize profit.
The intention is to get the consumers to self-select into the high- and low-WTP groups by setting price and quality appropriately. That is, the seller wants to choose price/quality packages so that the consumers with high WTP choose the high-price/high-quality package, and the consumers with low WTP choose the low-price/low-quality package.
The Times’s plan is, obviously, a variation on this versioning strategy, where the quality variable that is being controlled is the number of stories available to be read in a month. By establishing a volume-based trip wire for a paywall, the Times introduces a mechanism that requires its readers to self-select based on the value they perceive in the Times’s offering and hence their willingness to pay.
Such versioning strategies have proven very successful for many digital goods. Software companies routinely use versioning to segment their customers and optimize their profits, and many cloud services – such as Google Apps – are also following the strategy. The common thread through the strategies is that the “best customers” pay more, while the “worst customers” pay little or nothing. When news stories or other media products are digitized, they also become candidates for versioning strategies. If news organizations don’t experiment with versioning plans, they’d be foolish.
The only thing cockeyed about the economics of the Times’s plan is Jarvis’s view of it.