pricing strategies versioning - 👍...

VERSIONING:THE SMART WAY TO

SELL INFORMATION

Positioning andpricing strategiesbecome all themore importantwhen the marginalcost of yourproduct is zero.

by Carl Shapiro and Hal R.Varian

IN 1986, NYNEX ISSUED THE FIRST ELECTRONICphone book, a compact disc containing all thetelephone listings for the New York area.

Charging $10,000 a copy, the company sold the CDsto the FBI, the IRS, and other large commercial andgovernmental organizations. Sensing a great busi-ness opportunity, the Nynex executive in charge ofthe project, James Bryant, left to set up his owncompany. Pro CD. His goal was to produce an elec-tronic directory covering the entire United States.

The phone companies, fearing an attack on theirlucrative yellow pages businesses, refused to licensedigital copies of their listings to Pro CD. But thatdidn't stop Bryant. He went to Beijing and hiredChinese workers - at $ 3.5 o a day - to type into com-puters every listing from every U.S. telephonebook. The resulting database, containing more than70 million phone numbers, was used to create a mas-ter disc, which in turn was used to create hundredsof thousands of copies. The CDs, which cost wellunder a dollar each to produce, sold for hundreds ofdollars, 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 Assistanceand American Business Information rushed tolaunch competing products containing essentiallythe same information. Because their products wereindistinguishable, the companies were forced to

Carl Shapiro is the Transamerica Professor of BusinessStrategy at the Walter A. Haas School of Business at theUniversity of California at Berkeley. Hal R. Varian isthe dean of the School of Information Management andSystems at the University of California at Berkeley.They are the authors of Information Rules: A StrategicGuide to the Network Economy (Harvard Business SchoolPress, 1998; see http://www.inforules.com).

compete on price alone. Not surprisingly, pricesplunged. Soon, CD phone directories were sellingfor a few dollars in discount software bins. A high-priced, high-margin product just months before, theCD phone book had become a cheap commodity.

The rapid rise, and even more rapid fall, of CDtelephone directories stands as a cautionary tale forthe purveyors of information products, particularlythose sold in digital form. It reveals that the so-called new economy is still subject to the old laws ofeconomics. In a free market, once several companieshave sunk the costs necessary to create an undiffer-entiated product, competitive forces will usuallymove the product's price toward its marginal cost-the cost of manufacturing an additional copy. Andbecause the marginal cost of reproducing informa-tion tends to be very low, the price of an informationproduct, if left to the marketplace, will tend to below as well. What makes information products eco-nomically attractive-their low reproduction cost-also makes them economically dangerous.

Many information producers make the mistake ofassuming that their products are exempt from theeconomic laws that govern more tangihlc goods.But, as Pro CD found out, that's just not so. Althoughinformation goods have unusual production eco-nomics, they are nevertheless subject to thesame market and competitive forces thatgovern the fate of any product. And theirsuccess, too, hinges on traditionalproduct-management skills: gain-ing a clear understandingof customer needs.

106 ARTWORK BY THEO RUDNAK

achieving genuine differentiation, and developingand executing an astute positioning and pricingstrategy.

Information's Dangerous EconomicsTo forge a winning strategy for an information prod-uct, you need to understand the economics of infor-mation production. Information goods, which wedefine as goods capable of being distributed in digi-tal form, have always been characterized by a dis-tinctive cost structure: producing the first copy isoften very expensive, hut producing subsequentcopies is very cheap. A book publisher, for example,may spend hundreds of thousands of dollars to ac-quire, edit, and design a manuscript, but once thefirst copy of the book has been printed, the cost ofprinting another is usually only a few dollars. To get

a movie made, a producer may spend a hundredmillion dollars on cast, crew, script, and sets, butmaking a print of the final cut will cost only a fewhundred dollars. The fixed costs of producing infor-mation are large, in other words, but the variablecosts of reproducing it are small.

The sharp skew toward fixed costs is not the onlything distinctive about the cost structure of infor-mation goods. The fixed costs and the variable coststhemselves have unusual characteristics. The fixedcosts tend to be dominated by sunk costs-coststhat are not recoverable if production is halted. Ifyou invest in a new office building or factory andlater decide you don't need it, you can recover partof your fixed costs by selling the facility. But if yourfilm flops, you probably won't be able to sell off thescript or the sets, and if your CD is a dud, it ends upin the cut-out racks at $4.95.

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VERSIONING: THE SMART WAY TO SELL INFORMATION

The variable costs of producing information alsohave a unique feature: the unit cost of creating anadditional copy of an information product typicallydoes not increase even if a great many copies aremade. Information producers, in other words, havefew capacity constraints, which is quite a differentsituation from that faced by most manufacturers. Ifsales of microchips grow, for example, Intel will atsome point need to build an expensive new fabrica-tion facility to meet the added demand. And if salesof airplanes increase, Boeing will have to investheavily in new plants, machinery, and people.When these and other traditional manufacturersreach the limit of their existing capacity, the cost ofproducing an additional unit goes way up. Thatdoesn't happen with most information products,which can be reproduced with a high degree of au-tomation at very low cost. If you can make onecopy, you can make a million copies, or ten millioncopies, at roughly the same unit cost.

Because of their cost structure, informationproducts offer vast economies of scale: the moreyou produce, the lower your average cost of pro-duction. That's why Microsoft, with its dominancein personal-computer operating systems and busi-ness applications, enjoys gross profit margins of92%. But the cost structure has a hig downside aswell. Because the fixed costs are both large andsunk, companies that don't enjoy market domi-nance can be caught in devastating price wars. Ifcompetition forces a company to reduce its pricesto a level near its marginal production costs-aswas the case with publishers of CD phone books-that company will never be able to recoup its bigup-front investments. It will, in time, face eco-nomic doom. What economists call a perfectlycompetitive market represents a disaster scenariofor information producers.

The dangers inherent in the economics of infor-mation production become even more pronouncedwhen the information is produced digitally. Copiesof information in digital form - such as CDs or dig-ital video disks-are much cheaper to reproducethan analog or print copies. Think of encyclope-dias. Printing an encyclopedia set can cost morethan a hundred dollars. Cutting a CD-ROM of thatsame set costs just pennies. By reducing variablecosts, digital reproduction further exaggerates theskew toward fixed costs.

And that's not all. When digital information isdelivered over a network, the variable costs candisappear almost completely. Because the producthas no physical form-it exists purely as bits ofdata-there's no cost for manufacturing, no cost forpackaging, no cost for shipping. Once the first copy

of the information has been produced, transmit-ting additional copies is essentially free. Consideragain the case of electronic phone books. Today,if you want to quickly look up phone numbersfor people around the country, you don't even needto buy a CD-no matter how cheap they've be-come. You can search phone listings for free atdozens of Web sites. It costs next to nothing to letan additional customer search an on-line database,so competing providers give the information awayto all comers, hoping to make their money byselling ads.

Many commentators have marveled at theamount of free information on the Internet, but toeconomists like us it's no surprise. The generic in-formation flowing through cyberspace - phone

The Logic of the Free VersionA refrigerator manufacturer would quickly go broke itit Started handing out free samples of its products. Butinformation producers give away free versions all thetime. When you buy a computer, you are likely to finda bundle oi free software on the hard drive. When yousurf the Web, you discover not only oceans of freelydistributed news stories, statistics, and other informa-tion, hut also loads of software demos and "freeware"that you can download with a few clicks of your mouse.

Free versions of digital goods are common for tworeasons. First, the low marginal eost of creating copiesof information means that it doesn't require much, ifany, investment to give information away, Second, in-formation Is an "experience good"-customers don'tknow what it's worth until they've actually tried itFree versions provide customers with an easy and at-tractive way to test out a digital product.

Of course, if all you did was give information awayfor free, you wouldn't have much of a business. [ManyWeb site operators are learning this lesson the hardway,) There has to he sound husiness logic hehind thefree offer. We have found that the most savvy informa-tion producers offer free versions only when they arelikely to achieve one or more of the following goals:

Building Awareness. Many companies use free ver-sions simply to create awareness of their products.They give away a version with limited content or fea-tures in order to entice consumers to pay for the fullversion. Computer game makers, for example, distrih-ute free demos over the Web or on CD-ROMs bundledwith game magazines. The demos allow users to playonly the first few levels of a game-enough to gethooked hut not enough to get bored. The hope is, otcourse, that the user will rush out to buy the complete

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108 HARVARD BUSINESS REVIEW November-December 1998


numbers, news stories, stock priees, maps, and thelike-is simply selling at its marginal eost: zero.(See the insert "The Logic of the Free Version.")

Linking Price to ValueThe extremely low marginal costs of informationproduction rule out many traditional prieing strate-gies. You can't, for example, use cost-based pricing.Nor can you set prices according to the competi-tion-that's a sure road to ruin. The only viablestrategy is to set prices according to the value a cus-tomer places on the information.

But which customer? The value of a piece of in-formation can vary dramatically from one person tothe next. A stock market speculator will place a far

greater value on stoek quotes than will a long-terminvestor who huys and holds. A computer "poweruser" will value the latest operating-system upgrademuch more than the average home user will. And adrug company executive will likely place morevalue on the text of the latest FDA rulings than apharmacist, who, in turn, will place greater valueon it than a premcd student. Information never hasthe same value for every potential customer.

In a perfeet world, an information producerwould sell its product to each buyer at a differentprice, refleeting the value that the different buyersplace on it. In reality, though, such personalizedpricing is rarely possihle. For one thing, even inthese days of cheap computing, it is awfully expen-sive to capture, store, and distribute data on the

game. Using a free version to build awareness worksfor games because each game is unique; the eustomercan't buy a substitute. But if you're only one of manyproviders of the same information, a free version maysimply underscore the commodity nature of yourproduct. The customer, spoiled by the free version,will he motivated to Hnd the cheapest possihle sourceofthe information.

Gaining Follow-on Sales. A more sophisticatedstrategy is to give away a version in order to huild ahase of customers to which you can sell follow-onproducts, such as extensions, upgrades, and services.The free version, in this case, is usually a completeversion; no content is missing and no features are dis-ahled. The idea is to get customers to hecome depen-dent on the product. The more they use it, the moreinterested they'll he in add-ons. McAfee Associates,lor example, offers many of its core virus-protectionproducts for free over the Weh. It makes money hyselling site licenses to companies, upgrades to individ-uals, and an array of services to hoth groups. McAfee'sproducts now account for half the sales of antivirussoftware.

Creating a Network. Because many digital goods aresuhject to network effects - they only hecome valuahleonce a large numher of people arc using thcm-freeversions can also he a good way to hring a product's useup to a critical mass. Adohe, for example, gives away asimple version of its Acrohat software that enablesusers to view and print electronic documents even ifthey lack the software the documents were createdwith. Because Adobe was the first to seed the marketwith such a program, it is now ahle to sell full versionsof Acrohat-at hetween $200 and $600-to anyone

who wants to share electronic documents over theWeh or through other media.

Attracting Eyeballs. As the war for attention contin-ues to intensify on the Internet, free information he-comes ever more valuahle as a lure to attract the eyesof surfers. Some information companies, in fact, arefinding that they can earn more money from advertis-ing than from selling their own information. Playhoy,for example, posts fret- images of its playmates on itsWeh site, along with banner advertisements that itsells for more than $10,000 a month. Each image in-corporates a digital watermark, enahling Playhoy totrack not only how many people view the image tm itsown site hut also how many people view it after it'sheen copied onto other sites. In this way, Playhoylearns more about its on-line customers and how theyuse its products, further strengthening its ability tosell ads as well as on-line and print suhscriptions.

Gaining Competitive Advantage. Sometimes thestrategic value of getting a large number of people to useyour informatitin is greater than the economic value ofgetting a smaller numher of people to huy it, Microsoft,for example, gives away its Internet browser in order toprevent Netscape from gaining control over computerdesktops. That competitive henefit far outweighs themoney it could make hy selling the hrowser. Microsoftsometimes finds itself on the other end of such strate-gies, too. One of the main reasons Sun Microsystemsgives away many of its Java programming tools is to re-duce the market power wielded hy Microsoft. Becauselava can he used with any computer, it makes operat-ing systems like Windows 98 relatively less valuahleand hardware, such as Sun's servers, relatively morevaluable.

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tastes of individual customers. For another, tradi-tional sales channels, like retail stores, cannot setan array of prices for the same good. (Even if theycould, it would be next to impossible to get cus-tomers to stay within their intended pricing strata-just look at all the gyrations airline customers gothrough to locate the cheapest routes.) And finally,information producers run the risk of annoying oreven alienating their customers if they charge dif-ferent prices for the same product.

But there is a practical way to set different pricesfor basically the same information without incur-ring high costs or offending customers. You do it byoffering the information in different versions de-signed to appeal to different types of customers.With this strategy, which we call versioning, cus-tomers in effect segment themselves. The versionthey choose reveals the value they place on the in-formation and the price they're willing to pay for it.

Traditional information providers have alwaysused versioning, in one form or another, as a way tostructure their product lines. Publishers release abook first in hardback and later in paperback, sell-ing the same text at a high price to readers who

The trick is to identify the best ways to distinguishthe different versions of your product. You need todetermine which features will be highly valuable tosome customers but of little value to others. Thenyou need to create the right number of versions andset the right prices for them. The goal is to get eachcustomer to pay the highest possible price for theproduct, thus maximizing the overall returns. Sincethe customers themselves are selecting the pricethey'll pay, based on their own calculation of the in-formation's value, they will be far less likely to takeoffense at paying different prices than they would ifthe manufacturer were imposing the prices on them.

The Many Versions of VersioningIn the past, versions of information products wereusually based on timing or, more precisely, delay.For almost any type of information, some peoplewill always be more eager to get their hands on itthan will others. That's the rationale for releasinghardcovers before paperbacks and for showingmovies in theaters before putting them on tape.Delay is often a good basis for versions of digital

information as well. PAWWS Finan-cial Network, for example, offers two

With versioning, customers reveal the versions of us portfolio accountingsystem, one at $8.95 a month and the

value they place on information andwhat they're willing to pay for itmust have the book right away and at a lower priceto people who don't mind waiting. In a similar way,movie houses charge $7 or more for a ticket toa film that can be rented six months later for $3 ahousehold.

When information is produced digitally, version-ing becomes an even more flexible and powerfulstrategy. For one thing, it's easy to manipulate digi-tal data, so the cost and time required to produceand distribute different versions go way down. Foranother, the proliferation of CD-ROM players,VCRs, and Internet browsers opens many kindsof information to a much larger and more diverseaudience. When legal information was conveyedonly in heavy and expensive tomes, lawyers werethe only people interested in purchasing it. Nowthat the information can he searched and bought bythe bit, there are many more potential customersfor it. Versioning provides a way to sell informationto those customers in a form that they will valuewithout cannibalizing the existing high-price,high-margin market.

other at $50.00. What's the difference?The inexpensive service uses stockquotes that are delayed by 20 minutesto calculate portfolio values, whereasthe premium service uses real-time

quotes. Those 20 minutes are very valuable to oneset of the company's customers.

But with digital information, delay is only oneof many possible dimensions for versioning. Justconsider the wide variety of ways in which digitalproducts are differentiated today;

Convenience. Restricting the time or place atwhich a customer can access information, or re-stricting the length of access, is often a good wayto get buyers to reveal the value they place on theinformation. The more a customer needs the infor-mation, the more freedom they'll want in accessingit. America Online, for example, offers differentmonthly membership plans based on convenience.The standard plan, which provides unlimited ac-cess, costs $21.95. An alternative plan costs $4-95but allows only three hours of connection time-ifyou use more, you pay a high hourly surcharge. Byoffering the cheaper version, AOL can attract cus-tomers who have only a limited need for its service-they may use it solely for e-mail, for example - whilemaintaining much higher prices for customers with

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a greater dependence on it. Similarly, some on-linedatabase companies offer discount subscriptions tousers who agree to log on only outside of normalbusiness hours.

Comprehensiveness. Some customers will pay abig premium for information that offers a depth ofdetail-in geographical coverage, historical scope,or statistical detail. Public affairs specialists andjournalists, for example, will value the ability tosearch the full text of articles from newspapersaround the world. Many scholars and students willvalue extensive historical information. Marketingmanagers will value information on individual cus-tomers and their long-term purchasing patterns.

Many newspapers and magazines are using com-prehensiveness as the basis for creating versions oftheir on-line products. The New York Times andBusiness Week, for example, give away their currenteditions' content on the Web, but they sell access totheir extensive archives. Because there are so manysources of news on the Internet, these publicationsknow that the only way to attract readers-and inturn advertisers - is to give away their freshestcontent. But they can charge for their past articlesbecause the segment of customers that values thosearticles - writers, researchers, and the like - have noother practical source for them.

Manipulation. Another important dimensionthat can form the basis for versioning is the abilityof the user to store, duplicate, print, or otherwisemanipulate the information. Back in the days ofcopy-protected software, companies like Borlandsold two versions of their programs-one was lowpriced and could not be copied and the other washigh priced and could. Many information providerstoday use similar constraints on informationmanipulation to distinguish their products.Lexis-Ncxis, for instance, imposes additionalcharges on users who want to print or down-load information rather than just view iton screen.

Community. The chat rooms and bul-letin boards that crowd the Web demon-strate that many people value the opportu-nity to discuss information with otherswho have similar interests. By restrictingusers' ability to join an on-line community,providers can identify customers whoplace value on the community in addi-tion to the information.

Silicon Investor, a popular Web site forinvestors in high-tech industries, offershundreds of discussion boards on indi-vidual companies. It allows anyone toread the messages posted on the boards

for free. But if you want to post a message - or send aprivate e-mail to another member-you have to payan annual membership fee of $ioo or a lifetime feeof $200. By allowing free access to the informationon the site, Silicon Investor gets more people to visitthe site, enabling it to charge more for advertising.By charging an extra fee for posting messages, itmakes money on customers who want to do morethan read.

Annoyance. People who pay the Silicon Investormembership fee also get an added benefit: they havethe capability to turn off the advertisements postedthroughout the site. The ability to avoid the annoy-ance of on-line ads is valued by some Web surfers,and they're willing to pay extra for it.

Similarly, many shareware programs, which aredistributed free for trial use, incorporate a start-upscreen that asks users if they're ready to purchase aregistered version. The only way to avoid the annoy-ing screen is to send in money.

Speed. A common strategy for software makers isto sell versions of their programs that run at differentspeeds. The most serious users naturally gravitate tothe faster versions even if they have to pay a lot morefor them; the greater efficiency outweighs the highercost. Wolfram Research, for example, used to sell twoversions of Mathematica, its program for performingsymbolic, graphical, and numerical mathematics.The high-priced professional version used a comput-er's floating-point processor to speed up the calcula-tions. The cheaper student version disabled theprocessor, slowing the calculations considerably.

Interestingly, Wolfram had to write more code toget the student version to work without the float-ing-point processor. The inexpensive version thus

When information is produced digitally, versioning becomes an evenmore powerful and flexible strategy. Because it's easy to manipulatedigital data, many different versions can be created cheaply and quickly.

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cost more to produce than did the premium version.But offering the low-speed version made economicsense because it expanded the overall user network,making the professional product even more valuableto the sophisticated users, such as professors whowanted to share files with their students. (See theinsert "Value-Suhtracted Versions.")

Data Processing. Various data-processing capabil-ities can often be built into an information product,enabling certain users to carry out sophisticatedtasks. H&.R Block, for example, offers the standardversion of its Kiplingcr's TaxCut software to peoplewho just want an automated way to fill in their taxforms. But it also offers a pricier premium version,TaxCut Deluxe, that includes a number of othertools-for example, it has an audit feature that ex-amines your return and highlights entries likely tocatch the attention of IRS agents.

User Interface. Varying the way that customersaccess information can be a particularly good basis

for versioning. Sophisticated users will often bewilling to invest time learning a complex interfacethat offers, for example, powerful searching capa-bilities. (And their up-front investment of timewill make them less likely to shift to a competingproduct later.) More casual users will want a sim-pler, more intuitive interface even if its capabilitiesare rudimentary. Adobe's $600 Photoshop softwarefor manipulating photographic images has a com-plex interface intended for professional designers.But the company also sells a lower-end product,the $50 PhotoDeluxe, that has a stripped-down in-terface geared for home users. You can't do as muchwith PhotoDeluxe, but you don't have to spend alot of time learning how to use it, either.

Image Resolution. Many digital products includeimages, and different users will place different valueson the quality of the images. The stock-photo housePhotoDisk, for example, offers its photographs overthe Web at different resolutions. Professional

Value-Subtracted VersionsA few years back, IBM offered two very similar ver-sions of one of its printers-the high-end LaserPrinterand the less expensive LaserPrinter E. The two ver-sions looked the same and functioned the same, withone exception: the LaserPrinter could print ten pagesper minute while the E version could print only five. Atesting lab for computer equipment examined the twomodels and found that a special chip had been insertedinto the LaserPrinter E to slow down its operation.IBM had, in other words, deliberately degraded the per-formance of its high-end model in order to create acheaper model. And hecause the suhtraction of valuerequired the manufacture and installation of a specialchip, the low-priced version actually cost more to pro-duce than the high-priced one.

IBM's tactic was unusual. When most manufactur-ers want to create versions of their products, they startby building a hare-bones model, then add features tocreate premium versions. The high-end models costmore to create than the low-end alternatives. Toyota,for example, spends considerahly more to produce atop-of-the-line Camry XLE, with leather upholstery,antilock brakes, and traction control, than it does tomanufacture an entry-level Camry CE that lacks theluxury features.

For digital goods, however, the IBM method is therule, not the exception. Most versions of digital infor-mation are created by subtracting value rather than hyadding it. The producer first invests in developing themost technologically advanced version-in order tohave a distinctive product that will appeal to the most

demanding and least price-sensitive customers-then removes features or capabilities to taihir theproduct to less demanding customers. As the low-endusers' needs advance, they can follow an establishedupgrade path within the same product family,

PhotoDisk, for example, scans its stock photos athigh resolution to create its premium product, thendegrades them to produce low-resolution copies. Offer-ing the low resolution versions requires extni work-and extra server space for .storage-so it actually coststhe company more to produce its cheap product thits expensive one.

Charging less for products that cost you mt>re to pro-duce may sound illogical, hut for digital goods itmakes sense. The extra investment required to createdegraded versions is usually modest and can be re-couped quickly as sales grow. And the revenue fromversions designed to appeal to different market seg-ments helps offset the hig fixed costs required toate the product initially.

There's an important caveat to value subtraction:you have to make sure that customers can't transformthe degraded version back into the original. With aworld full of talented hackers, that's no easy feat.There have heen reports, for example, that users ofMicrosoft's $250 workstation version of its NT soft-ware have figured out how to turn it into the originaland more powerful $1,000 server version with just afew simple tweaks of the code. When you choo.se thedimensions of your product to manipulate to creafcdifferent versions, choose earefully.

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designers creating glossy brochures purchase high-resolution images at $49.95 each, but newsletterproducers settle for lower resolution images at$19.95. The myriad pornography sites on the Weboften offer low-quality "thumbnails" of their pho-tographs for free but charge for the ability to viewand download high-resolution copies.

Support. Some information providers offer differ-ent levels of technical support at different prices.You can, for example, download Netscape's Webbrowser for free over the Net or, for $40, you can be-come a subscriber and receive not only the softwarebut also an instruction manual and one free phonecall to a support technician. Using technical supportas a basis for versioning can be tricky, though.Highlighting the added value of support may raisequestions in customers' minds about the reliabilityof the product. And failing to deliver on promises ofsupport can turn into a publie relations nightmare.

In addition to being used in isolation, the differentdimensions of versioning can also he combined. Di-alog, the large on-line information provider, createsversions of its Wcb-accessible database by alteringboth its user interface and its comprehensiveness.A high-end version, DialogWeb, is designed for cor-porate researchers and other information profes-sionals. It has a powerful but complex interface,allowing highly sophisticated searches, and offersaccess to the full range of Dialog's content. Anotherproduct, DataStar, is much cheaper and much lesspowerful, offering a subset of the full Dialog databasewith a simplified interface. DataStar suits casualusers well, but because of its limitations it does notsiphon away professional users from DialogWeb.

The Mechanics of VersioningSo how many versions should you offer? There's nopat answer to that question. The number should beguided by two considerations: the characteristicsof the information that you're selling and the valuethat different customers plaee on it. If your infor-mation can be used in many ways, it probablymakes sense to offer a wide array of versions. But iithe value of your information hinges on the num-ber of users who access it in the same format - if, inother words, the information is subject to networkeffects-you may want to restrict the number ofversions you offer.

Kurzweil Applied Intelligenee, for example, offersmany versions of its voice recognition software.Kurzweil understands that voice recognition hasmany different applications and that they varygreatly in the value they provide to users. Collegestudents will be attracted to a simple produet that

HARVARD BUSINESS REVIEW November-December 1998

enables them to create documents hy speaking intotheir computers. But given their limited budgets,they'll only buy such a product if its price is low.Doctors, on the other hand, will be drawn to a highlysophisticated produet that is able to understand aspecialized vocabulary-and because such a productwill save them a lot of time, they'll pay handsomelyfor it.

To capture the different levels of eustomer value,Kurzweil offers seven different versions of its soft-ware, distinguished mainly by the size and special-ization of the vocabularies they recognize. Thetop-of-the-line, $8,000 version for surgeons. VoiceOrtho, is 100 times more expensive than the $79entry-level product for students, VoicePad Pro. Be-tween those extremes are versions tailored to homeusers, business users, and lav r̂yers, all at differentprice points. Beeause each segment's needs areunique, there's little ehance that buyers will beconfused by the various options. And there's alsolittle chance that customers targeted for high-priced versions will opt instead for lower-prieedversions. A version unable to recognize legal terms,for example, would have little value for an attorney.The way customers define the value of the productlocks them into their intended segment. (See thetable "One Product, Many Versions.")

For other eompanies, a more limited array of op-tions makes sense. Intuit, for example, offers onlytwo versions of its popular Quicken software forpersonal finaneial management. Unlike Kurzweil'sproduct. Quicken doesn't have a wide variety ofapplications-a lawyer balances her checkbook inpretty mueh the same way a doctor does-so havingto choose from a broad range of versions would

One Product; Many VersionsRecognizing that its voice recognition softwarecan be used in many ways, Kurzweil AppliedIntelligence offers a broad array of versions atvery different prices.

Version Price Vocabulary

VoicePad Pro $79 20,000-word general

Personal $295 30,000-word general

Professional $595 50,000-word general

Office Talk $795 business

Law Talk $1,195 legal

Voice Med $6,000 medical

Voice Ortho $8,000 special-purpose medical

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simply confuse customers. By limiting the numberof versions. Intuit gets other henefits as well. Cus-tomer support stays simple, and users are ahle toshare files with less risk of incompatibility.

But by offering only one high-end produet andone low-end version, Intuit, like many informationcompanies, may he missing out on an importantopportunity. The two-version strategy, though en-ticing in its simplicity, ignores the psychologicalphenomenon known as "extremeness aversion."When huying produets, consumers normally try toavoid extreme choices-they fear they'll pay toomuch if they go for the most expensive version, andthey worry they'll get too little if they opt for thecheapest. They are drawn instead to a compromisechoice - a version in the middle of the product line.Like Goldilocks, they don't want "too hig" or "toosmall"-they want the product that's "just right."

By offering three versions of a product, compa-nies can shift huyers away from the entry-levelproduet and to the more expensive middle offering.The effect can he quite dramatic. In one experi-ment, researchers offered customers different setsof microwave ovens. When the choice was hetweena no-frills oven at $109.99 and a midrange model at$179.99, customers chose the midrange oven 45%of the time. When a high-end oven at $199.99 wasadded to the choice set, people chose the midrangeoven 60% of the time. The existence of this phe-nomenon is the reason McDonald's offers its drinksin three sizes rather than just two.

Information produeers can also capitalize onextremeness aversion. If they are currently offeringonly two versions, they should eonsider adding athird, high-end product to their line. If Intuit, forexample, offered a third version of its Quicken soft-ware-Quicken Gold, say-at a price higher thanthat for the Deluxe version, many huyers whowould have bought the standard product will in-stead move up to Quicken Deluxe. The importantthing to recognize is that the product you reallywant to sell should he positioned in the middle-the high-end product is there mainly to pull peopletoward the compromise choice.

The optimum number of versions to offer is, aswe've seen, rarely clear-cut. The hest way to decideis often through trial and error. Because it's usuallyinexpensive to create new versions of an informa-tion product, a company can do a lot of experimen-tation. Recently, for example. Information America,a company that provides puhlic reeords to hanks,government agencies, and law offices, was trying todecide whether to offer its services to users operat-ing at home. The company felt that demand wouldbe high enough to justify entry into the new mar-

ket, hut it was concerned that a price low enoughto attract home users might cannihalize its sales toprofessionals. To gain insight into the prohlem, theeompany created a suhsidiary, KnowX, to offerhome users access to a subset of its datahases viathe Weh. It turned out that the restricted offeringwas very popular - and it didn't attract the high-endprofessionals. With today's powerful teehnologiesfor distrihuting information, more and more com-panies are, like Information America, finding iteasy to explore market segments that were notreachahle hefore.

Old Ideas, New ApplicationsInformation has always played a central role in oureconomy-a simple fact that too often gets lost inall the hype ahout the information age. And the to-tal amount of information in existence hasn't ex-panded all that much in recent decades. What haschanged is that the information has become dra-matically more accessihle. Many of the greattechnological advances of the twentieth century-telephones, radio, motion pietures, television,computers-have served to speed the flow andwiden the availability of information. The arrival ofthe Internet is just the latest step-alheit a very higstep - in a process that continues to unfold.

As access to information has expanded, so toohave the opportunities for selling informationgoods to a hroader and more diverse set of cus-tomers. Versioning provides a way to serve thatlarger market by tailoring the same core of informa-tion to the needs of different buyers. It not onlyenables you to gain more revenue from an existingproduct but also provides a basis for thinking cre-atively ahout how to distinguish your product fromcompeting offerings. By monitoring how the mar-ket reacts to new versions, you gain ever greaterinsight into how customers define value, allowingyou to continually refine your product line. A cre-ative versioning strategy is often the best defenseagainst the commoditization of information.

Success in selling digital goods does not require awhole new way of thinking about husiness. Rather,it requires the same kind of smart managing andsmart marketing that have always set apart the hestcompanies. The real power of versioning is that itenahles you to apply tried-and-true product-man-agement techniques-segmentation, differentiation,positioning-in a way that takes into account boththe unusual economics of information productionand the endless malleability of digital data. 0

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114 HARVARD BUSINESS REVIEW Novemher-December 1998

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