Twenty years ago, I participated in some pricing meetings on my new line of computer games. In the room were two Stanford MBAs, two Harvard MBAs and someone from Kellogg, I think. How did we decide between $24.95, $29.95 or $34.95?
We flipped a coin.
But we were scientific about it. A single elimination ladder, best of three.
Pricing has always been a combination of economics and marketing and luck. My hero Joel Spolsky (best engineer who knows how to write) has a piece on this at Joel on Software.
The thing is, I disagree with him.
Pricing is a very effective signaling device, no doubt about it. People (and businesses) assume that good stuff is worth more. People pay for stuff on eBay for stuff based on the velocity of the auction instead of the innate value of the item. Real estate brokers warn you that a house that doesn’t sell right away is hard to sell because people look at a house that’s been on the market for a few months differently. All irrational and all based on signaling.
The reason that lousy movies cost the same as blockbuster movies, though, doesn’t have to do with signalling. (the fear is that people won’t go to cheap movies because the cheap price will tell them it is a lousy movie). Of course, this isn’t what happens with DVD sales. They sell plenty of really cheap DVDs that you never heard of… for a lot less than the new Star Wars Movie. No, the pricing of movies has to do with industry traditions and being stuck. It’s just too hard to get everything in alignment and for all the players to say okay.
Which leads to the current debate over how much Apple should charge for iTunes. 99 cents a song is a great signal. It tells the purchaser that this is somehow "fair."
The record companies want to charge MORE for hot hits, though. The thing is, this will mean raising the average price, because for every song they sell for $2, don’t expect a lot of songs to cost five cents.
Which leads us to the wisdom of Jeff Bezos. There are two kinds of companies, Jeff says. Companies that work to lower prices (like Amazon, most of the time) and companies that work to raise prices (like the music industry, all of the time).