For a few dollars more (IV)

Third-degree price-discrimination strategies are limited, however. Beyond age and some forms of group membership, there are few observable signals of willingness to pay that can (legally) be exploited, and for many products it is difficult to prevent low-value consumers from reselling their low-priced products to members of high-value groups.

In situations in which a seller can’t use an observable signal of group membership to segment consumers, a seller can still adopt a strategy that economists refer to as “second-degree price discrimination.” Here the seller’s goal is to create versions of the product that are just different enough that a high-value consumer will voluntarily pay a high price for a product that is also being sold at a low price to low-value customers.

The hardcover-paperback strategy in book publishing is a classic example of second-degree price discrimination. Separate hardcover and paperback releases allow publishers to “discriminate” between high-value and low-value customers by relying on the fact that high-value customers generally are more willing to pay for quality (better binding and paper), usability (print size that is easier to read), and timeliness (reading the book as soon as possible after release) than low-value consumers.

When this is true, releasing a hardcover book before the paperback version will cause high-value consumers to voluntarily pay a higher price for a book they know they will eventually be able to get for less money as a paperback.

The main concern when implementing this or any other second-degree price-discrimination strategy is to ensure that high-value customers aren’t tempted to trade down to the lower-priced products. When is that temptation strong? When the quality of both products seems similar to consumers. This was exactly the concern of the publisher who approached us about its e-book strategy.

Influenced by the conventional wisdom of some in the industry, it worried that consumers perceived e-books and hardcover books as similar products, and that releasing them simultaneously would reduce their valuable hardcover sales. What we found in the data, however, was that this conventional wisdom was wrong.

Our data from the natural experiment described previously contained 83 control-group titles (titles that were released simultaneously in e-book and hardcover format during the period four weeks before and four weeks after the dispute) and 99 treatment-group titles (titles for which, during the dispute, the e-book was released one to eight weeks after the hardcover).

The data showed that delaying the e-book release resulted in almost no change in hardcover sales for most titles. Most digital consumers, it seemed, did not consider print books a close substitute for digital ones – apparently, digital consumers were primarily interested in consuming a digital product. Put another way, consumers did not seem to perceive e-books as a lower quality version of hardcover books, but rather as a fundamentally different product.

Even more surprising was the effect on digital sales. Our data suggested not only that digital consumers weren’t particularly interested in physical product, but also that they were quite fickle when the digital product wasn’t available when they wanted to buy it. Counting all sales in the first twenty weeks after each e-book’s release, e-book sales for delayed titles were 40 percent lower than sales of e-books released alongside the hardcover version.

This suggests that e-books are a very different product from their print counterparts. It also suggests that when these digital consumers couldn’t find the product they wanted to buy when they wanted to buy it, many of them simply left, and didn’t come back. Maybe they just lost interest; maybe they found a different product to serve their needs; or maybe, even though they had initially been willing to pay for a legal copy, they sought out an easily available pirated one when the legal copy wasn’t available. Whatever the case, our data suggested that the second-degree price-discrimination strategies that worked well for hardcovers and paperbacks didn’t work as well for hardcovers and e-books.