Supply and demand principles in product pricing

Cheap now, pay later

Imagine the following situation: You buy a new laptop, but are offered a number of options. The same hardware/software configuration can be obtained cheaply, if you are prepared to switch certain functionality off or if it is priced expensively for all functionality.

There are many real world examples of this phenomenon:

1. Microsoft's family of operating systems, all built from the same source, but functionality enabled/disabled based on the end-user pricing, so the home version is cheap, but no corporate authentication etc.
   
2. Mobile phones, where the phone is "jailed" and functionality enabled/disabled based on the pricing options/desires of the network providers.

This basic principle is of course closely aligned with supply and demand pricing principles. In supply pricing, you charge a fixed margin on your product (your profit) irrespective of the utility or ultimate value of the product to the end consumer. If you then find out that the product is very useful to the end user and they are prepared to pay more than what you were charging them, and very importantly, there is some commercial reason why you can charge them (mostly no competitor to undercut you), then go into demand pricing and you increase your profit to the maximum that the client will pay.

Both supply and demand pricing are around in many forms today and they both have their supporters.

Here is my take on supply and demand pricing:

1. Unprotected and efficient markets are in general inclined to stick to supply pricing because competitors undercut each other when pricing is increased, thereby keeping the price as low as possible for customers. Standards and consumer protection is an issue since fierce competition drives unscrupulous suppliers to cut corners.
2. In the IT word, where technology choices result in lock-in, the formation of protected market (which can easily be argued to be inefficient), results in pricing quickly going to demand pricing. Examples of this software licensing models such as the mentioned example of Microsoft's operating systems and sometimes even hardware leasing models (a machine is supplied with 2 processors, but only one is switched on unless you pay more).
3. The mobile phone industry is basically a huge cartel because the market is in effect protected. So the mobile operators supply a data connection to their consumers, but pricing is variable based on which application generates the data (voice is metered by the minute and based on geographical origin or source while data is a flat monthly rate). Suddenly, the service providers are spending energy trying to stop you from doing things that are technologically completely feasible (for instance, putting voice over a data connection).
4. Security abhors demand pricing. The bulk of security challenges today originates where suppliers force clients into a certain mode of operation, but if the client can circumvent the controls that the supplier imposed on him/her, then they can increase the value of their product. Examples include, digital content provision, mobile phones, many online services etc.
   

I suspect that the Nexus 1 (Google's phone) will provide its owners with Root access to the phone, and this will remove the bulk of headaches from a security perspective for the service providers as they cannot control the technology on the phone to enforce user behavior.

Complexity as an indication of a raw deal

When a client sees demand pricing, it should be clear that they are not getting the best possible deal (take note European Commissioner for Competition that this a great way to determine the impact of legislation that results in protection of markets). Increased complexity of deals and an over abundance of rules is an indication that the consumer is getting a raw deal.

The role of government in competition

Lastly, how should the mobile phone networks have been built in order to circumvent the demand pricing in place today?

An option is that governments provided the call distribution infrastructure (cell towers and back-haul) and allowed companies to complete with each other on it, then the competition would probably have encouraged innovation and better pricing strategies. However, this huge new government department itself might quickly become the problem and probably should itself be given to the private sector and fragmented over a number of suppliers.

By separating the companies that supply the communication infrastructure and those that sell the services on it, you keep free enterprise alive by provide choice to all parties unlike the current situation where a company like Vodafone controls not only the distribution infrastructure but everything up to the instruments and what software runs on them.

The idea of governments selling a limited number of licenses to successful bidders to own all aspects of the mobile services, in order to raise short term revenue was a short sighted view that now has us in a stranglehold of demand pricing.