CHAPTER 1

Introduction—Digital Disruption and Yesterday’s Logic

The greatest danger in times of turbulence is not the turbulence it is to act with yesterday’s logic.

—Peter Drucker

FairPay is a new logic for conducting ongoing business relationships that adaptively seek win–win value propositions in which price reflects value.

FairPay is a logic for seeking to learn and apply what my pricing demon knows (see Prolog). It is an architecture for business processes that are adaptively configured to seek win–win with customers cooperatively, in a new kind of equity-based dynamic pricing.

The idea for FairPay arose in response to the new challenges (and opportunities) of selling digital services in networked markets, and may be most applicable there—at least initially. But there is reason to think that it will work well for some physical product/service businesses, and in time might be useful far more broadly. Much of this book focuses on digital services, but the wider potential is outlined as well.

We all recognize that we are at the infancy of a digital era, with the mantra that “the Internet changes everything.” Our society, business, markets, media, services, and even our most basic human communications and relationships are mediated by digital communications networks and computer processing. We have recognized the need for new logic in many aspects of business in this strange new world, but the most central aspect of our markets, the setting of price, has barely changed at all. Our core approach to how customers and service providers relate to one another needs a radically new logic that addresses the new realities of digital services in networked markets.

We are facing huge turbulence in these markets, most visible in content industries that have been disrupted by digital, so that the very nature of how we think of value has come loose. Major industries such as music and newspapers are being devastated, with others such as TV/ video/movies beginning to see disruption. Long-established businesses are in turmoil, and even nimble upstarts have challenges in making their value propositions attractive beyond narrow markets. It is hard to get consumers to be willing to pay, and the traditional alternative of advertising support is increasingly threatened. Companies face threats of piracy and bypass (via Google and Facebook). Advertising is under siege by technical challenges (including the shift to mobile) and growing consumer rebellion in the form of ad-blocking.

Our consumer value propositions are just not working well. Too many consumers are just not willing to pay the prices that companies think they should. Many companies fed into that by offering digital content services free, and now find it problematic to charge.

There are a number of fundamental reasons why traditional methods do not work for pricing digital experiences in networked markets:

• Replication is nearly free—The invisible hand flails aimlessly, having no scarcity of supply to ration against demand—pricing becomes an arbitrary shot at what “the market” will bear. Meanwhile many consumers think that “information wants to be free” and question why they should pay at all.

• Value is experiential, personal, and context-dependent—Conventional pre-setting of prices by producers fails to relate to wide variations in value received. There is not one market, but a multitude of markets of one, each of which fluctuates over time.

• Relationships are the new marketing—Conventional efforts at “relationship marketing” have been bolted on to traditional transaction-oriented business practices and only scratch the surface of true relationships that seek to maximize customer lifetime value (CLV). Companies are beginning to recognize the importance of “customer journeys” and “loyalty loops” but are just beginning to understand how to integrate them into business practices.

Recognizing the importance of these factors, freemium subscription models have emerged as the current best practice in many industries. Freemium (free + premium) is a step toward relationship-building in which a limited level of free service is used as a loss-leader to attract as many potential users as possible, with the hope of then converting them to a premium level that they can be convinced to pay for once they have experienced at least some of the value. But freemium is just one limited step in the right direction. It fails to exploit networked relationships to seek pricing that customers can see as fair.

Digital businesses face two fundamental problems:

1. The driving problem is how to make the business sustainably profitable in this digital era.

2. That problem centers on difficult questions of price—free or paid? and how set?

A New Logic

FairPay is a simple but fundamental rethinking of how businesses and consumers conduct exchanges with one another in a digital marketplace.

• It proposes a new architecture for approximating an optimal price—one that is personal and dynamically context-dependent—by building a deep relationship that is based on dialogs about value.

• It embodies modern concepts of business as the co-creation of value by businesses and customers working cooperatively.

• It provides a new and empowering process for co-pricing, a form of participative pricing.

FairPay makes dialogs about value a central feature of a new kind of emergent learning relationship that becomes an integral focus of each customer journey—to shape what people are offered, what they buy, and at what price. It moves from the mass-market tyranny of set-pricing, to personalized, dynamic pricing—in a way that uniquely develops trust, fairness, loyalty, and profit—to maximize CLV for as many customers as can be served profitably—and can factor in social values as well.

• FairPay re-envisions elements of freemium; paywalls; subscriptions; membership or loyalty programs; dynamic pricing; value-/performance-/outcomes-based pricing; and pay what you want (PWYW), to provide a strong and sustainable customer relationship and revenue stream.

• FairPay solves the nasty problems of pricing digital products and other experience goods—by seeking to approach optimal price discrimination, based on in-depth learning about each customer—and does this in a relationship-centered, participatory way that assures customer buy-in.

• It is this relationship focus at the core of FairPay that creates a new dimension to B2C customer relationships—one that previously has only been approximated in high-end industrial B2B value-/performance-/outcomes-based pricing.

• FairPay builds on the lessons of PWYW participative pricing, in consumer markets—but adds this new dimension of feedback and control over ongoing relationships to make that more sustainably profitable.

The core process enabling FairPay works over relationships, by applying a deceptively simple balance of powers:

1. Selectively empower the buyer to unilaterally set whatever value-based price the buyer considers fair—after the sale, when the real value is experienced and known.

2. Track that buyer value-based price and determine whether the seller agrees that is fair, and use that information to empower the seller to decide whether to make further offers on those terms to that buyer in the future. (Unfair buyers are eventually downgraded to lesser offers or fixed-price.)

3. Continue this balancing in future transactions, to build a relationship based on fair value exchange that adapts and evolves over time, frames the value that was delivered, and a suggested price for that—and nudges the buyer to be generous by offering more value in the future for more generosity now.

This repeating cycle gives buyers a strong incentive to price fairly, to build a beneficial relationship—and enables sellers to limit their future exposure to those who do not—using decision rules that can readily be tuned to specific situations, segments, and objectives (see Figure 1.1).

At first glance, this core process may appear to have limited effectiveness and applicability, but on closer scrutiny it can be viewed as representing a profound shift—shifting the entire focus on customer relationships from price to value. As such it has the potential to transform how companies manage customer relationships, integrating a new dimension—of time and relationship—that has previously only been tacked on to transaction-oriented exchanges. This book explains how and why this is workable.

Many have seen potential in participatory pricing, but seller control and predictability has been a big concern—how can the powers of buyer and seller be fairly balanced to lead to sustainably win–win pricing? FairPay makes participatory co-pricing practical, controllable, and profitable for mainstream consumer business use. It does this by turning it into a repeated game—using structured dialogs (choice architectures) plus Internet-enabled tracking, to limit price-setting privileges to only those who price fairly over an ongoing relationship, and to guide customers to price fairly. These dialogs generate a whole new level of customer feedback on their experiences—and their real willingness to pay for them—as that evolves over the relationship.

Figure 1.1  FairPay participative process

Source: www.fairpayzone.com/2011/03/fairpay-pricing-some-process-diagrams.html

I first outlined FairPay in 2010 on my blog at FairPayZone.com. This book draws heavily on the materials in that blog (see FPZLink). A brief introduction coauthored with Marco Bertini was published in the Harvard Business Review blog series in 2013 (Bertini and Reisman 2013) and a further paper is pending publication (Reisman and Bertini 2014). Other collaborations with Adrian Payne and Pennie Frow led to a presentation at the Naples Forum on Service in 2015 (Frow, Reisman, and Payne 2015), and further collaborative work is in progress.

How It Works—Customer Participation in Pricing as a Privilege

We have been conditioned to think only of seller-set prices (the price tag) or traditional negotiation (haggling over price) that work in a context of isolated transactions. FairPay is a logic that operates more holistically—it introduces a new kind of balance of powers that works over a series of trans-actions to build a relationship. A customer is selectively granted new power to set prices, but the seller decides whether to continue granting that power to that customer. The relationship continues as long as both are satisfied. This feedback control loop creates a new logic for adaptively seeking win–win value that grounds and enriches the customer journey.

It is anticipated that FairPay would be offered to customers selectively, as a privilege, as an alternative to a conventional pricing such as a paywall, but that conventional set-price paywalls would remain for customers who do not adapt well to this new responsibility for fair, win–win pricing—the implicit contract of what I call an “invisible handshake” (as explained later).

FairPay is designed to become a primary pricing model, but first it can be trialed in low-risk tests, such as premium tiers and loyalty programs, customer acquisition/retention, or for other selected product tiers or market segments. It builds stronger customer relationships for greater profit from a wider market. Early uses should be targeted to customer segments expected to take well to it—starting with the most promising relationships—and then gradually expand more broadly as its benefits become clear, and customers become familiar with this new logic.

The core mechanism suggested for FairPay is outlined in the following boxes and Figure 1.1.

Keep in mind that, in its purest form, this process never sets final prices in advance of a transaction. It is not a way to negotiate transaction prices that then are pre-set going forward. That could be done, but then the whole dynamic of adaptation to value as it changes in context over time would be lost. At times it may be desirable to put this process on autopilot, to limit the frequency of pricing dialogs once a stable situation seems to exist—but to maintain the full power of FairPay, prices should always remain open to unilateral reset by the customer, based on their current experience.

Why It Works

Behavioral economics: FairPay builds on extensive behavioral economics research to shift from simple transactional behaviors to more collaborative behaviors:

• To give sellers control of how much power to yield to buyers, depending on how well they pay over an ongoing learning relationship;

• To segment buyers based on their payment behavior; and

• To nudge buyers to pay generously, using structured dialogs and incentives.

Many ask why customers would pay if they do not have to, but extensive experience with even simple, purely voluntary forms of PWYW pricing shows that people actually do pay, even when they do not have to. People have an inherent desire to be fair. Understanding and applying these motivations is central to making FairPay work well, and we will explore this from many angles. And keep in mind that FairPay’s conditional extension of offers adds controls to restrict customers who choose to price unfairly.

Game theory: Even the hard-headed homo economicus, the rational, self-interested utility maximizer of classical economics (not just the homo reciprocans of behavioral economics), will see the compelling logic of FairPay. FairPay is structured as a “repeated game” in which it is worthwhile to pay up, to invest in reputation building, in order to maximize FairPay access to future purchases. It is just a matter of careful and constantly adaptive game design to ensure that the game remains win–win (and that any losses from those who seek to game the system or to play unfairly and then quit are limited to be acceptably small).

Basic economics: It has long been known that the most economically efficient prices are not uniform, but are customized for each customer to the actual value they receive, and their willingness to pay for it. This is true in the theory of optimal price discrimination, and has been proven effective in high-end B2B businesses where actual value-in-use can be cooperatively evaluated and used to set prices based on performance and outcomes. Doing that in mass consumer markets had seemed unfeasible, but FairPay now points the way to doing just that, in a consumer-friendly way.

Customer journeys: Modern marketing practice is increasingly focused on fostering customer journeys that develop “loyalty loops” to maximize the repeat business that leads to sustainable profit. What better way to build strong loyalty loops than to center them on true dialogs about individual value perceptions?

Where It Works

• FairPay promises to be most useful for any product/service where low marginal costs apply, so a seller can afford to put a limited amount of product at risk in order to seek to build a profitable relationship with a customer. This includes most forms of digital content (newspapers, magazines, music, video, e-books, and games), software/apps, and services (of any kind) offered to consumers (or low-end B2B offers).

• It can also apply to perishing items of any kind, including physical products/services (much like Priceline and Groupon).

• Even for products/services for which there is a high variable cost, FairPay can be used with a seller-set minimum price floor that at least covers the variable cost, to focus on fair sharing of the rest of the value surplus. (The base price can be paid up front, while the value bonus can be set and paid after the experience is known.)

• FairPay is especially relevant to experience goods and services, where the perceived value depends on the usage by the particular customer, as they perceive it, in their unique usage context—which cannot be reliably predicted in advance. More and more, we are in such an “experience economy.”

Businesses should begin by seeking low-hanging fruit. Initial sweet spots will be with customers who are disposed to high fairness and genero-sity—such as superfans getting much-appreciated service from deserving providers—and wherever the seller has a particularly strong human appeal to sustainable compensation, whether based on service quality or social contributions. Once the power of FairPay is demonstrated in such sweet spots (even if only with a minority of customers), broader expansion will become more and more compelling to both customers and firms.

In addition to better pricing, FairPay generates a new kind of detailed database on each customer’s fairness and willingness to pay for specific value propositions—a new kind of Big Data about value, a Cloud of Value—that can become an essential tool for targeting marketing offers.

FairPay can be applied by individual content/service businesses, but it gains economies of scale and network effects when applied across a platform serving multiple provider/seller businesses. For platform providers, this database Cloud of Value can be leveraged across the platform to predict how known customers will respond to new providers—creating a valuable asset much like a credit rating database. Learning how fairly individual customers pay current providers enables predictions about how they will deal with new providers, so that this learning process can be leveraged across a whole market ecosystem. That can enable offers to be targeted to those who are most likely to respond cooperatively, even for new service providers.

How Do You Get FairPay?

FairPay is a logic, not a product—it is an architecture for a new way of doing business. I have been working on FairPay on a pro-bono basis (in collaboration with prominent marketing scholars).

• The concepts have been developed in depth and published, starting in 2010. The precursor elements of FairPay have all been proven in commercial use, but the full FairPay control process has not yet been put into use. FairPay has generated wide interest, and discussions on implementation and trials of the full process are underway.

• The expectation is that some individual businesses will implement FairPay services themselves, and some will rely on platform providers who will offer core FairPay software and services. There have been promising ongoing discussions with both selling businesses and platform providers.

• Proof of concept testing is needed to validate and refine our understanding of how consumers will respond to this conditional grant of pricing power, and how businesses can best manage the process to frame value propositions, nudge behaviors, and define decision rules that elicit sustainable pricing behavior.

• There are many variations in how FairPay can be applied. Even if initial tests fail to generate the desired results, they will provide insight into how to adapt these methods to work better. FairPay moves us toward a model that is consistent with leading-edge thinking in marketing. Starting down that path will almost certainly lead us to an approach that works far better than current methods.