Sustainable advantage

For several semesters, I taught a required course on management as part of New York University's M.S. in publishing program. The syllabus relied on a single text and a variety of articles and exercises, including one on pricing.

Taught as part of a class on competitive strategy, the pricing exercise divided the class into competitive teams. Each side was responsible for a single gas station; the two stations operated across the street from one another.

The teams were given the same information about the cost structure of their businesses and the impact of price differentials on market share. Each team was asked to set a price at the start of each "day". We repeated the exercise for five days.

Over the course of seven semesters and a total of 28 teams, only one team consistently tried to raise its prices, to signal to the other team that there was more money to be made for both sides at a higher price. Every other team either immediately cut prices, trying to gain market share, or abandoned a higher-price strategy when the gas station across the street cut its prices.

In class, I used the results of the exercise to make a point about price wars: starting one, particularly when selling interchangeable goods, makes sense only when you have a sustainable cost advantage. Otherwise, you're just giving money away.

Because it was an in-class exercise, the example was drawn tightly and simply. Real life is seldom so clearly articulated. Moreover, it applied specifically to physical goods. Pricing digital goods, whose marginal cost can approach zero, is an exercise in revenue maximization.

But the pricing exercise came to mind this summer, when Overstock began to offer hardcover books at prices that were 10% lower than those on Amazon. Unsurprisingly, Amazon responded in kind.

To be fair, Overstock announced that it was lowering its prices for a limited time (initially a week, though that was extended). Its pricing move was seen by some as a form of advertising, a way to call attention to the book inventory it has on hand.

Shortly after Overstock started the price war, CEO Patrick Byrne told Publishers Weekly that he'd like book publishers to sell him their excess inventory, a move that would help Overstock dramatically increase its book sales. Interviewed by Judith Rosen, Bryne claimed "For ten years, we've been trying to get publishers to see the light."

Byrne also wants "to form a consortium with independent booksellers so that we can synthetically create what Walmart offers." PW rightly pointed out that starting a price war is an odd way to gain favor with independent booksellers, none of whom can claim a sustainable cost advantage.

Perhaps Byrne hopes to share some of Overstock's cost advantage with independent booksellers. That model seems odder still: wait to see which books fail; buy up the excess inventory for pennies on the dollar and offer the physical books at prices that crowd out front-list sales.

Maybe Byrne would benefit from talking to one or more of my former students. They learned their price-war lessons in the second week of the semester.

About Brian O'Leary

Founder and principal of Magellan Media Consulting, Brian O’Leary helps enterprises with media and publishing components capitalize on the power of content. A veteran of more than 30 years in the publishing industry and a prolific content producer himself, Brian leverages the breadth and depth of his experience to deliver innovative content solutions.

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