The consumer CD-ROM market has replaced
its old software pricing method with a new, more stable model called net pricing,
or cost plus. This mass-market pricing model treats CD-ROM titles as consumer
products. Net pricing can return more profit to publishers, allow distributors
to offer stable prices to retailers and let all retailers buy the title at close
to the same price. Plus, it helps titles get into traditional consumer outlets,
such as toy stores, where retailers are accustomed to net pricing.
As the prices
of CD-ROM titles fall and as a mass market develops, distributors are protecting
their profits and stabilizing their costs of operation by pricing titles according
to the level of service, including warehousing and shipping, offered to retailers.
Before switching to mass-market pricing, the CD-ROM industry followed a software
model. The buy price the distributor offered the publisher was based on a percentage
(usually 55 percent to 70 percent) off the suggested retail price (SRP), which
had been established by the publisher and accepted by the distributor. The distributor
then determined a sell price for the retailer, again based on a discount (usually
40 percent to 50 percent) off the SRP. Distributors lived on the 15 percent
to 30 percent margin between the buy and sell prices. But the SRP quickly became
a meaningless convention. Titles with $99 printed on the box were selling at
a street price of $49 or less. Consumers refused to pay more than that for a
title, and they searched for the best price in different stores, in catalogs
and at flea markets. And prices will continue to fall: typical CD-ROM street
prices in early 1995 are $29.95.
Retailers, faced with intense competition,
needed a more flexible pricing structure to respond to changing market pressures.
Distributors sought to stabilize their business model, despite pressure from
retailers to accommodate the rapidly changing price expectations on the street.
The logical focus of attention was the only variable that distributors could
control: the cost of distributing products. Some retailers cost more to service
than others. For example, retail chains that lack centralized warehousing services
and require drop-shipping to all of their stores consume tremendous resources.
The solution for many CD-ROM distributors has been to settle on a single cost
to retailers, a fixed wholesale (net) price, with added surcharges to account
for the cost of doing business with each specific retailer or chain. Surcharges
are expressed in dollar amounts or as a percentage of the invoice amount to
the retailer.
Concrete foundation
Under the net pricing system, the distributor's business model is not motivated
by the whim of market pricing, by volume orders or by the class of trade of
retailers (its customers). Pricing is now driven by the services required by
the retailer. "The change to net pricing was a business decision related to
more accurate prediction and control of our margins," said Kelly Conway, director
of affiliate labels for CD-ROM publisher Electronic Arts. "Now we have one price
for all customers, based on the services we provide them."
Net pricing treats CD-ROM titles
as consumer products.
Net pricing also helps control distributors' balance sheets and makes it easier
to make price changes in the channel. When the titles in inventory had a value
based on the nearly fictitious SRP, falling prices forced distributors to regularly
devalue the worth of inventory and administer price changes throughout the channel.
This can mean that a successful sale on reduced-price titles can be bad news
for the distributor, because of the lowered inventory evaluation (since retailers
pass the price reduction up the accounting chain to the distributor) and overhead
costs for administering the change. Net pricing helps stabilize this accounting
and administration. Broderbund adopted net pricing for its Living Books series
when major chains such as Egghead wanted the freedom to set prices for the consumer
without being tied to a discount structure related to the SRP. The change positioned
Living Books to expand into toy stores, which run on net pricing structures,
according to Susan Lee-Merrow, vice president of marketing for Living Books.
Changes upriver, too
The shift to net pricing and distribution structures is changing the business
models for publishers, too. Now a publisher working with an affiliate-label
distributor such as Electronic Arts or Broderbund can expect to pay distribution
services fees of 20 percent to 30 percent of the agreed-on price for titles
accepted on consignment. Net pricing fees replace the discount off the previously
used SRP, and they can actually return more money per title to the publisher.
The pioneering days of CD-ROM
are behind us. The ground swell of serious business is beginning to take hold.
Affiliate-label contracts under net pricing specifically state that titles are
received on consignment by the distributor, with 100-percent return privileges
back to the publisher. This language has replaced last year's clause that implied
the distributor "took title" to the inventory (a software expression that once
meant the goods could not be returned). The old language was confusing, since
the distributor was always contractually allowed to return any and all of the
inventory. It is early 1995, and these industry changes reflect our intentions
and point to our destination: an established mass market for titles, at appropriate
prices, executed in the channels like toys, audio CDs and other consumer goods.
The installed base reached 13.4 million multimedia machines (MPC and Mac) in
the home market at the end of 1994, nearly quadrupling in a single year, as
it did the year before. The pioneering days of CD-ROM are behind us. The ground
swell of serious business is beginning to take hold.
Joey
Tamer refines the vision, strategy and success of companies --
Fortune 1000, capitalized start-ups and investment fund.
www.joeytamer.com
(310) 245 5310 joey @ joeytamer.com