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Microsoft over the past couple of years has jumped on the price discrimination bandwagon. It was difficult for them to engage in product and price differentiation because they were generating piles of cash as a monopoly. Microsoft is a monopolist in the operating systems arena and with their office suite of applications. The marginal cost to produce incremental levels of software and other information goods, such as DVDs and music, is essentially zero. But as usual, the fixed costs are substantial, and because Microsoft is a price setter, they chose to sell at a price that covers their fixed costs but still permits them to make a large profit without irritating too many consumers.
For many years, Microsoft was not interested in price discrimination based on geography, market segment, or per capita GDP. But Microsoft had to move toward price discrimination because the willingness-to-pay for software was related to software piracy. Students and individuals with low incomes are price-sensitive and will simply turn to piracy when the price exceeds their willingness-to-pay. They also had to offer certain market segments lower prices because piracy was essentially rampant. Microsoft began to realize that they were leaving money on the table because they did not take dramatic steps to price discriminate through product differentiation.
Sometimes product differentiation does not work. Microsoft tried to differentiate the Vista operating system (see the snap shot of Windows 7 and Vista Versioning in Figure 5.6, “Windows 7 and Vista Product Differentiation”). But Vista never gained legs for a variety of technical, customer support and marketing reasons. The product was not ready for prime time. They continued to product differentiate and price discriminate with the release of Windows 7. Home Premium was priced at $199.99, Professional at $299.99, and Ultimate at $319.99. They definitely used the Goldilocks versioning. It appears that Windows 7 was a success because it was a stable, fast, and friendly operating system.
Of late, Microsoft has also had to contend with Google’s foray into the online office application suite called Google Docs and IBM’s offering of open-sourced Linux-based applications. The competition is heating up and the Microsoft monopoly is under attack on many fronts. Monopolies are often transitory as the competition looks for a crack in the armor and a chance to drink from the fountain of plenty. The growth of cloud computing (where data storage and CPU cycles move toward the utility model) and the availability of net-centric applications could continue to erode Microsoft’s market share. They have, however, started to address the attack by introducing a cloud-based Office 365 and the Azure development platform.
Dynamic differentiation is the ability to sell personalized closely related, but not identical products to consumers. In a perfectly competitive market, there are a large number of knowledgeable sellers selling a standardized product to a large number of knowledgeable consumers. In such a market, product and price differentiation is difficult, if not impossible. In such a market, it is also impossible to extract any additional money from such consumers even if you can identify how much each consumer is willing-to-pay. That is why businesses turn toward product differentiation and the monopolistic competition model. As noted before, over 99% of the approximately 23+ million businesses are involved in monopolistic competition.  The king of monopolistic competition is certainly L’Enfant terrible Michael Dell and his creation, Dell.com.
Michael Dell started out with three guiding principles:
1. Always listen to the customer.
2. Never sell indirectly.
3. Disdain inventory.
It appears that always listen to the customer is the driving force behind his model, but in reality, never selling indirectly is the engine behind the Dell model. Dell believes that the best way to listen to his customers is watch the customer select from a menu of system features and let the customer tell them what they value. This is the epitome of dynamic differentiation. By selling directly, Dell is very close to the customer and Dell can constantly adapt to subtle shifts and changes in customer preferences. Because they know what features are in greatest demand, they can move them to the high-end products. It is indeed manipulation, and a way to extract consumer surplus. And as an added benefit, Dell can carry very little inventory because they are listening to their customers and building the systems as the orders arrive.
Dell has of course adapted its model and has put more emphasis on listening to their customers. They are now selling products indirectly in the USA, in China, and all over the world. This is, in part, because PCs and laptops are becoming commodity products and less differentiable, but also because Dell has been listening to their current and potential customers. Some of them want the instant gratification of buying and taking it home today and some of them want to touch and feel before they buy.
Dell’s Migration and Evolution
At one time, Dell was more-or-less a pure pull company, just like Amazon.com. Much of their entire production system was driven by actual orders from customers. Part of their production process has also pushed products to consumers, but they are on balance a pull process company. They have been drawn toward the dark side and push production because of the demands of the marketplace. In a push production process, orders are forecasted and some products are scheduled for production based on forecasts and retailer demand rather than end-consumer. This change in attitude toward selling directly also coincides with Dell’s move to sell off their manufacturing units. They are attempting to alleviate the risk inherent in manufacturing products before customers order them. The risk is ofcourse excess inventory and Dell disdains inventory. After Dell sells their manufacturing facilities, their systems suppliers will then absorb some of the risk of carrying excess and outdated inventory.
Dell, because of its direct selling and the ability to install numerous features, is a prime example of dynamic differentiation. They offer literally thousands of different product configurations or versions
Dell, because of its direct selling and the ability to install numerous features, is a prime example of dynamic differentiation. They offer literally thousands of different product configurations or versions.