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Companies generally set prices on the Internet in two ways. Many start-ups offer untenably low prices in a rush to capture first-mover advantage. Many incumbents simply charge the same prices on-line as they do off-line. Either way, companies are missing a big opportunity. The fundamental value of the Internet lies not in lowering prices or making them consistent but in optimizing them. The Net lets companies optimize prices in three ways. First, it lets them set and announce prices with greater precision. Different prices can be tested easily, and customers' responses can be collected instantly. Second, because it's so easy to change prices on the Internet, companies can adjust prices in response to even small fluctuations in market conditions, customer demand, or competitors' behavior. Third, companies can use the clickstream data and purchase histories that it collects through the Internet to segment customers quickly. Then it can offer segment-specific prices or promotions immediately.

Managers miss out on significant profits because they shy away from pricing decisions for fear that they will alienate their customers. But if management isn't controlling its pricing policies, the customers probably are. Two basic principles, the pocket price waterfall and the pocket price band, show managers how to control the pricing puzzle. The pocket price waterfall reveals how price erodes between a company's invoice figure and the actual amount paid by the customer--the transaction price. It tracks volume purchase discounts, early payment bonuses, and frequent customer incentives that squeeze a company's profits. The pocket price band plots the range of pocket prices over which any given unit volume of a single product sells. Wide price bands are common, with many manufacturer's transaction prices ranging over 60%. Using the pocket price bank enables a manager to control the price range to greater profits.