October 8, 20031

Teck H. Ho

Pricing Policy:Pricing Policy:Time CustomizationTime Customization

I. Economic and Behavioral Foundations of Pricing

II. Power Pricing Concepts

October 8, 20032

Teck H. Ho

OutlineOutline

Time customization of prices: The short term

Trial and accelerate purchase

Potential demand buildup

Peak and off-peak pricing

Demand probing and yield management

Potential negative consequences

The long-term dynamic effects

October 8, 20033

Teck H. Ho

ExamplesExamplesCampbell offered trade deals to retailers during summer (a

eight-week period)

Introductory offer on a new product

Varying airfares over time

Early bird specials

Hotels’ winter specials

October 8, 20034

Teck H. Ho

Basic MotivationsBasic Motivations

InformationAbout Demand

Known

InitiallyLimited

Not Timedriven

Timedriven

1. Trial

2. PurchaseAcceleration

3. Potential Build-up

4. Peak Load

5. Peak Load withDemand Shift

6. Demand probing

7. Yield Management

October 8, 20035

Teck H. Ho

1. Trial and 2. Purchase 1. Trial and 2. Purchase AccelerationAcceleration On Saturday, 11/22, 1986, Ho Camera offered 5 rolls of

Fuji film (24 exposures) at $15.98 less a $10 manufacturer’s mail-in rebate valid until 12/21, 1986.

The offer highlighted Fuji’s $5.98 “Final Cost After Rebate” or $1.20 per roll – approximately 60% less than the regular price.

The vast majority of consumers have been loyal to Kodak even though Consumer Reports citing virtually indistinguishable quality differences in their films.

Two goals:To persuade consumers to switch and try Fuji To accelerate purchase and “load pantry”

October 8, 20036

Teck H. Ho

1. Trial and 2. Purchase 1. Trial and 2. Purchase AccelerationAcceleration

Two other mechanisms for enacting price customization:CouponOn-shelf price cut

These mechanisms differ in two important respects:Reference priceSelectivity (areas, price-sensitive consumers, and Kodak consumers)

October 8, 20037

Teck H. Ho

Coupon redemptionCoupon redemption

A panel-level study of how shoppers redeem coupon when they purchase consumer packaged goods

Regular users are more likely to redeem coupons than previous nonusers

What is the motivation behind coupon offers?

Prior Prob. of

Redemption

% of Total Redemptions Accounted for

Nonuser 4.2% 28.5%

Infrequent User 17.8% 50.4%

Frequent User 31.3% 21.1%

October 8, 20038

Teck H. Ho

Shipments and Consumption versus Time

0

10

20

30

40

Month

Sh

ipm

ents

or

Co

nsu

mp

tion

Purchase Acceleration vs. Purchase Acceleration vs. Forward BuyingForward Buying

SEP DECJUN MAR

Shipments Consumption

How do you resolve this problem?

October 8, 20039

Teck H. Ho

EDLP versus HILO StoresEDLP versus HILO Stores

An examination of 3,000 common SKUs across 5 supermarkets (2 EDLPs and 3 HILO stores) (Ho, Tang, Bell, Management Science, 1998)

HILO stores have a higher price variance and a higher expected price

EDLP versus HILO stores

Number of trips

Average spending per trip

October 8, 200310

Teck H. Ho

Mean and Standard Deviation of Mean and Standard Deviation of Basket PricesBasket Prices

Tang, Bell, and Ho (California Management Review, 2002)

October 8, 200311

Teck H. Ho

Shopping BehaviorShopping Behavior

October 8, 200312

Teck H. Ho

3. Potential Buildup of Low-3. Potential Buildup of Low-WTP CustomersWTP Customers Mr. Coffee coffee maker (unit variable cost = $32)

The goal is to charge maximum WTP of a growing proportion of the market that would buy at regular price

Suppose customers for a coffee maker are of two types, one valuing the product at $60 and the other at $40.

Each group has a “birth” rate of 100 per month

1 2 3 4 5 6 Time

Price

$60

$40

October 8, 200313

Teck H. Ho

3. Potential Buildup of Low-3. Potential Buildup of Low-WTP CustomersWTP Customers

Month N($60) N($40) Contribution if P=$60

Contribution

If P=$40

1 100 100 $2800 $1600

2 100 200 $2800 $2400

3 100 300 $2800 $3200

4 100 100 $2800 $1600

5 100 200 $2800 $2400

6 100 300 $2800 $3200

Unit Variable Cost = $32

October 8, 200314

Teck H. Ho

Example of Value Variation Example of Value Variation Over Different Time PeriodsOver Different Time Periods

Time of Day Value change with work / leisure status NYNEX rate of initial minute oftelephone call (Boston to Philly) - 0.098 (11:00 p.m. - 8:00 am) - 0.178 (5:00 p.m. - 11:00 p.m.) - 0.29 weekday (8 a.m. - 5:00 p.m.)

Day of Week Work Day vs. Not Breakers Resort in West Palm Beach,Florida - $279/Night for Sunday - Thursday - $295/Night for Friday & Saturday

Week Holiday Periods EuroDisney Hotel Pricing

Month High season for resorts, demand for Hilton Head - 3 Bedroom - Ocean Frontproduct influenced by weather - March - August: $2100conditions - September - October: $2000

- November - February: $1450

Special Event Events causing convergence of people: Parking in China Town was Conventions and sporting events $20 per entry (instead of $3/hour)

during special event

October 8, 200315

Teck H. Ho

EuroDisney Hotel PricingEuroDisney Hotel Pricing

Hotel Rating

Hotel Adjacent

(Francs)

Holiday

(Francs)

Premium

**** Hotel New York 2395 2480 6%

**** Disneyland Hotel 2035 2455 21%

*** Newport Bay Club 965 1330 38%

*** Sequoia 865 1230 42%

** Hotel Cheyenne 735 1120 52%

** Hotel Santa Fe 635 1020 61%

October 8, 200316

Teck H. Ho

4. Peak and Off-Peak4. Peak and Off-PeakLoad PricingLoad Pricing

$100$75$50

37.5

75

Off-PeakSalesVolume

$150$100$50

50

100

Peak SalesVolume

price150Sales price5.1150Sales

October 8, 200317

Teck H. Ho

5. Peak Load with Demand 5. Peak Load with Demand ShiftsShifts

Oakland to ChicagoNumber Day Flight Redeye

Professionals 100 $1,000 $100

Students 100 $600 $400

If we charge $600 for both day flight and redeye, we receive $120,000 (leading to zero demand for redeye)

If we charge $1000 for day flight and $400 for redeye, we receive $140,000 (shifting the students’ demand to the redeye)

October 8, 200318

Teck H. Ho

Uncertain DemandUncertain DemandConsider selling a product to a single customer and

three scenarios on information about a potential customer’s valuation of a product

You know she values the product at $5

You know she values it somewhere between $4.00 and $6.00

You know she values it somewhere between $0 and 10.00 (each value is equally likely)

Note the customer’s expected valuation is $5.00

October 8, 200319

Teck H. Ho

6. Demand Probing: Single 6. Demand Probing: Single PricePriceMean

Value

Value spread Optimal Price Prob. Of

Transaction

Expected

Revenue

$5 $5 $5 1.0 $5

$5 $5 + - $1 $4 1.0 $4

$5 $5 + - $2 $3.5 0.875 $3.06

$5 $5 + - $3 $4 0.667 $2.66

$5 $5 + - $4 $4.5 0.563 $2.53

$5 $5 + - $5 $5 0.500 $2.50

October 8, 200320

Teck H. Ho

Optimal Price Optimal Price (Variable Cost = 0)(Variable Cost = 0)

$10$5

1.0

X

Y

Prob.of a Sale

$6$4

1.0

Prob.of a Sale

$5

October 8, 200321

Teck H. Ho

Optimal Two-day Sale PricingOptimal Two-day Sale Pricing

$10$5

1.0

X

Y

$10$6.67Day 1

1.0

$3.33Day 2

Charge $6.67 in Day 1 and $3.33 in Day 2Expected Revenue = 1/3 (6.67) + 1/3 (3.33)

Prob.of a Sale Prob.

of a Sale

Unit variable cost =0

October 8, 200322

Teck H. Ho

7. Yield Management7. Yield ManagementAmerican Airlines pioneered the concept in the late

1970s

Leisure: Book well in advance, price oriented, and flexible on schedule

Business: Book on short notice, less price sensitive, and inflexible on schedule

Yield management system is to price and manage the availability of specific fare types over time as demand for a particular flight reveals itself

If bookings are above the norm, this is a signal to shut off availability of highly discounted fares

October 8, 200323

Teck H. Ho

Airline YM OperationsAirline YM Operations

ReservationSystem

Point of sale

inquiry

availabilitydisplayYM System

- forecasting- allocation

transactiondata

implementedallocations

YM Analyst- limited domain (O-D pair)- revenue performance incentive

forecastsrecommended allocationsbid price

October 8, 200324

Teck H. Ho

Basic Ideas: Chicago Basic Ideas: Chicago SFO SFO

Based on initial forecasts, start with initial allocations (number of seats) for the two fare classes.

Adjust the allocations based on demand realizations.For example, if the demand for Full Coach looks

promising, “close” the allocation for Discount. If later the demand is lower than expected, move

allocations to Discount again.

United (nonstop)

Full Coach (unrestricted)

$525

Discount (highly restricted)

$177

October 8, 200325

Teck H. Ho

Examples: What Examples: What motivations?motivations?Campbell offered trade deals to retailers during summer (a

eight-week period)

Introductory offer on a new product

Varying airfares over time

Early bird specials

Hotels’ winter specials

October 8, 200326

Teck H. Ho

Potential Negative Potential Negative ConsequencesConsequencesIncremental or substitute sale (e.g., negligible

increase in consumption)

Cost of customization (e.g., production and inventory costs)

System effectReference price effect

Wait for sale mentality

Fairness

October 8, 200327

Teck H. Ho

Long Term Dynamic EffectsLong Term Dynamic Effects

CurrentPeriod Price

CompetitiveSituation

Future PriceResponse Curveand Price/ProfitRealization

Future CostPosition

CurrentSales Volume

Current Cost

CurrentContribution

Price Response Curve

October 8, 200328

Teck H. Ho

Punch-linePunch-lineClearly understand the underlying motivation

Design the time-customization plan based on the motivation

Consider the potential negative consequences and long-term dynamic effects