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April 4, 2006
1
Teck-Hua Ho
Internet Pricing Models
I. Economic and Behavioral Foundations of Pricing
II. Innovative Pricing Concepts and Tools
III. Internet Pricing Models
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Teck-Hua Ho
OutlineOutline
A taxonomy of Pricing Models
Seller vs buyer posted pricing models
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Teck-Hua Ho
Product categories: Airline tickets, hotels, car rentals, vacation packages, and cruises.
Perishable inventories (e.g., yield management)
Price fairness is less of an issue
Marginal costs are close to zero
Will grocery products work?
http://www.priceline.com/
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Teck-Hua Ho
Rules: Customer bids, waits up to 1 hour. If bid is accepted, ticket must be purchased. If not accepted, customer must wait 7 days to re-enter bid.
Restrictions: Cannot specify time of flight, connection city or airline.
Refund Policy: No Refunds/Exchanges.
Hotels, Rental Cars: Yes
Loyalty Miles or Points: No
Rules: Customer can see fare and has 30 minutes to accept offer. Customers will be locked out for 72 hours if they reject offer.
Restrictions: Cannot specify time of flight, connection city or airline.
Refund Policy: No Refunds/Exchanges.
Hotels, Rental Cars: Yes
Loyalty Miles or Points: No
http://www.hotwire.com/index.jsp http://www.priceline.com/
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Teck-Hua Ho
Rules: Customer gets fares, number of tickets available and how long offer is valid. Customer can purchase ticket then or be notified if price falls to desired rate.
Restrictions: Can’t specify airline.
Refund Policy: No Refunds/Exchanges
Hotels, Rental Cars: YesLoyalty Miles or Points:
Available for some airlines.
Rules: Will search fares globally. Customers will be able to purchase tickets at Qixo for 1% on top of price found at searched site.
Restrictions: None.Refund/Policy: Depends on
site policy.Hotels, Rental Cars: YesLoyalty Miles or Points:
Available for some airlines.http://www.qixo.com/flight.html
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ObservationsObservations
Emergence and co-existence of new pricing mechanisms (e.g., www.priceline.com, www.ebay.com, www.landsend.com and etc.)
Unsubstantiated claims made by new pricing mechanism designers (e.g., “auction is the selling format of the future”, “priceline gives power back to the buyers”)
Shift in balance of power Buyer plays a bigger role in price setting process
Menu costs are very low so dynamic price customization is now practical (with customer information) (e.g., www.techdata.com )
Erosion of “ignorance premium”
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A Taxonomy of Pricing ModelsA Taxonomy of Pricing Models
Seller Buyer Seller & Buyer
Price Setting Party
Pri
ce O
ver
Tim
e / P
rice
For
mat
ion
Stat
icD
ynam
ic
www.priceline.comhttp://answers.google.com/answers/
www.landsend.com www.freemarkets.com
www.ebay.com
www.letsbuyit.com
Financial markets
www.amazon.com
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LetsbuyitLetsbuyit http://www.letsbuyit.com/cobuy_on_letsbuyit.html
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Teck-Hua Ho
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Chinese Consumers Overwhelm RetailersChinese Consumers Overwhelm RetailersWith Team TacticsWith Team Tactics
http://online.wsj.com/article_email/SB114106170222284388-lMyQjAxMDE2NDAxMzAwNjMxWj.html
Ex: Co-buyingEx: Co-buying
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Criteria to Evaluate Pricing Criteria to Evaluate Pricing ModelsModels
Social Welfare Metrics
Seller surplus
Buyer surplus
Inefficiency Marketing Metrics
Average price
Sales volume
Price Posting Behavior
Seller posted price
Buyer posted price as a function of WTP
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A Simple MarketA Simple Market
Seller 1 c=0
Seller 2 c=0
Buyer 1 40 Buyer 2 20Buyer 3 15Buyer 4 90Buyer 5 60Buyer 6 50
WTP
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Maximum Possible Surplus Maximum Possible Surplus (MPS)(MPS)
Seller 1 c=0
Seller 2 c=0
Buyer 1 40 Buyer 2 20Buyer 3 15Buyer 4 90Buyer 5 60Buyer 6 50
WTP
MPS = 40 + 90 + 60 + 50 = 240
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An Example: Fixed Price An Example: Fixed Price FormatFormat
Seller surplus = 45 + 40 + 40 = 125 = 52.08% of MPS
Buyer surplus = 45 + 20 + 10 = 75 = 31.25% of MPS
Inefficiency = 40 = 16.67% of MPS
Average Price = 41.67
Sales Volume = 3
Seller 1 c=0
Seller 2 c=0
Buyer 1 40 Buyer 2 20Buyer 3 15Buyer 4 90Buyer 5 60Buyer 6 50
45
40
40
WTPPrice
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Experimental Test-BeddingExperimental Test-Bedding
Develop a new price setting mechanism
Organize experimental/field markets with buyers and sellers using the new price mechanism and a benchmarked price mechanism
Provide sufficient monetary incentives to motivate buyers and sellers
Evaluate the price mechanisms based on performance criteria
Continue to fine-tune features of the new price setting mechanism to maximize a particular performance criterion
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Vernon SmithVernon Smith
Vernon Smith 2002 Nobel Laureate in Economics
"for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms"
http://xlab.berkeley.edu/
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An ApplicationAn Application
Is priceline’s mechanism superior to the traditional retail price setting mechanism?
Does the party who sets the price gains a greater portion of the surplus?
How would the priceline’s mechanism’s perform if the seller is allowed to set a minimum acceptable price (MAP)?
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Three Internet Pricing ModelsThree Internet Pricing ModelsSellers posting prices (e.g., www.amazon.com)
Buyers posting prices (e.g., www.priceline.com)
Sellers posting minimum acceptable prices (MAP) and buyers posting prices (a modified version of www.priceline.com)
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Experimental DesignExperimental DesignNine experimental sessions Eight subjects per session; 2 sellers and 6 buyersStandard experimental economics methodology (i.e.,
induced value, monetary incentives)Seller’s earnings = sum of (price – cost) for each unit
soldBuyer’s earnings = WTP - price Subjects made $20 on average, the actual payoffs
ranged from $8 to $39 (the experiment lasted for 75 minutes)
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Design of Amazon MarketDesign of Amazon Market
Determine the role of each subjectDetermine each buyer's WTP for the product (1-100) Each seller decides on a priceDetermine each buyer's buying sequenceDetermine whether there is a trade between each buyer
and seller According to the buying sequence, each buyer is
sequentially asked to indicate whether she would buy from each of the sellers
Determine the earnings for everyone
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Design of Priceline MarketDesign of Priceline MarketDetermine the role of each subject
Determine each buyer's WTP for the product (1-100)
Each buyer decides on a price
Determine each buyer's buying sequence
Determine whether there is a trade between each buyer and seller
According to the buying sequence, sellers are asked whether they would sell a unit to each buyer
Determine the earnings for everyone
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Design of Priceline Market with Design of Priceline Market with MAPMAPDetermine the role of each subject Determine each buyer's WTP for the product (1-100)Each seller decides on a minimal acceptable price (MAP) Each buyer decides on a priceDetermine each buyer’s buying sequenceDetermine whether there is a trade between each buyer
and seller Buyer prices that are below all MAPs are rejected According to the buying sequence, sellers are asked whether they
would sell a unit to each buyer whose price is above their MAPs
Determine the earnings for everyone
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Results: Social Welfare Results: Social Welfare MetricsMetrics
AmazonAmazon PricelinePriceline Priceline with Priceline with MAPMAP
SellerSeller
SurplusSurplus50.6% 45.1% 45.7%
BuyerBuyer
SurplusSurplus33.2% 42.6% 42.3%
InefficiencyInefficiency 16.2% 12.3% 12.0%
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Results: Marketing MetricsResults: Marketing Metrics
Amazon Priceline Priceline
with MAP
Price 43.00 28.43 33.00
Sales
Volume
3.00 3.75 3.33
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Amazon: Price DistributionAmazon: Price Distribution
0.0%5.0%
10.0%15.0%20.0%25.0%30.0%35.0%40.0%45.0%50.0%
Frequency
< 38 38-45 >46
Price Range
Amazon: Price Frequency Plot
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Average Prices Over TimeAverage Prices Over Time
Prices Over Time
0
10
20
30
40
50
60
1 2 3 4 5 6 7 8 9 10
Time
Pri
ce Amazon
Priceline
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Seller Posted Price (Amazon) versus Seller Posted Price (Amazon) versus MAP (Priceline with MAP)MAP (Priceline with MAP)
Seller Posted Price versus MAP Over Time
0
10
20
30
40
50
60
70
1 2 3 4 5 6 7 8 9 10
Time
Po
ste
d P
rice
o
r M
AP MAP
Posted Price
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Priceline: Posted Price versus Priceline: Posted Price versus WTPWTP
Priceline: Buyer Posted Price versus WTP
010203040506070
0 10 20 30 40 50 60 70 80 90 100
WTP
Bu
yer
Po
sted
Pri
ce
Posted Price = 5.62 + 0.41 x WTP (R2=0.73)
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Priceline with MAP: Priceline with MAP: Posted Price versus WTPPosted Price versus WTP
Posted Price = 4.25 + 0.39 x WTP (R2=0.71)
Priceline with MAP: Buyer Posted Price versus WTP
05
101520253035404550
0 10 20 30 40 50 60 70 80 90 100
WTP
Bu
yer
Po
sted
Pri
ce
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SummarySummaryDevelop a new price setting mechanism
Organize experimental/field markets with buyers and sellers using the new price mechanism and a benchmarked price mechanism
Provide sufficient monetary incentives to motivate buyers and sellers
Evaluate the price mechanisms based on performance criteria
Continue to fine-tune features of the new price setting mechanism to maximize a particular performance criterion
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Punch-linePunch-line
The power to set a static price (i.e., make a take-it-or-leave-it offer) allows a party to gain a higher surplus
In analyzing a price model:Determine the criteria of performance
Engage in experimental test-bedding
