CH 4CH 4

Signaling and Managing CompetitionSignaling and Managing Competition

Kent B. Monroe (2007). Pricing: Making Profitable Decisions. 3rd Edition (Singapore: McGraw-Hill) .

0202Chapter ObjectiveChapter Objective

1. To learn how to acquire, process, and utilize relevant and correct information about customers, competitors, and their environment to successfully manage competition.

0303Market FailureMarket Failure

MARKET FAILURE

Perfect Competition

• Many sellers , Same Product, no seller can influence price

• Market Power• Public Goods• Externalities

• Asymmetric Information

0404Asymmetric Information Asymmetric Information (P.78)

• Occurs when one party in a transaction or competitive situation

has more information than the other party.

- Hidden information - Hidden action

0505Asymmetric Information Asymmetric Information (P. 78)

How to avoid incorrect inferences about one’s behavior & intentions ?

External SIGNALS

Seller

Buyers

SIGNAL INCENTIVES

Buyers

0606TwoTwo Forms of Asymmetric Information Forms of Asymmetric Information (P. 78)

Adverse Selection• occurs when buyers cannot detect product quality prior to purchase and use.

Moral Hazard• occurs when the seller can change quality of their offerings withoutdetection by buyers prior to purchase or trial.

External SIGNALS

INCENTIVES

0707Signals Signals (P. 79)

• It is the actions or announcements conveying information about a firm’s intentions or abilities.

• It is a piece of information that can be revealed to the market at some cost to the providers

• It has meaning to the receiver only if it can be interpreted.

Timing is important as to how signals are interpreted.

External Cues

0808Signals Signals (P. 29)

For the external cues to be perceived as a signal, there must be:

• Observable differences in the product characteristic or cue across sellers.

• Differences between the quality and quality sellers in the cost of providing the cue.

• Perceptions of product quality in the market that vary directly with the characteristic or cue.

0909Quality Signals Quality Signals (P. 80)

1. Provide information about quality• Buyers are skeptical about claims

2. Provide other information, signals about the truthfulness of claims• Such a signal alerts others about product quality, reputation, intentions, future actions,

or forecasts.

What can sellers of high quality products do ?

signals clear, consistent with other signals and convey commitment.

1010Types of Quality Signals Types of Quality Signals (P. 80)

1. Default-Independent Signals• The seller incurs the signal cost regardless of whether it fails to perform as promised

2. Default-Contingent Signals• The seller incurs the signal cost only when they fail to perform as promised.

Default-Independent Signals Default-Contingent Signals

Sale Independent Sale Dependent Revenue Risking Cost Incurring

Types• Publicly visible expenditures prior to transactions

• Private expenditure related to sales transactions

• Future revenues at risk

• Future costs at risk

Examples

Investment in:• Advertising• Brand Equity• Store name• Store/Facility decorations• Employees’ uniform• Capital expenditures

• Low introductory price• Temporary price reduction• Distribution allowances

• High price• Umbrella branding• Product/Brand bundling

• Warranties• Money-back guarantees

1111Brand Equity Brand Equity (P. 83)

• Represents value of brand name to the buyers

• Brand name signals relative quality level (e.g., Hyatt, Marriott etc).

• Brand name reduces buyers’ search and information processing costs, and perceived risk.

• To be credible, maintain consistent marketing and delivery of quality.

• Advertising claims must be consistent with actual quality delivered.

1212• It is a promise made by the seller that the product, or its performance related attributes, is free from defects in materials and workmanship.

• It provides a commitment to correct problems if they occur during the warranty period.

• Should be used for products whose quality-determining attributes are revealed over time

Warranties Warranties (P. 85)

1313Guaranties Guaranties (P. 85)

• A money-back guarantee promises to return the buyer’s purchase price

if the product fails to satisfy the buyer during the period covered by the guarantee

• Should be available for a limited period of time after purchase and used with products whose quality-determining attributes are revealed quickly after purchase

1414Signals are Important Signals are Important (P. 86)

Signals work to separate the overall market into

a high-quality and a low-quality market only…

• If the cost of signaling is too high for the low-quality firm to profitably mimic it.

• If the promise of the high-quality firm is enforceable either by buyer action or legal action

1515Read the case given at Box 4.3 and answer the questions carefully.

1. Among the two firms, which one was the most successful?

2. What are the major “Quality Signals” the winner was using?

3. What are the major reasons for the failure brand ?

Seat Work 2 Seat Work 2 (P. 84-85)

1616Adverse Selection• occurs when buyers cannot detect product quality prior to purchase and use.

Moral Hazard• occurs when the seller can change quality of their offerings withoutdetection by buyers prior to purchase or trial.

External SIGNALS

INCENTIVES

TwoTwo Forms of Asymmetric Information Forms of Asymmetric Information (P. 78)

1717Moral Hazard Moral Hazard (P. 86)

• It occurs when sellers can change the quality of their offerings without detection by buyers prior to purchase or trial.

• Buyers provide a profit incentive through a willingness to pay a “premium” price and to pay this price every time so long as quality remains at the desired level

1818Price Premiums Price Premiums (P. 87)

• Buyers’ willingness to pay a price premium and their willingness and ability to punish the seller if quality is compromised, provides incentives to solve this moral hazard problem

• High-quality sellers receive price premiums

2121Product Warranties and Guarantees Product Warranties and Guarantees (P. 88)

• If the warranty provides for full replacement of the product, then the buyer has little incentive to care for and maintain the product properly

• Providing a warranty or guarantee provides an incentive to the seller to maintain quality and thereby avoid or reduce the costs of warranty and guarantee problems

2222Price War Price War (P. 92)

• Firms battle for the patronage of customers, try to take business from a rival, or seek to drive a competitor out of the market

• When competition is gaining in these battles, price reductions occur

leading to price wars

2323Price War Price War (P. 92)

2424Causes of Price Wars Causes of Price Wars (P. 93)

1. Intentional strategic actions.

2. Failure to seek price premiums for benefit advantages.• Firm increases benefits, but does not increase price commensurate with increased value.

3. Competitive or market misreads or over-reactions • Not considering qualifiers of competitive deals• Misunderstanding incomparability of prices• Misinterpreting competitors’ price moves• Misreading market and/or market share change

2525Negative Effects of Price Wars Negative Effects of Price Wars (P. 92)

1. Sensitivity of profits to price decreases2. Price advantages disappear quickly3. Long term effects of customers’ reference prices4. Increases customers’ price sensitivity5. Decrease customers’ benefit and value sensitivity6. Industry shakeouts seldom occur

2626Avoiding Price Wars Avoiding Price Wars (P. 94)

1. Avoid strategies that force a competitive price response

2. Avoid your competitive misreads

3. Avoid pricing over-reaction

4. Understand the value relationships

5. Communicate prices properly

6. Use price-market segmentation

7. Develop long-term customer relationships

8. Develop a flexible pricing structure

9. React to competitive price moves directly and in kind

Explain the various ways of Avoiding the price Explain the various ways of Avoiding the price war? war? SELF STUDY TOPICSELF STUDY TOPIC