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Pricing
2(c) 2000-2007, I.P.L. Png & D.E. Lehman
OutlineOutline
uniform pricing complete price
discrimination direct segment
discrimination indirect segment
discrimination bundling selecting the
pricing policy
3(c) 2000-2007, I.P.L. Png & D.E. Lehman
Uniform Pricing
4(c) 2000-2007, I.P.L. Png & D.E. Lehman
Uniform Pricing: Profit Profit MaximumMaximum
MR = MC
Equivalently, set the incremental margin percentage equal to the inverse of absolute value of price elasticity of demand,
(price - MC) / price = -1/e
5(c) 2000-2007, I.P.L. Png & D.E. Lehman
Uniform Pricing: Price ElasticityPrice Elasticity
always set price so that demand is elastic
if demand more elastic, then lower incremental margin percentage (IM%)
e = -2 IM% = 1/2e = -1.5 IM% = 2/3
6(c) 2000-2007, I.P.L. Png & D.E. Lehman
Uniform Pricing: Private-Label ColaPrivate-Label Cola
Suppose that WalMart learns that demand for private-label cola is less elastic than the demand for Coca Cola. Should WalMart set a higher price for
private-label cola? Elasticity IM% Price = cost + margin
7(c) 2000-2007, I.P.L. Png & D.E. Lehman
Uniform Pricing: ShortcomingsShortcomings
leaves buyers with a lot of surplus
does not sell to every potential buyer
marginal cost
price
buyer surplus
potential buyers
$
0quantity
8(c) 2000-2007, I.P.L. Png & D.E. Lehman
OutlineOutline
uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling selecting the pricing policy
9(c) 2000-2007, I.P.L. Png & D.E. Lehman
Complete Price Discrimination
Price each unit at buyer’s benefit and sell quantity where MB = MC
maximum profit - theoretical idealdifferent from MR = MC
Implementation: must know entire marginal benefit and marginal cost curves
10(c) 2000-2007, I.P.L. Png & D.E. Lehman
Complete Price Discrimination: PracticePractice
auctions
11(c) 2000-2007, I.P.L. Png & D.E. Lehman
OutlineOutline
uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling selecting the pricing policy
12(c) 2000-2007, I.P.L. Png & D.E. Lehman
Direct Segment Discrimination
Price by segment
Implementationfixed identifiable characteristic - basic for
segmentationAge, gender, nationality, locationno re-sale
13(c) 2000-2007, I.P.L. Png & D.E. Lehman
Direct Segment Discrimination
simple case: uniform price within each segment
within each segment IM% = -1/efor segment with more elastic
demand, then lower incremental margin percentage (IM%)
14(c) 2000-2007, I.P.L. Png & D.E. Lehman
Direct Segment Discrimination
15(c) 2000-2007, I.P.L. Png & D.E. Lehman
Direct Segment Discrimination: “Not for “Not for Retail Sale”Retail Sale”
Heinz serves
• institutional customers (food service, restaurants) directly
• retail customers indirectly through supermarkets and grocery stores
16(c) 2000-2007, I.P.L. Png & D.E. Lehman
Internet Services
residential -- $30-50/month business – over $100/month
How is discrimination possible?
17(c) 2000-2007, I.P.L. Png & D.E. Lehman
Direct Segment Discrimination: LocationLocation
Free on board (FOB) price - does not include delivery
Cost including freight (CF) price - includes delivery
conventional productsdigital products
18(c) 2000-2007, I.P.L. Png & D.E. Lehman
Direct price discrimination: Gray Gray MarketsMarkets
Price differential parallel imports Retailers: Hong Kong music stores source
music CDs through parallel imports Consumers: 2 million U.S. consumers buy
drugs from Canadian pharmacies (on-line)
Managing the gray market packaging warranty service technical differentiation
19(c) 2000-2007, I.P.L. Png & D.E. Lehman
Asian Wall Street Journal
Price for annual subscription, May 2006
Print: Hong Kong (HK$ 2,700)
US$ 348
Print: Singapore (S$ 525)
US$ 331
Print: Tokyo (Yen 94,500)
US$ 845
Interactive: Worldwide US$ 99 Why different prices for print edition but not interactive edition?
20(c) 2000-2007, I.P.L. Png & D.E. Lehman
OutlineOutline
uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling selecting the pricing policy
21(c) 2000-2007, I.P.L. Png & D.E. Lehman
Indirect Segment Discrimination
Structure choice to earn different incremental margins from each segment
Implementation seller controls some variable to which
segments are differentially sensitive buyers cannot circumvent the variable
22(c) 2000-2007, I.P.L. Png & D.E. Lehman
Traveler
Segment
Unrestricted Travel ($)
Restricted Travel ($)
Maria Business 1000 200 Tom Business 900 180 Robin Vacation 500 400 Leslie Vacation 280 224
Air Travel: Air Travel: BenefitsBenefits
23(c) 2000-2007, I.P.L. Png & D.E. Lehman
Product
Fare ($)
Sales Total Rev. ($)
Total Cost ($)
Profit ($)
Unrestricted 900 2 1,800 400 1,400
Restricted 399 1 399 200 199
*MC=200
Air Travel: Air Travel: Indirect Segment Indirect Segment DiscriminationDiscrimination
24(c) 2000-2007, I.P.L. Png & D.E. Lehman
Profitability Policy Information Requirement
Highest Complete price discrimination
Highest
Direct segment discrimination
Indirect segment discrimination
Lowest Uniform pricing Lowest
Pricing Policies: RankingRanking
25(c) 2000-2007, I.P.L. Png & D.E. Lehman
Outline
uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling selecting the pricing policy
26(c) 2000-2007, I.P.L. Png & D.E. Lehman
Bundling
strategy pure bundling mixed bundling
implementation segments derive different benefits from
separate products negatively correlated preferences low marginal cost
27(c) 2000-2007, I.P.L. Png & D.E. Lehman
Cable Television: Cable Television: EXAMPLE EXAMPLE
Suppose a cable company provides two channels, educational and music. There are two types of customers. One likes education channel much more than music. The other has equal preference towards the two channels.
Suppose there are 4000 first type customers, 6000 second type customers.
Suppose the marginal cost of providing one channel service to one customer is zero.
Suppose the company has a fixed cost of 100,000.
28(c) 2000-2007, I.P.L. Png & D.E. Lehman
Cable Television: Cable Television: EXAMPLE EXAMPLE
“if every segment … was wild about one thing and hated the rest, they have done their job” (Economist) Segment Education
channel Music channel
Conservatives $20 $ 2
Middle of road $11 $11
29(c) 2000-2007, I.P.L. Png & D.E. Lehman
Pure or Mixed Bundling
What is the profit-maximizing pricing policy if marginal cost per channel = 5 Compared to the case where MC=5, now the company is better off with a mixed bundling strategy.
30(c) 2000-2007, I.P.L. Png & D.E. Lehman
Outline
uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling selecting the pricing policy
31(c) 2000-2007, I.P.L. Png & D.E. Lehman
Cannibalization
“ business travelers were contorting their schedules to .. qualify for fares with leisure travel restrictions”
Northwest VP Tom Bach degrade low-end item upgrade high-end item
32(c) 2000-2007, I.P.L. Png & D.E. Lehman
Cannibalization
Low-margin item draws customers away from higher-margin product.
Possible solutions: Limit availability of low-end item Separate distribution channels Product design
Degrade low-end itemUpgrade high-end item
What’s wrong with product design?
Audi A6
VW Passat
34(c) 2000-2007, I.P.L. Png & D.E. Lehman
Information technology
More discrimination more data on
buyers easier to
customize products
online auctions
More price competition (less discrimination) easier to
compare prices