pricing. 2 (c) 2000-2007, i.p.l. png & d.e. lehman outline uniform pricing complete price...

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