Innovative Two-Part Pricing Example: Kodak s first line of printers 9. Pricing Strategy 2 Shan-Yu Chou 1 Shan-Yu Chou 2 Outline 3C: Cost, Consumers and Competition Break-Even Analysis Segmented Pricing Competitive Pricing (Game-theoretic approach) E-Pricing Pricing Strategies 3C: Cost, Consumers and Competition Three Approaches Cost-Based Pricing Competition-Based Pricing Value-Based Pricing Game-theoretic approach Customized Pricing Shan-Yu Chou 3 Shan-Yu Chou 4 1
Strategic Issues Product life cycle Product positioning Functional, Image or Experiential brands? Product portfolio Differentiation of products Network externality New Product Pricing Skimming or Penetration Pricing Inelastic Demand Segments with different price sensitivity Capacity Constraint Threat of entry Shan-Yu Chou 5 Shan-Yu Chou 6 Break-Even Analysis( Cost) Contribution Margin Ratio Break-Even Quantity Example 1 Q 1 =4800, p 1 =$250, vc=$112.50 What is the break-even quantity if we cut price 5%? What if an equipment with cost $15,000 has to be purchased for Q>5,000? Should we cut our price 5% if E=-2.6? Shan-Yu Chou 7 Shan-Yu Chou 8 2
Example 2 Netflix Competitive Pricing Previously, $9.99 per month for DVD-bymail plus streaming. Now $15.98 per month (60% increase), a combination of an existing $7.99-a-month streaming-only plan with a new $7.99-amonth DVD-only plan. Assume average variable costs per customer are $3.50 per month, which do not change with the price increase. Current Price=p 1, Current Quantity=Q 1 What if your competitor lowers his price to p 2 (p 2 <p 1 )? Suppose price-matching allows you to maintain Q 1 while not-matching will reduce your quantity sold to Q 2. Should you match his price or not? Shan-Yu Chou 9 Shan-Yu Chou 10 Segmented Pricing (Consumers) Third-degree Price Discrimination Product Line Pricing Bundle Pricing Volume Pricing Promotion Pricing Third-degree Price Discrimination MR 1 =MR 2 =MC Demand Elasticity E p1 =-2, E p2 =-4, P 1 =$1.5, P 2 =? Shan-Yu Chou 11 Shan-Yu Chou 12 3
Third-Degree Price Discrimination Two Segments for Movies: A and B. The Capacity constraint=4, v.c.=1. Suppose that a movie is so popular that all tickets will be sold out by serving B only. Should the firm offer discount tickets to A? Consumer Valuation Segment A r.p. Segment B r.p. Consumer 1 6 Consumer 5 12 Consumer 2 7 Consumer 6 14 Consumer 3 8 Consumer 7 16 Consumer 4 10 Consumer 8 18 Shan-Yu Chou 13 Shan-Yu Chou 14 Uniform Pricing: What would be the optimal price? P=12, Q=4; Π=44 < 48. Optimal Pricing Segmented Pricing: What would be the the high price and the promotional price? P H =14, Q H =3; P L =10, Q L =1; Π=48=13*3+9*1. Bundle Pricing Pure Bundling Strategy (P B ) Pure Component Strategy (P 1, P 2 ) Mixed Bundling Strategy (P 1, P 2, P B ) Shan-Yu Chou 15 Shan-Yu Chou 16 4
Example 1 Example 2 Theater A Theater B Theater A Theater B Movie 1 12 10 Movie 1 12 10 Movie 2 3 4 Movie 2 4 3 Total 15 14 Total 16 13 Shan-Yu Chou 17 Shan-Yu Chou 18 Example 3 Consumer Product 1 Product 2 Total A 10 90 100 B 40 60 100 C 60 40 100 D 90 10 100 Cost 30 30 60 Example 4 Consumer Product 1 Product 2 Total A 10 90 100 B 50 70 120 C 70 50 120 D 90 10 100 Cost 30 30 60 Shan-Yu Chou 19 Shan-Yu Chou 20 5
Example 5 Consumer Product 1 Product 2 Total A 20 100 120 B 40 60 100 C 60 40 100 D 100 20 120 Quantity Discount Two Part Tariff T=F+PQ F: Fixed Fee P: Variable Price Volume Pricing Cost 30 30 60 Shan-Yu Chou 21 Shan-Yu Chou 22 Promotion Pricing Everyday low price (EDLP) or high-low promotional pricing? Theories of Price Promotion Inventory Cost Transference Demand Uncertainty Price Discrimination Competitive Strategy Prisoner s Dilemma Segments (proportion) Raising Prices in Hot Weather? Valuations in cold weather Valuations in hot weather Highs (α) 2 (=V H ) 2.8 (=V H + ) Lows (1-α) 1 (=V L ) 1.8 (=V L + ) If α=0.6, what would be the optimal prices for hot weather and for cold weather? Must the price in hot weather be higher? Shan-Yu Chou Shan-Yu Chou 23 24 Segmented Pricing Shan-Yu Chou 24 6
Source: W. Baker et al., Pricing Smarter on the Net, Harvard Business Review, 2001(Feb.):122-127. The Reality of E-Pricing Transparency Efficiency Easy for price comparison and behavior tracking. The Reality of E-Pricing (Cont.) Most on-line buyers actually shop around very little; Price is not the main consideration for corporate buyers. Shan-Yu Chou 25 Shan-Yu Chou 26 Profiting from E-Pricing Customized Pricing Precision e.g., Amazon s price experiments Adaptability e.g., e-bay and Priceline Segmentation e.g., Ford s segment-specific pricing and promotion Shan-Yu Chou 27 Segments Valuation Proportion Highs 2 (=V H ) α Lows 1 (=V L ) 1-α Assume a monopolist sells a product to consumers in two periods. What are the optimal uniform prices (if α=0.4)? What are the optimal prices if the firm can condition its prices on purchase history? Is it more profitable than otherwise? Shan-Yu Chou 28 7
Uniform Pricing When 0.4, the firm will serve two segments in two periods by setting price at V L =1 because 2V L 2=2 αv H =1.6. Profit Π u = 2V L =2. In general, under uniform pricing, Π u =max (2V L, 2αV H )= 2V L, if and only if V / V L H. Shan-Yu Chou 29 Price Conditioning with All Myopic Consumers Assume consumers do not recognize the price they face on the next purchase may depend on their behavior today. P 1 =V H =2 P 2 =V L =1 for those who do not purchase; P 2 =V H =2 for those who purchase. Π c =2αV H +(1-α)V L =1.6+0.6=2.2>2. Shan-Yu Chou 30 Is Price Conditioning always Profitable with Myopic Consumers? Π c =2αV H +(1-α)V L 2V L =Π u iff What if Price Conditioning with All strategic consumers* At the second period, If no cookie P 0 ; If the cookie indicating that they bought on a prior visit P b ; If the cookie indicating that they did not buy on a prior visit P n. *Supplemental notes Shan-Yu Chou 31 Shan-Yu Chou 32 8
Is Pricing Conditioning Profitable? (when consumers are all strategic)* Check the following pricing plan: P 0 =V H ; P n =V L ; P b = V H -(V H V L ) The firm s profit under price conditioning: Π c = V L + αv H, which is less than Π u =Max (2 V L, 2αV H ). Why? Shan-Yu Chou 33 Personalized Services** What if the marketer provide personalized services to highs and lows when they repeat purchase? Suppose the personalized services raise highs valuation to 3 (V H2 ) and lows to 1.1 (V L2 ). What would be the optimal customized prices? Is price conditioning profitable? Shan-Yu Chou 34 When will Price Conditioning be Profitable? (Cont.)** Π c = V L1 + αv H2 Π u =Max (V L1 + V L2, α(v H 1 +V H 2 )) only if **For your reference only. Shan-Yu Chou 35 9