Pricing Outline u uniform pricing u complete price

Pricing

Outline u uniform pricing u complete price discrimination u direct segment discrimination u indirect segment discrimination u bundling u selecting the pricing policy 2

Uniform Pricing 3

Uniform Pricing: Profit Maximum u MR = MC u Equivalently, set the incremental margin percentage equal to the inverse of absolute value of price elasticity of demand, (price - MC) / price = -1/e 4

Uniform Pricing: Price Elasticity u always set price so that demand is elastic u if demand more elastic, then lower incremental margin percentage (IM%) w e = -2 IM% = 1/2 w e = -1. 5 IM% = 2/3 5

Uniform Pricing: Private-Label Cola u Suppose that Wal. Mart learns that demand for private-label cola is less elastic than the demand for Coca Cola. w Should Wal. Mart set a higher price for private-label cola? w Elasticity IM% w Price = cost + margin 6

Uniform Pricing: Shortcomings $ buyer surplus u leaves buyers with a lot of surplus u does not sell to every potential buyers price marginal cost 0 quantity 7

Outline u uniform pricing u complete price discrimination u direct segment discrimination u indirect segment discrimination u bundling u selecting the pricing policy 8

Complete Price Discrimination u Price each unit at buyer’s benefit and sell quantity where MB = MC w w maximum profit - theoretical ideal different from MR = MC u Implementation: must know entire marginal benefit and marginal cost curves 9

Complete Price Discrimination: Practice u auctions 10

Outline u uniform pricing u complete price discrimination u direct segment discrimination u indirect segment discrimination u bundling u selecting the pricing policy 11

Direct Segment Discrimination u Price by segment u Implementation w w w fixed identifiable characteristic - basic for segmentation Age, gender, nationality, location no re-sale 12

Direct Segment Discrimination simple case: uniform price within each segment w within each segment IM% = -1/e w for segment with more elastic demand, then lower incremental margin percentage (IM%) 13

Direct Segment Discrimination 14

Direct Segment Discrimination: “Not for Retail Sale” Heinz serves • institutional customers (food service, restaurants) directly • retail customers indirectly through supermarkets and grocery stores 15

Internet Services u residential -- $30 -50/month u business – over $100/month How is discrimination possible? 16

Direct Segment Discrimination: Location u Free on board (FOB) price - does not u Cost including freight (CF) price - includes include delivery w w conventional products digital products 17

Direct price discrimination: Gray Markets u Price differential parallel imports w w u 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 w w w packaging warranty service technical differentiation 18

Asian Wall Street Journal Price for annual subscription, May 2006 Print: Hong Kong (HK$ 2, 700) Print: Singapore (S$ 525) US$ 348 Print: Tokyo (Yen 94, 500) US$ 845 Interactive: Worldwide US$ 99 US$ 331 u Why different prices for print edition but not interactive edition? 19

Outline u uniform pricing u complete price discrimination u direct segment discrimination u indirect segment discrimination u bundling u selecting the pricing policy 20

Indirect Segment Discrimination u Structure choice to earn different incremental margins from each segment u Implementation w w seller controls some variable to which segments are differentially sensitive buyers cannot circumvent the variable 21

Air Travel: Benefits 22

Air Travel: Indirect Segment Discrimination *MC=200 23

Pricing Policies: Ranking 24

Outline u uniform pricing u complete price discrimination u direct segment discrimination u indirect segment discrimination u bundling u selecting the pricing policy 25

Bundling u strategy w w pure bundling mixed bundling u implementation w w w segments derive different benefits from separate products negatively correlated preferences low marginal cost 26

Cable Television: 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. 27

Cable Television: EXAMPLE 28

Pure or Mixed Bundling What is the profit-maximizing pricing policy if u marginal cost per channel = 5 u. Compared to the case where MC=5, now the company is better off with a mixed bundling strategy. 29

Outline u uniform pricing u complete price discrimination u direct segment discrimination u indirect segment discrimination u bundling u selecting the pricing policy 30

Cannibalization “business travelers were contorting their schedules to. . qualify for fares with leisure travel restrictions” Northwest VP Tom Bach w w degrade low-end item upgrade high-end item 31

Cannibalization u Low-margin item draws customers away from higher-margin product. u Possible solutions: w w w Limit availability of low-end item Separate distribution channels Product design w w Degrade low-end item Upgrade high-end item 32

VW Passat Audi A 6 What’s wrong with product design?

Information technology u More discrimination w w w more data on buyers easier to customize products online auctions u More price competition (less discrimination) w easier to compare prices 34