Pricing

2 (c) , I.P.L. Png & D.E. Lehman Outline  uniform pricing  complete price discrimination  direct segment discrimination  indirect segment discrimination  bundling  selecting the pricing policy

3 (c) , I.P.L. Png & D.E. Lehman

4 Uniform Pricing

5 (c) , I.P.L. Png & D.E. Lehman Profit Maximum Uniform Pricing: Profit Maximum  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

6 (c) , I.P.L. Png & D.E. Lehman Price Elasticity Uniform Pricing: Price Elasticity  always set price so that demand is elastic  if demand more elastic, then lower incremental margin percentage (IM%)  e = -2  IM% = 1/2  e = -1.5  IM% = 2/3

7 (c) , I.P.L. Png & D.E. Lehman Private-Label Cola Uniform Pricing: Private-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

8 (c) , I.P.L. Png & D.E. Lehman Shortcomings Uniform Pricing: Shortcomings  leaves buyers with a lot of surplus  does not sell to every potential buyer marginal cost price buyer surplus potential buyers $ 0 quantity

9 (c) , I.P.L. Png & D.E. Lehman Outline  uniform pricing  complete price discrimination  direct segment discrimination  indirect segment discrimination  bundling  selecting the pricing policy

10 (c) , 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 ideal  different from MR = MC  Implementation: must know entire marginal benefit and marginal cost curves

11 (c) , I.P.L. Png & D.E. Lehman

12 (c) , I.P.L. Png & D.E. Lehman Practice Complete Price Discrimination: Practice  auctions

13 (c) , I.P.L. Png & D.E. Lehman Outline  uniform pricing  complete price discrimination  direct segment discrimination  indirect segment discrimination  bundling  selecting the pricing policy

14 (c) , I.P.L. Png & D.E. Lehman Direct Segment Discrimination  Price by segment  Implementation  fixed identifiable characteristic - basic for segmentation  Age, gender, nationality, location  no re-sale

15 (c) , I.P.L. Png & D.E. Lehman Direct Segment Discrimination simple case: uniform price within each segment  within each segment IM% = -1/e  for segment with more elastic demand, then lower incremental margin percentage (IM%)

16 (c) , I.P.L. Png & D.E. Lehman Direct Segment Discrimination

17 (c) , I.P.L. Png & D.E. Lehman “Not for Retail Sale” Direct Segment Discrimination: “Not for Retail Sale” Heinz serves institutional customers (food service, restaurants) directly retail customers indirectly through supermarkets and grocery stores

18 (c) , I.P.L. Png & D.E. Lehman Internet Services  residential -- $30-50/month  business – over $100/month How is discrimination possible?

19 (c) , 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: WorldwideUS$ 99  Why different prices for print edition but not interactive edition?

20 (c) , I.P.L. Png & D.E. Lehman Location Direct Segment Discrimination: Location  Free on board (FOB) price - does not include delivery  Cost including freight (CF) price - includes delivery  conventional products  digital products

21 (c) , I.P.L. Png & D.E. Lehman Gray Markets Direct price discrimination: Gray Markets  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

22 (c) , I.P.L. Png & D.E. Lehman Outline  uniform pricing  complete price discrimination  direct segment discrimination  indirect segment discrimination  bundling  selecting the pricing policy

23 (c) , 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

24 (c) , I.P.L. Png & D.E. Lehman Air Travel: Benefits

25 (c) , I.P.L. Png & D.E. Lehman *MC=200 Air Travel: Indirect Segment Discrimination

26 (c) , I.P.L. Png & D.E. Lehman Ranking Pricing Policies: Ranking

27 (c) , I.P.L. Png & D.E. Lehman Outline  uniform pricing  complete price discrimination  direct segment discrimination  indirect segment discrimination  bundling  selecting the pricing policy

28 (c) , 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

29 (c) , I.P.L. Png & D.E. Lehman 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.

30 (c) , I.P.L. Png & D.E. Lehman Cable Television: EXAMPLE

31 (c) , 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=0, now the company is better off with a mixed bundling strategy.

32 (c) , I.P.L. Png & D.E. Lehman Outline  uniform pricing  complete price discrimination  direct segment discrimination  indirect segment discrimination  bundling  selecting the pricing policy

33 (c) , 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

34 (c) , 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 item  Upgrade high-end item

 What’s wrong with product design? Audi A6 VW Passat

36 (c) , I.P.L. Png & D.E. Lehman Information technology  More discrimination  more data on buyers  easier to customize products customize products  online auctions online auctions  More price competition (less discrimination)  easier to compare prices compare