1. CHAPTER 15
Pricing
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2. What Price? Business strategies Pricing
Cutting costs, Introducing new products
Divesting or merging
Price strategy (pricing)
Pricing
Considered extremely important
Small percentage of firms do any serious pricing research
One-third don’t know what to do with the results once they have them
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3. Marginal Revenue and Marginal Cost
Fundamental approach to pricing
Find the quantity where MR = MC
Set price according to demand
Complications
More than one product; Attract competitors
Different customer niches; Rivals’ response
Perception of the quality of the product
Technology
Enabling firms to be much more precise about their pricing
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4. Personalized Pricing Consumer surplus Personalized pricing
Difference between consumers’ willingness to pay for a good and the market price
Personalized pricing
Firms - getting more of the consumer surplus
Selling identical goods at different prices
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5. Figure 15.1 Consumer Surplus
The market price for a good or service is illustrated as P1. Consumers would be willing and able to pay more for the good or service, as pointed out by the demand curve above the market price. The area ABC is the consumer surplus
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6. Figure 15.2 Pricing with Market Power
A firm with market power charges a higher price and sells a lower quantity than the perfectly competitive or commodity firm. Consumer surplus is reduced from ABC to ADE.
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7. Personalized Pricing Perfect price discrimination
Each customer is sold the product at a different price
Third-degree price discrimination
Groups of customers with similar price elasticities of demand
Each group pays a different price for the identical product
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8. Personalized Pricing Second-degree price discrimination
Firm - not able to identify the value each consumer places on each unit of the good
Firm - able to group multiple units of the good
Charge different prices for the different groups
Quantity discounts
Single / uniform price
Every customer pays the same price
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9. Self-Selection: Product-Line Extension
Similar to price discrimination
Firm is not able to easily distinguish the customers
A new product is introduced so as to induce the customers to self-select
And pay different prices for essentially the same product
Price setting where MR = MC
For each of the products
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10. Peak-Load Pricing Peak-load pricing strategy
A form of price discrimination
Customers purchasing the product at peak times pay a higher price
Than customers purchasing the product at off-peak times
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11. Business Insight Peak-Load Pricing at the Movies
Makes sense when there are large lines
Raise the price during popular times
Cut the price during off-times
Businesses
Reluctant to adopt peak-load pricing
Customers: “unfair”
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12. Business Insight Peak-Load Pricing at the Movies
Movie theaters - peak-load pricing
Expensive evening shows
Cheap matinees
Crowds are bigger in the evenings
Weekend matinees - a lot more crowded than weekday evenings
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13. Cost-Plus Pricing Cost-plus pricing Full-cost pricing, markup pricing
Firm estimates the per-unit cost of producing and selling the product
Firm adds a markup to the estimated cost
Include certain costs that cannot be attributed to any specific product
Provide a return to the firm’s investment
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14. Cost-Plus Pricing Price: P = (average cost)(1 + markup)
markup is a percentage
Cost-plus pricing rule
Will be the profit-maximizing strategy
Only if marginal cost rather than average cost is used
And if the markup = [1/(1 − 1/e)] − 1
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15. Framing The context Odd pricing
In which a choice is presented is important to the decision maker
Will affect the price elasticity of demand
Perceptions matter
Odd pricing
Specifying the rightmost digits in the price in amounts that are less than the higher even price
Gain – relative to the reference price
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16. Framing Price elasticity of demand can be changed Made less elastic
If consumers feel like they own the product
Buyers want to retain the status quo
To keep the assets they already own
The purchase decision can be influenced
By having the buyers assume ownership
Even temporarily, prior to purchase
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17. More Complexities Pure bundling Bundle together two goods
The only way the goods can be purchased is as a package
Higher profit than selling the goods individually
Does not discriminate among the customer segments
All customers pay the same price
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18. More Complexities Mixed bundling Tying
Buyers have a choice between the bundle and the individual products
Higher profit than selling only the bundle
Tying
A form of bundling
Any requirement that products be bought or sold in some combination
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19. More Complexities Cannibalization Multiple products
Sales of one product produced by a firm reduce the demand for another product produced by that same firm
Multiple products
Profit-maximizing strategy for firms with multiple products:
For each product: MRi = MC for all i
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20. More Complexities Joint products
Products that are interdependent in the production process
A change in the production of one causes a change in the cost or availability of the other
Two demand curves
Both products share a common marginal cost curve
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21. More Complexities Joint products Could be linked
Bi-products (complements in production)
Produced by the same inputs (substitutes in production)
Fixed or variable proportions
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22. Interdependencies among Firms
Pricing strategies
Used by firms that have market power
Used by firms whose behavior does not depend on the behavior of rivals
Independent
Most markets
Firms are interdependent
Price wars
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23. Prisoner’s Dilemma Dilemma Office Max and Staples
Strategies: high or low price
Solution: both select the lower price
Lower revenues than if both would choose the higher price
Could get out of this dilemma and increase profits by cooperating
Problem: illegal to “fix” prices
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24. Figure 15.3
Price War
Office Max finds that a lower price is its best choice no matter what Staples does. Staples similarly finds that the lower price is its best choice as well.
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25. Prisoner’s Dilemma Meet the competition clause
Firm - has the option to meet any offer the customer receives from a rival firm
Reduces the incentive for one firm to attempt to steal customers from another
Most favored customer clause
Ensures the customer that he or she will get the best price the company gives to anyone
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26. Competing on Other Than Price
Differentiation
The product
The company
Price competition
Typically leads to commoditization
Zero economic profits
A firm is better off
If it is able to differentiate itself or its products
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