1. P RICING P OLICY & S TRATEGIC T HINKING MBA NCCU Managerial Economics Jack Wu

2. P RICING P OLICY

3. C ASE : E MIRATES A IRLINE, D UBAI -M UMBAI, E CONOMY CLASS, M AY 2004 FareRestrictionsPrice Year KRTAE1NoneAED 2250 (US$ 613) Special Excursion QEE4MAE1 Min. 7 days, max. 4 mths stay AED 1900 Basic Season Special Excursion LLE4MAE1 Low season; min. 7 days, max. 4 mths stay AED 1550 Basic Season Special Excursion VLE4MAE1 Low season; min. 7 days, max. 4 mths stay AED 1200

4. E MIRATES A IRLINE, M UMBAI -D UBAI, E CONOMY CLASS, M AY 2004 FareRestrictionsPrice Economy unrestricted LRT NoneINR 25,600 (US$ 557) Economy restricted LRTIN1 NoneINR 22,700 Regular Excursion LEE3M1 Min. 7 days, max. 3 mths stay INR 20,100 Special Excursion VEE3MIN1 Max. 3 mths stay.INR 17,000

5. E MIRATES A IRLINE Why does Emirates charge lower fare for passengers originating from Mumbai? How is this discrimination possible?

6. P RICING P OLICY uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling

7. 0 30 55 80 25005000 marginal revenue marginal cost demand Quantity (Units a year) Price (Thousand Yen per unit) UNIFORM PRICING

8. U NIFORM P RICING : P ROFIT M AXIMUM 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

9. P RICE E LASTICITY 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

10. P RICING P RIVATE -L ABEL C OLA 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?

11. S HORTCOMINGS U NIFORM P RICING : S HORTCOMINGS leaves buyers with a lot of surplus does not sell to every potential buyer marginal cost price buyer surplus potential buyers $ 0 quantity

12. C OMPLETE P RICE D ISCRIMINATION 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

13. C OMPLETE P RICE D ISCRIMINATION : P RACTICE bargaining auctions

14. D IRECT S EGMENT D ISCRIMINATION, I price by segment implementation  fixed identifiable characteristic --- basic for segmentation  no re-sale

15. D IRECT S EGMENT D ISCRIMINATION, II 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. 0 30 55 80 25003000 Quantity (Units a year) Price (Thousand Yen per unit) (a) Men’s demand 0 30 50 Quantity (Units a year) Price (Thousand Yen per unit) (b) Women’s demand marginal revenue demand 40 1000 marginal revenue demand marginal cost DIRECT SEGMENT DISCRIMINATION, III marg. cost

17. NYNEX T ELEPHONE S ERVICE New York City residential -- $16/month business -- $23/month How is discrimination possible?

18. A SIAN W ALL S TREET J OURNAL 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?

19. I NDIRECT S EGMENT D ISCRIMINATION 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

20. AIR TRAVEL: BENEFITS

21. *MC=200 AIR TRAVEL: INDIRECT SEGMENT DISCRIMINATION

22. C HINESE E MBASSY : V ISA F EES Application period 1 day3 days7 days Single entry$75$60$25 Double entry$85$70$35

23. PRICING POLICIES: RANKING

24. B UNDLING strategy pure bundling mixed bundling

25. C ABLE T ELEVISION : B ENEFITS

26. P URE OR M IXED B UNDLING What is the profit-maximizing pricing policy if marginal cost per channel = 0 marginal cost per channel = $5

27. P URE OR M IXED B UNDLING Generally, if item is costless, no loss from giving it to every consumer --> pure bundling; if item is costly, then should avoid providing it to low-benefit users --> use mixed bundling to screen out low-benefit users. Mixed bundling is form of indirect segment discrimination structured choice between bundle and separates

28. S TRATEGIC T HINKING

29. Nov. 16: Coca-Cola raised price 7% Nov. 22: Pepsi raised price 6.9% “Coke and Pepsi will move now from price-based competition to marketing- based competition”, Andrew Conway, Morgan Stanley C ASE : C OKE VS. P EPSI, 1999

30. C OMPETITIVE D ILEMMA What should Coke do?

31. S TRATEGIC S ITUATIONS parties actively consider the interactions with one another in making decisions game theory -- set of ideas and principles to guide strategic thinking simultaneous actions: strategic form sequential actions: extensive form

32. D OMINATED S TRATEGY generates worse consequences than another strategy, regardless of the choices of the other parties never use dominated strategy

33. N ASH E QUILIBRIUM Given that the other players choose their Nash equilibrium strategies, each party prefers its own Nash equilibrium strategy No one is willing to deviate unilaterally from a Nash equilibrium

34. S OLVING FOR N ASH E QUILIBRIUM eliminate dominated strategies, then check remaining cells “ arrow ” technique

35. C OMPETITIVE DILEMMA N ASH EQUILIBRIUM : C OMPETITIVE DILEMMA Pepsi Raise priceDiscount Coke Raise price C: 3, P: 3 C: 0, P: 5 Discount C: 5, P: 0 C: 1, P: 1  What should Coke do?

36. C OKE AND P EPSI G AME Nash equilibrium: for both parties, “raise price” is dominated by “discount”. but discounting is bad for both -- if only they could agree somehow to raise price. Coke and Pepsi stuck in this situation for four years until November 1999.

37. P RISONERS ’ DILEMMA N ASH EQUILIBRIUM : P RISONERS ’ DILEMMA Sam Do not confessConfess Ian Do not confess I: 0, S: 0 I: -10, S: 0 Confess I: 0, S: -10 I: -5, S: -5  What should Sam do?

38. No Nash equilibrium in pure strategies WHERE TO ADVERTISE?

39. R ANDOMIZED S TRATEGIES choose among pure strategies according to probabilities must be unpredictable Example: where to advertise _ We.com: ½ NBA and ½ NHL _ Competitor.com: ½ NBA and ½ NHL

40. R ETAIL PRICE COMPETITION R ANDOMIZED STRATEGIES : R ETAIL PRICE COMPETITION Pricing trade-off: high price to extract buyer surplus of loyal customers low price to get store switchers Solution: randomized discounts

41. E VENING NEWS C OORDINATION / COMPETITION : E VENING NEWS Delta 7.30pm8.00pm Zeta 7.30pm A: 1, B: 1 A: 3, B: 4 8.00pm A: 4, B: 3 A: 2.5, B: 2.5

42. C OORDINATION AND C OMPETITION Prime time for news is 8:0pm; second best is 7:30pm; since audience is limited, get maximum viewership if two channels schedule at different times. Question: which station gets 8:0pm? Situation has elements of coordination -- avoiding same time slot competition -- getting the 8:0pm slot

43. Z ERO /P OSITIVE S UM zero-sum games: pure competition -- one party better off only if other is worse off positive-sum games: coordination -- both can be better off or both worse off co-opetition: competition and coordination

44. C OORDINATION / COMPETITION : F UTURE DVD STANDARD Consumers Blu-rayHD-DVD DVD player manuf- acturers Blu-ray M: 1, C: 1 M: -1, C: -1 HD-DVD M: -1, C: -1 M: 1, C: 1

45. F OCAL P OINT C OORDINATION /C OMPETITION : F OCAL P OINT Single Nash equilibrium - clear focal point Multiple Nash equilibria - look for focal point to see which one to play

46. S EQUENCING Game in extensive form – sequence of moves: nodes branches outcomes

47. E XTENSIVE F ORM : E QUILIBRIUM backward induction  final nodes  intermediate nodes  initial node

48. E XTENSIVE F ORM - TV N EWS S EQUENCING : E XTENSIVE F ORM - TV N EWS

49. S TRATEGIC M OVE Action to influence beliefs or actions of other parties in a favorable way credibility – first mover advantage – second mover advantage

50. E XAMPLES Examples: Evening TV news -- both stations want to move first: which one can? Use strategic move, eg, contracts with advertisers to deliver news at 8pm. Famous Chinese general: after crossing a river, burnt his ships -- strategic move to force soldiers to fight harder. Issue: Is the move credible? Will it convince the other players? Advantage doesn’t always go to first mover; In war, better to see opponent’s move, and then take action, eg is enemy moving south or north? new product category -- let competitor test the market and educate the customers

51. consumer Litho Make prints Do not Buy Do not Make more prints Do not (1) serial number (2) destroying the plate (3) other solution? L ITHOGRAPHER

52. C ONDITIONAL S TRATEGIC M OVES Threats – if it succeeds, then it needn’t be carried out Promises – if it succeeds, then it needn’t be carried out Ideal strategic move doesn’t impose costs

53. MORGAN STANLEY: “ SHAREHOLDER RIGHTS PLAN ” If any party acquires 10% or more of company ’ s shares, other shareholders get right to buy additional shares at 50% discount. Impact on hostile bidder?

54. S HAREHOLDER R IGHTS P LAN This shareholder rights plan is a threat to potential bidders: most hostile bidders begin with small stake; with shareholder rights plan, if bidder acquires more than 10%, then rights triggered, and bidder will be diluted. Nickname: poison pill. Actually works against shareholder rights -- by entrenching existing management.

55. Sharon Hilda acquires 100,000 shares doesn’t bid does not activates rights Hilda loses on initial stake + cost of takeover rises P OISON P ILL

56. Union Employer reject union demand accept do not strike Lose current wage and possibly gain in future wage Maintain current wage Why are strikes rare in American professional football? S TRIKE

57. C ONDITIONAL STRATEGIC MOVE : W ITHOUT DEPOSIT INSURANCE depositor maintains deposit withdraws deposit bank insolvent bank remains solvent principal + interest zero depositor principal bank remains solvent bank insolvent

58. C ONDITIONAL STRATEGIC MOVE : W ITH DEPOSIT INSURANCE depositor maintains deposit withdraws deposit bank insolvent bank remains solvent principal + interest principal depositor principal bank remains solvent bank insolvent