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电子商务Lecture07 - Pricing


Pricing, Bundling and Location Decisions: A primer
Jifeng Luo Antai College of Management, SJTU jifengluo@gmail.com

Outline
Pricing
? Reservation price, consumer surplus ? Reference price

? Monopoly pricing
? Price discrimination

Bundling
? Concepts underlying bundling

Reservation price and CS
Reservation price (RP) and consumer surplus
? Maximum price a consumer is willing to pay for another unit of the product or service ? e.g., suppose a buyer has a RP of $5 for a bag of sugar. We sell her a bag for $3. What is her consumer surplus? ? Let’s say that the consumer could buy either a bag of salt or sugar. Her RP for salt is $4 and her RP for sugar is $5. Sugar is sold at $3 and Salt is sold at $3.50. Which would she buy?

Implications

Ways to compete are to reduce price or increase RP
? Add value in a cost effective way ? We will see how the latter can be accomplished

Outline
Pricing
? Reservation price, consumer surplus ? Reference price

? Monopoly pricing
? Price discrimination

Bundling
? Concepts underlying bundling

Some lessons from psychology
Buyers rely on an expectation of what seems to be a reasonable price. This is referred to as a reference price. Advertising and framing can affect this reference price. Here are some important examples
The unique value effect
? The more unique the product or service, lower the price sensitivity and higher the price that can be charged.

? Can you think of an example? ? Other examples? Relationship to brand equity?

Reference Price: Continued

The substitute awareness effect
? The greater the number of substitutes the customer is aware of, the greater the price sensitivity

? Relationship between knowledge of substitutes and search costs
? What role do shopbots play in reducing search costs?

Increased Customer Information

Reference Price: Continued

The difficult comparison effect
? The more difficult it is to compare options, the less the role of price in the decision ? How does this apply to Cell Phone plans? ? How does this apply to luxury cars? ? Attributes that are non-standard other than price?

Summary from psychological studies

Rather than let buyers set their own reference price, set it for them (e.g., suggested retail price or MSRP with cars).
Suggest the comparisons the buyer should be making

The concept of a fair price is based on cost to produce. Sellers try to justify their price in terms of their cost

Internet Market Characteristics

“The Internet is a nearly perfect market because information is instantaneous and buyers can compare the offerings of sellers worldwide. The result is fierce price competition, dwindling product differentiation, and vanishing brand loyalty.” — Robert Kuttner, Business Week 1988

Why is Price Transparency Bad?

Cuts margins
Commoditizes product Weakens customer loyalty to brands Create impression of price unfairness

How to Combat Price Transparency

Innovate
Price discriminate Smart pricing
? Vary prices by market

Bundle products with other goods and services

Outline
Pricing
? Reservation price, consumer surplus ? Reference price

? Monopoly pricing
? Price discrimination

Bundling
? Concepts underlying bundling

Maximizing Revenues: Monopoly Pricing

?

Firm estimates demand curve , sets price to maximize profits a) Some consumers get product at a lower price than their WTP c) Firm prices out some consumers who could buy the product and increase the firm’s profits
High q Low q

?

?

Outline
Pricing
? Reservation price, consumer surplus ? Reference price

? Monopoly pricing
? Price discrimination

Bundling
? Concepts underlying bundling

Price Discrimination: an example
Let the demand for a product be described by D(p) = 9 – p. MC for producing a unit is $1. Let there be customers with RP’s of 8, 7, 6 and so on The monopoly price that maximizes profits $5
? How? Profit at that price is $16.

However, if the monopoly charged a different price to each customer. Say $7 to the customer with RP of $8, $6 to a customer with RP of $7 and so on till the buyer with a RP of $2. Profit is now 6 + 5 + 4 + 3 + 1 = $19

Types of price discrimination?
Selling different units of output at different prices The case of monopoly pricing
? First degree price discrimination

? Units sold at different prices based on knowing the RP of the buyers. Prices vary from person to person ? Difficult to implement in practice
? Second degree price discrimination

? The firm does not know each individual’s RP but identifies it imperfectly though a form of self selection. The firm offers different package of goods and the buyers choose, in doing so they reveal something about their RP’s. ? E.g.,airline ticket pricing
? Third degree price discrimination

? Involves the use of a customer signal (age, occupation, elasticity of demand) to price discriminate arbitrary ? E.g., Senior citizen discounts

Price Discrimination

Firm sells product to different consumers at different prices

Strategy: Set Price Close to consumer’s Willingness-to-pay Price discrimination Improves profits

First-degree Price Discrimination

When firm can identify each consumer's WTP, it can offer a unique price (= WTP) to each consumer having WTP > MC.
? All consumers with WTP > MC buy the product, firm can extract all the consumer surplus ? Hard to implement, but easier on the Internet

? Auctions ? Dynamic pricing based on individual purchase behavior

Third-degree Price Discrimination

When consumers fall into groups (e.g., child/ youth/ adult) that can be observed by the firm, it can offer a different price to each group
? Requires that groups can be directly addressed and isolated (no resale). ? Often implemented by geographical location

? Many software products sold to academic and business users, or student vs. professional ? Internet makes it difficult to isolate groups by geography

Third degree Price discrimination example

P

P Professional users Academic users pH*

Professional users

P*

=
Q P

Q Overall demand curve Academic users

+
Assume zero marginal costs pL* Q

Second-degree Price discrimination

When firm knows the consumers' WTP only in aggregate, it can offer quality-differentiated products at different prices, inducing consumers to self-select. Versioning: For information goods (text, multimedia content, software, remote computation service), create multiple versions of the good, varying some product feature Windows NT vs. 98; Saturday night stay tickets

Product differentiation
Vertical differentiation: When product versions are ordered on quality, one version is universally accepted to be better than another
? Quicken: Basic and Deluxe version
? iMac: 300MHz G3 vs. 400 MHz G4 processor

Horizontal differentiation: When product versions are not comparable on quality
? iMac: tangerine vs. lime colors

2nd-degree Price Discrimination Example - Versioning (adapted from Varian)

Value-Based Pricing

Don’t need to price by identity
Offer product line, and watch choices Design menu of different versions
? Target different market segments ? Price accordingly (self selection)

Quicken Example

Quicken for Windows at $20
Quicken Deluxe at $60

Example

40 type As: $100 for speed, $40 for slow
60 type Bs: $50 for speed, $30 for slow Identity-based pricing: $7000 revenues Offer only speedy:
? $50 is best price, revenues=$5,000

Offer only slow: best price =?? revenues = ??
Offer both: best prices=?? revenues=??
Assumption: 1. zero marginal cost 2. When p=r, consumers choose to purchase

Making Self-Selection Work

May need to cut price of high end May need to cut quality at low end Value-subtracted versions
? May cost more to produce the low-quality version.

In design, make sure you can turn features off! Windows Basic/Home Edition/Profession

How Many Versions?

One is too few
Ten is (probably) too many So how many Two things to do
? Analyze market

? Analyze product

Analyze Your Market

Does it naturally subdivide into different categories? AND
Are their behaviors sufficiently different? Example: Airlines
? Tourists v. Business travelers

Analyze Your Product

Dimensions to version
High and low end for each dimension Design for high end, reduce quality for low end Low end advertises for high end

Dimensions to Use

Product Dimension Delay User interface Convenience

Users/Uses User impatience (Fedex, Stock Quote) Novice/Experienced (DialogWeb,
DataStar)

Daily/Weekly rental

Image resolution
Speed of operation

Newsletter/Glossy (picturedisk)
Slow/Fast (Mathematica)

Dimensions to Use
Product Dimension Format Capability Features Comprehensiveness Users/Uses Raw/Organized (Lexis/Nexis) Special use (Voice recognition) Additional functions (Quicken, tech
support)

Depth of information

Annoyance
Support

Hi price, no ads
Hi/Lo

Goldilocks Pricing

Default choice: 3 versions Extremeness aversion Small/large v. small/large/jumbo

If you don’t believe me, we can do a game.

Microwave Oven Example

Bargain basement at $109, midrange at $179
? Midrange chosen 45% of time

High-end at $199 added
? Mid-range chosen 60% of time

Wines
? Second-lowest price

Outline
Pricing
? Reservation price, consumer surplus ? Reference price

? Monopoly pricing
? Price discrimination

Bundling
? Concepts underlying bundling

Bundling
Consider the following example Two classes of consumers Software suite consisting of a word processor and a spreadsheet Type A WTP -- $ 120 for WP, $100 for SS Type B WTP -- $100 for WP, $120 for SS Lets say you have to sell this product Assumption: WTP for a bundle is the sum of the WTP for the components Assumption: Goal is to maximize revenue, marginal cost is negligible What would you do?

Bundling Example
Type of Consumer
Type A consumer Type B consumer

Word Processor
120

Spreadsheet

100

100

120

Bundling

Offer a package
? Microsoft Office; 90% market share

Work together

Discount one of the products
Option value: zero incremental price Microsoft's per-processor license

Reduce Dispersion

Example: price separate or together
Mark: $120 for WP, $100 for spreadsheet Noah: $100 for WP, $120 for spreadsheet Profits
? Without bundling: $400

? With bundling: $440

Unbundling

The Internet make it easier to bundle as well as unbundle.
? Take advantage of extreme dispersion in WTP ? E.g. unbundle the whole music album into individual songs ? Unbundling is hard in physical world since selling each song separately would be costly for music maker ? The Internet provides a channel for unbundling

Rebundling

Unbundle CDs into songs and rebundle favorite songs from different CDs into one package to a consumer

Lessons

Version your product
? Delay, interface, resolution, speed, etc.

Add value to online information Use natural segments, otherwise use 3 Control the browser Bundling may reduce dispersion Unbundling to take advantage of large dispersion

Penetration Pricing
Pricing below cost Penetration pricing is a common tactic to build an installed base. Discounting to attract large, visible, or influential customers is virtually unavoidable in a standard war In some cases, especially for software with a zero marginal cost, you can go beyond free samples and actually pay people to take your product. There is nothing special about zero as a price, as long as you have multiple revenue streams to recover costs. E.g. Firefox

Survival Pricing
When the firm finds itself falling behind in a network industry, it is tempting to cut price in order to spur sales, a tactic we call survival pricing. The temptation should be resisted. Survival pricing is unlikely to work. It shows weakness. The problem is that the purchase price of software is minor in comparison with the costs of deployment, training, and support. Corporate purchasers, and even individual consumers, were much more worried about picking the winner


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