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Executive MBA Program : Corporate Economics 752

Executive MBA Program : Corporate Economics 752. Hand in your essay on behavioral economics in your life & times today please. Price Discrimination – is when pricing similar items differently. BOGO Early bird specials Super saver pricing Revenue Management

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Executive MBA Program : Corporate Economics 752

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  1. Executive MBA Program:Corporate Economics 752 Hand in your essay on behavioral economics in your life & times today please. Price Discrimination– is when pricing similar items differently. • BOGO • Early bird specials • Super saver pricing • Revenue Management • Marketers and firm managers use price gimmicks to increase revenue. • Some price discrimination injures competition and is illegal. Others do not.

  2. The Great Electrical Machinery Conspiracy • US v. General Electric et al., F. Supp. 197 (1961) • 29 corporation were successfully prosecuted for price fixing of transformers, generators, switchgears, and other electrical equipment • Three big firms, Allis-Chalmers, Westinghouse, and GE were involved in heavy equipment sold to the government’s Tennessee Valley Authority. • A subpoena of ITE Circuit Breaker Company landed the Justice department with documents on the Phases of the Moon Pricing used on bids • 7 Defendants went to jail for 30 days and firms had to pay $2 million, and also 1,900 civil suits of over $400 million. • Our own Allis Chalmers was never quite the same again.

  3. Dirty Helen’s Bar • To avoid detection the conspirators used only first names, called from pay phones, and met at Dirty Helen’s Bar. • Dirty Helen (a.k.a. Helen Cromwell) had a bar at the Sunflower Inn in Milwaukee that was frequented in the 30’s, 40’s and 50’s by gangsters, millionaires, society, famous sportsmen and just plain people.  • With no furniture to speak of guests plopped down on the plushly carpeted floor sipping one of two options: House of Lords Scotch or Old Fitzgerald Bourbon.  • Secret meetings, however, don’t always stay secret. Dirty Helen: A Zany, Wonderful, Unconventional Ex-Madam and Tavern-Keeper Tells of Her Adventures, the Fascinating People She Has Known and the Exploits That Make Her a Living Legend by Helen Cromwell, 1966

  4. Pricing Strategies for the FirmChapter 10 Segmentationa.k.aPrice Discrimination Economic PD vs Illegal Price Discrimination different prices to enhance profits vs different prices to destroy competitors as in predatory price cutting First, Second, & Third Degree Price Discrimation

  5. Price Discrimination: Economic Definition • Price Discrimination • Goods which are NOT priced in proportion to their marginal cost, even though technically similar • Necessary Conditions: • 1. Some Monopoly Power • In Perfect Competition, P = MC • 2. Ability to Arbitrage • Separate Customers and Prevent Reselling

  6. Arbitrage - Buy Cheap to Sell Dear • Arbitrage of Goodsis Very Easy • Hard to be effective with price discrimination • Arbitrage of Services is Very Difficult • Easy to price discriminate • Many Ways to Separate Customers: 1. Geography 2. Income 3. Gender 4. Age 5. Time 6. Race 7. Language 8. Transient/Resident 9. Salesperson 10. Ability to Haggle

  7. Coupons Rebates Professionals with multiple locations Ticketron vs. Tickets at the theater box office Renaissance Faire tickets vs. buying them at a grocery store Standby airline tickets Twilight movie tickets Volume discounts Pricing of daily car rentals with per mileage charges Bundling of orchestra tickets vs. separately Premium gas vs.regular gas, though difference in cost is tiny Alcoa cable vs. sheet aluminum Many, Many Examples

  8. In Simple Monopoly, there is only one price Consumers receive a consumer surplus But in Price Discrimination, monopolists can SCOOP OUTallconsumer surplus Why Price Discriminate? MC Simple Monopoly CS PSM D QSM Q

  9. Charge the MOST that a person is willing to pay for each good Consumer Surplus is Zero Produce MORE than in Simple Monopoly Output the same as in Perfect Competition First Degree Price Discrimination:perfect price discrimination Price Discriminating Monopoly MC D Q Different Prices for Each Unit Q1st

  10. Car Sales as Perfect Price Discrimination Ahh, that is $16,663 for 60 months at our 3.08% financing, plus $2,000 = $18,663 “How much do you plan to pay a month?” you inadvertently reply: $300 per month, and Ihave $2,000 down payment! Here’s one for only $18,600. It’s swell. Incentivesto Understate True Willingness to Pay

  11. What happens if you start to bleed from a nasty cut? • Go to the Norris Health Center or an emergency room at Columbia St. Mary’s • What is the first question they ask? • Is health care a product or a service? • Would expect to see price discrimination?

  12. Second DegreePrice Discrimination (7 types) Units are Grouped All or Nothing Price Discrimination • Buy a group of items, but CANNOT buy them individually • Four Light Bulbs, but not individual bulbs • Candy bars in Movie Theaters -- large size 1. Not permitted to bring FOOD into a movie theater: Why?

  13. Willing to pay $2.20 for a 4-once chocolate bar At 50¢ per ounce, would buy only 2 bars All or Nothinggets one off of the demand curve at, say, $2.00 for a 4-ounce bar Demand for Ounces of Chocolate all or nothing 50¢ 90¢ 60¢ 40¢ 30¢ 12 34 Oz.

  14. 2. Two-Part Pricing:Another 2nd Degree Form • A price for the privilege of buying items • PLUS a price per item • Examples: • Country Club Dues and Greens Fees • Cover Charge to Enter and a Price Per Drink Cover Charge MC Q

  15. If P = 4.50 - Q and MC = .50Find Optimal Cover Charge Monopoly: QM = 2 & PM = 2.50 Note: MR = 4.5 – 2Q = .50, so 2Q = 2, or Q = 2 and P = 4.50 – 2 = $2.5 • At P = $.50, he/she buys 4 beer mugs • Biggest cover charge is the area of a triangle • Height is 4 • Base is 4 • (1/2)Height•Base • Max cover charge is $8.00 $4.50 PM Cover Charge $8.00 $.50 Q 4 QM

  16. 3. Declining Block Pricing • Price declines as the quantity purchased increased • Examples: • TJ Maxx, second pair half price • telephone charges • foreign film festivals • Price declines similar to the demand curve D P Q

  17. 4. Declining Block Pricing Over Time • Price declines over time • Often called “Price Skimming.” • Those in the avantgardewish to get it first, others are willing to wait • Examples: • Hardcover & Paperback Books • Electrical & Computer Products P D TIME

  18. Second Degree Price Discrimination: 5. Bundling Time Warner could offer the History Channel (H) and Showtime (S) individually or as a bundle of both. Suppose the reservation prices of customers 1& 2 are presented in the boxes below. CASE A : Preferences are negatively correlated S H If the cost to Time Warner is $1 per customer for licensing fees, the profits of bundling is 22 – 4 = $18, In contrast, the profits of selling each separately is 17-2= $15. Bundling is more profitable! 1 2 11 11 9 2 38 $22 Bundling generates more revenue 9 + 8 = $17 Selling separately

  19. Changing the preferences: Bundling Suppose, however, that everyone likes Showtime more than the History Channel, such that preferences are positively correlated as given below. CASE B: Preferences are positively correlated If the cost to Time Warner is $1 per customer for licensing fees, the profits of bundling is 20 – 4 = $16, In contrast, the profits of selling each separately is 22-3= $19. Selling separately is more profitable! S H 1 2 91 8 6 10 14 20 16 + 6 = 22 Selling separately

  20. Changing the cost of licensing: Bundling Suppose the cost of licensing rises to $3 per show. Renting the History Channel to person 1 is a money loser for Time Warner. CASE A: Preferences are negatively correlated S H When the cost to Time Warner is $3 per customer for licensing fees, the profits of bundling is 22 – 12 = $10, In contrast, the profits of selling each separately is 17-6= $11. Now selling separately is best! 1 2 11 11 9 2 38 $22 Bundling generates more revenue 9 + 8 = $17 Selling separately

  21. Second Degree Price Discrimination: 6. Mixed Bundling Suppose there are three customers and they can either buy a bundle or buy separately. CASE C : Can buy bundle for $13 or buy S for $8 and buy H for $5 Bundle Only: If the cost to Time Warner is $3 per customer for licensing fees, the profits of bundling is 33 – 18 = $15, Separate Only: In contrast, the profits of selling each separately is 26 -12 = $14. In mixed bundling, sell the bundle for $13 and sell S for $9 and sell H for $8. Person 1 buys only S. Person 2 buys the bundle @ $13, Person 3 buys only H. Profit = 30 – 12 = $18. BEST! S H 1 2 3 9 2 8 5 3 8 11 13 11 $33 16 + 10 = $26 Selling separately At S for $8 and H for $5

  22. Mixed Bundling • McDonalds sells Extra Value Meals, as a bundle of sandwich, fries, and a soft drink for less than it sells them separately. But selling both bundles and items separately is mixed bundling. • Suppose that Bob would pay $3 for a burger and $1 for a soft drink • Mary would pay $2 for a burger and $2 for a soft drink • Jim would pay $3.50 for burger and nothing for a soft drink • If the individual price of a burger is $3 and the individual price of a drink is $1.50, then Bob buys a burger, Mary buys a soft drink, and Jim buys a burger. With only ala carte pricing, the revenue $3 (Bob) + $1.50(Mary) + $3(Jim) = $7.50. • If the extra value meal bundle (of a burger and drink) costs $4, both Bob and Mary buy the bundle, but Jim buys nothing. Hence, with only bundling, the revenues is $4 (Bob) + $4 (Mary) = $8. • Mixed Bundlingyields revenue of $4 (Bob) + $4 (Mary) + $3(Jim) = $11, which is the highest revenue.

  23. Bundling (as Block Booking) Example http://en.wikipedia.org/wiki/United_States_v._Paramount_Pictures,_Inc. 1948 Often the pricing arrangement includes purchasing groups of dissimilar products. The products are bundled or sold as a block, as in theatrical or sporting tickets. Preferences are uncorrelated Preferences are correlated A B A B 1 2 250 270 150 100 80190 80 100 165 175 180 340 500 360 160 + 200 = 360 simple monopoly 165 + 200 = 365 simple monopoly

  24. 7. All You Can Eat Pricing AYCE Pricing -- A specified price for an unspecified quantity. Examples: Salad Bars, Legal Retainers, HMO’s Area under demand curves represent most willing to pay for an AYCE offer P ounces

  25. Discussion Time – Yeah! • Ask, “what I don’t get is…” or • Using economics, please explain why we do what we do. The Milwaukee River Autumn in Glendale, Wisconsin

  26. Third Degree Price Discrimination a.k.a. Market Segmenting Price Discrimination East West Market PM MC MR Example with a Simple Monopoly Price in both markets

  27. Third Degree Price Discrimination East West Market PE PM PW MC MR MR Example with a Different Prices in Each Market MR

  28. Segment markets by price sensitivity Charge higher prices in the markets that are the most inelastic Then P1 = $150 and P2 = $120 Pricing In Segmented Markets P ( 1 + 1/ EP ) = MC Suppose MC = $100 in 2 markets and E1 = -3 and E2 = -6 Why are haircuts for kids cheaper than for adults?

  29. What, a 2nd Discussion Time? • Any last minute questions you have please?

  30. The Disruptors’ FeastChapter 11: Climate & Human Well Being • We know from changing the number of wolves in Yellowstone, many things change. • Likewise, human development is likely to impact for good & ill the world. • In North America, deforestation occurred throughout the 19th and early 20th century, but has been stable for the last 100 years. • Greenhouse gas emissions rose, but have been declining for a decade. http://education.seattlepi.com/rates-deforestation-reforestation-us-3804.html

  31. Improving Environmental Indicators Water Quality & Endangered Species Declining Greenhouse Gases over the past decade • Lake Erie – once un-fishable is now teeming with perch • Bald eagles no longer endangered, also: • American Alligator • Grizzly Bear • White Rhino • Siberian Tiger • Wood Stork & others • Changes in pesticides. • Change in fuel additives.

  32. The EPA and MTBEMethyl Tertiary Butyl Ether • Sometime regulations for the environment backfire. • The EPA required MTBE in its reformulated gasoline (RFG) in 1979 • But, it causes cancer in humans and animals • It pollutes drinking water • It makes drinking water taste horrible • Not until 2005 was MTBE removed • You can’t sue the government for causing countless cancers but any private firm that did this would have been ruined

  33. Executive MBA Program:Corporate Economics 752 • Adapt or Die– market forces change, and firms adapt to them or go out of business • Competitive Pressures– product, tastes, styles, have to be current. • Macroeconomic and Regulatory Challenges– modify your world.

  34. The Case for Strong Headwinds for McDonaldsChapter 16 Worldwide brand for McDonalds Ray Kroc in 1955 bought a restaurant in San Bernardino, CA from two brothers with the last name McDonald. Now, the company operated 34,480 restaurants in 119 countries, of which 27,882 were franchised or licensed and 6,598 were operated by the company. But challenges occur to a great fast food firm Wendy’s, Burger King, Subway compete in dollar menu and low carb. Gov’t regulation of calories. New entrants: Chipotles, Panera, Starbucks, & Dunkin’ Donuts.

  35. Vanishing Restaurant Chains • Blimbie subs and sandwiches: 60% closure of mall businesses • Ponderosa Steakhouse: 64% closure of outlets • Big Boy: 65% closure of restaurants • Don Pablo’s tex-mex: 71% closures • Tony Roma’sribs: 72% closures • TCBY frozen yogurt stores: 77% closures • Damon’s Grill and Sports Bar: 78% closures • Country Kitchendiners: 79% closures • Ground RoundGrill and Bar: 81% closures • Bennigan’s Irish themed pub and grill: 88%

  36. Steps McDonald’s Corp Made • Modernize restaurants – coffee bar styling rather than 1950’s diners • Wifiwith modern chairs • Dual drive through lanes • Visual displays of orders • Expanded coffee offerings • Flat-screen TVs in stores • Nutritional information and offerings for kids • International expansion

  37. Economic influences • Changing demand patterns – quick casual restaurants vs. fast-food restaurants • Oligopolistic behavior – each watches the offerings and actions of the other firms • What industry is McDonald’s in? • The death of the Happy Meal? • Keep the clown or drop him? • Millennials – get them the McWraps • Cost cutting – in napkins?

  38. Innovations – Adapt or Die • Worldwide tastes • French: McBaguette • Finland: Rye McFeast • Recycling Winning Themes • Monopoly Games • Seasonal drinks • Alternative Quarter Pounders

  39. The New Frontier - China • KFC already has 3,700 restaurants in China • Pizza Hut has 626 • McDonald’s has 1,400. • Drive thru challenges in China • Should they make Rice-Burgers? Or go with US style Quarter Pounders? • Growing at about 200-250 stores per year. • But meat quality issues. • Ad focus on FRESH and SAFE ingredients. • Political risks – Chinese government could order them closed at any time.

  40. All Day Breakfast! • Causes some dislocation of other items. • Are breakfast items higher or lower margin? • Not the only restaurant chain to do this: Denny’s, IHOP, and Bob Evan’s comes to mind. • Why did this modification seem to resonate in 2015?

  41. Battle of the Bulge - Calories • Modern concerns over fat and fitness • Regulations to post calorie count • Some evidence that posting calories does impact some consumer behavior • However, their salad business has been relatively weak

  42. Macroeconomic Influences • Worldwide downturns in 2001 and 2008 • Some declines in same-store sales • Some trading down to cheaper restaurants, helping McDonald’s • Commuters to work often breakfast at McDonald’s, and their breakfast business is impacted by employment • Statistical research – Appendix 16 shows demand for McDonald’s food is elastic. • What does that do to the Dollar Menu strategy?

  43. Break!!!

  44. Oral Presentations on McDonalds • We’ll divide into 6 of the 7 groups based on your selected Group Names. Did “Storm Team,” get inspired by Stormtroopers?” • Which your group presents will be based on drawing numbers from a hat. • Divvy up the group project numbers, work for a time in your teams, make a PowerPoint if you want to, and then come back to present your view on our case on Chapter 16. Everyone should speak about equally.

  45. Group 1: Emerging Markets • Can use the textbook • Application Question 2, page 470 • Compare and contrast the fast-food chain’s strategies in emerging markets. • How does a global firm assure quality of their experience abroad? • Each member of team presents a part of your answer.

  46. Group 2: Non-price Factors • Can use the textbook • Application Question4, page 470 • What variables other than price appear to have the biggest impact on the demand for McDonalds’ products? • How much influence does the company have over these variables? • Each member of team presents a part of your answer.

  47. Group 3: Malls and Mini-restaurants • Can use the textbook • Technical Question 4, page 470 • How did McDonald’s Development on its mini-restaurants improve its overall profitability? • How should the changing nature of malls and food courts play in McDonald’s plans? • Could McDonald’s enter the sub-sandwich market without the grill and fries? Why or why not? • Each member of team presents a part of your answer.

  48. Group 4: The Macroeconomic Environment • Can use the textbook • Application Question 5, page 470 • How does recession and recovery impact a fast food restaurant? • Chipotle's a small 16 store chain all in Colorado, when McDonald’s bought a large part of the firm in 1998 and sold it in 2006? Yet Chipotle's continues to grow through the 2008 recession. Why a different growth path in face of macroeconomic headwinds? • Chipotle's motto is Food with Integrity. What trends does this represent? • Each member of team presents a part of your answer.

  49. Group 5: Statistical Estimation of Demand Curves • Can use textbook, especially Appendix 16. • What is the price elasticity facing McDonald’s? • Should McDonald’s raise its prices then? • What is the “full price” of fast food? • What are some of the other prices (substitutes and complements) that go into a decision to demand a McDonald’s meal? • According to the income elasticity, is McDonald’s a luxury, necessity, or inferior good? Why? • What good does it do to study demand and other variables using statistical models of regression? • Each member of team presents a part of your answer.

  50. Group 6: Oligopolistic Behavior or Monopolistic Competition? • Can use the textbook • Technical Question2, page 470 • Consider Chapter 9 on Oligopoly. Do you think McDonald’s engages in tactic collusion with other fast food companies? Why? • Do you think that McDonald’s is a dominant firm price leader? Why? • Do you think McDonald’s faces a kinked demand curve? Why or why not? • Do you think that the conditions are right for Cournot oligopoly or is more like monopolistic competition. Why? • Can you give an example of McDonald’s and rivals acting like Game Theory? • Each member of team presents a part of your answer.

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