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Pricing

Pricing. Outline. uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling selecting the pricing policy. Uniform Pricing. Uniform Pricing: Profit Maximum. MR = MC

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Pricing

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  1. Pricing

  2. Outline • uniform pricing • complete price discrimination • direct segment discrimination • indirect segment discrimination • bundling • selecting the pricing policy

  3. Uniform Pricing

  4. 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

  5. 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

  6. 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

  7. potential buyers $ buyer surplus price marginal cost 0 quantity Uniform Pricing: Shortcomings • leaves buyers with a lot of surplus • does not sell to every potential buyer

  8. Outline • uniform pricing • complete price discrimination • direct segment discrimination • indirect segment discrimination • bundling • selecting the pricing policy

  9. 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

  10. Complete Price Discrimination:Practice • auctions

  11. Outline • uniform pricing • complete price discrimination • direct segment discrimination • indirect segment discrimination • bundling • selecting the pricing policy

  12. Direct Segment Discrimination • Price by segment • Implementation • fixed identifiable characteristic - basic for segmentation • Age, gender, nationality, location • no re-sale

  13. 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%)

  14. Direct Segment Discrimination

  15. Direct Segment Discrimination:“Not for Retail Sale” Heinz serves • institutional customers (food service, restaurants) directly • retail customers indirectly through supermarkets and grocery stores

  16. Internet Services • residential -- $30-50/month • business – over $100/month How is discrimination possible?

  17. Direct Segment Discrimination:Location • Free on board (FOB) price - does not include delivery • Cost including freight (CF) price - includes delivery • conventional products • digital products

  18. 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

  19. Asian Wall Street Journal • Why different prices for print edition but not interactive edition?

  20. Outline • uniform pricing • complete price discrimination • direct segment discrimination • indirect segment discrimination • bundling • selecting the pricing policy

  21. 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

  22. Air Travel: Benefits

  23. Air Travel: Indirect Segment Discrimination *MC=200

  24. Pricing Policies: Ranking

  25. Outline • uniform pricing • complete price discrimination • direct segment discrimination • indirect segment discrimination • bundling • selecting the pricing policy

  26. Bundling • strategy • pure bundling • mixed bundling • implementation • segments derive different benefits from separate products • negatively correlated preferences • low marginal cost

  27. 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.

  28. Cable Television: EXAMPLE

  29. Pure or Mixed Bundling What is the profit-maximizing pricing policy if • marginal cost per channel = 5 • Compared to the case where MC=5, now the company is better off with a mixed bundling strategy.

  30. Outline • uniform pricing • complete price discrimination • direct segment discrimination • indirect segment discrimination • bundling • selecting the pricing policy

  31. 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

  32. 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

  33. VW Passat Audi A6 • What’s wrong with product design?

  34. Information technology • More discrimination • more data on buyers • easier to customize products • online auctions • More price competition (less discrimination) • easier to compare prices

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