I. Economic and Behavioral Foundations of Pricing

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# I. Economic and Behavioral Foundations of Pricing - PowerPoint PPT Presentation

Sample Exam Questions I. Economic and Behavioral Foundations of Pricing II. Innovative Pricing Concepts and Tools III. Internet Pricing Models Example 1: EVC

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## I. Economic and Behavioral Foundations of Pricing

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Sample Exam Questions

I. Economic and Behavioral

Foundations of Pricing

II. Innovative Pricing

Concepts and Tools

III. Internet Pricing

Models

Example 1: EVC
• High-tech Manufacturing has developed a new type of seat belts that is easier to install and more comfortable to wear than the seat belts currently in use.

The cost of a standard seat belt to automobile manufacturers is \$5.00. The labor cost to install one belt is \$3.00. The new belts take 10% less time to install with a resulting labor cost of \$2.70 per belt.

A marketing research study suggests that car buyers are willing to pay \$50 more for a car equipped with the new and more comfortable belts. (A typical car requires five seat belts.)

• What is the EVC (per car) of the new seat belts to auto manufacturers?
Example 1: EVC
• Reference Value = \$5 x 5 = \$25
• Differentiation Value = \$0.3 x 5 + \$50 = \$51.50
• EVC = \$76.50
Example 2: Ho’s Diagram
• Burger King has decided to cut the price for its Original DOUBLE WHOPPER Sandwich from \$2.49 to \$1.99. The unit variable cost is \$0.99.
• What is the minimal % increase in sales necessary for a profitable price cut?

= - (\$1.99 – \$2.49) / (\$1.99 – \$0.99) = 50%

• What is the minimal price elasticity needed for this to be a profitable price cut?

= 50 % / ( 0.5 / 2.49) x 100%) = 2.5

Example 3: Customer versus Product Margin (Loss Leader)
• As a pricing analyst for Hogrocery chain, you are asked to prepare the analysis of a proposal to price frozen chicken low in order to attract shoppers to the Ho store. The current price for chicken is \$1.09 per pound. The proposal is to set a promotional price of \$0.69 per pound. The wholesale cost of the chicken, prepackaged and ready for sale, is \$0.59 per pound.
• By tracking past changes in sales of chicken with changes in sales of other grocery products, you discover that each one pound change in the sales of chicken is associated with the following changes in the sales of other products:
• Assume the above sales relationship holds, by how much must chicken sales increase (in percentage terms) to make this price promotion profitable?

= - (0.69 – 1.09) / (0.10 + 0.40 + 0.20 + 0.20 – 0.10) = 0.4 / 0.8 = 50%

Example 4: Customize, Customize, Customize
• Answer the following questions, clearly stating the price customization variable used in each case. Each example should be chosen so that the customization variable involved is different from the other examples.
• Pick any bookstore and describe a price customization strategy that it adopts.
• Pick any restaurant and describe a price customization strategy that it adopts.
• Pick any hotel and describe a price customization strategy that it adopts.
Example 5:
• Explain the differences if any between the following pairs of pricing policies:
• “Buy One Get One Free” and “50% off”.
• “An in-store price drop of \$5 to \$20” and “a coupon of \$5” on a product that is regularly priced at \$25.
Example 5: Reference Price
• Explain the differences if any between the following pairs of pricing policies:
• “Buy One Get One Free” and “50% off”.
• “An in-store price drop of \$5 to \$20” and “a coupon of \$5” on a product that is regularly priced at \$25.
Example 6: Revenue Model Design
• Visit www.bizrate.com and describe its revenue model. What are its revenue levers? Give a specific suggestion to improve the model.
• Other interesting websites include:
• www.shopping.com
• http://personals.yahoo.com/
• http://www.cafepress.com/cp/info/
• http://www.ubid.com/
BizRate’s Revenue Model in 2003
• Revenue = “research” revenue + “e-commerce” revenue + “advertising” revenue

where NR is the number of retailers

NC is the number of “clicks”

NA is the number of banner ads

Example 7: Conjoint Analysis
• Sears Tires is interested in measuring consumers’ tradeoffs among the following attributes of a tire: Brand (Sears, Goodyear, Goodrich), Miles (30K, 40K, and 50K), Price (\$50, \$60, \$70), and Sidewall (White and Black).
• A conjoint experiment that involves a group of 50 customers from a targeted segment was conducted. Respondents rated a set of 18 product profiles on a 10-point scale and their ratings were used to construct the segment’s utility equation. Below is the regression output with the appropriately defined dummy variables:
Example 7
• Which brand has the highest brand equity?
• If the products available in the market are (Sears, 30K, \$50, Black), (Goodyear, 40K, \$70, White), and (Goodrich, 30K, \$50, Black), which brand is likely to have the highest market share?
• If the market share of a product in the marketplace is predicted by the following equation (typically we estimate this relationship using historical data):

where Ui is the utility of product i and the denominator is the sum of the utilities of all products available in the marketplace. Compute the market share for Sears.

Example 7
• Sears is considering three price options for a new and improved product: (Sears, 40K, \$50, White), (Sears, 40K, \$60, White) or (Sears, 40K, \$70, White). Assume Sears replaces the old product with the new one.
• If the marginal cost is \$25 and the total market size is 2 million units per year, which price option should Sears adopt in order to maximize its annual profits?
• How would the above answer change if Goodyear drops its price to \$60 while Goodrich keeps its price unchanged?