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Decreasing returns . Traditional models had decreasing returns Works for bulk processing manufacturing industries Coffee plantation Equilibrium was predictable and orderly Therefore winning meant operational excellence, differentiation, and reasonable margins. No one could dominate.

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decreasing returns
Decreasing returns
  • Traditional models had decreasing returns
  • Works for bulk processing manufacturing industries
    • Coffee plantation
  • Equilibrium was predictable and orderly
  • Therefore winning meant operational excellence, differentiation, and reasonable margins. No one could dominate.
increasing returns
Increasing returns
  • Upfront costs
  • Network effects
  • Customer groove-in

Leads to:

  • Market instability – winner takes all
  • Unpredictable
  • Fat profits for the winner
a comparison
Traditional – production

Production is repetitive

Products remain same

Keep products flowing, improve quality, lower costs

Need control and planning

Need hierarchy

Optimization is possible

Internet – Casino

Winner takes all

Quest for next cash cow

Mission oriented not production oriented

Flat organizations

Give free rein

Reinvent, restructure, reposition, reorganize

Adapt – games changing constantly

A comparison
so what to do
So what to do ?
  • Pioneer
  • Develop superb technology
  • Build installed base – discount heavily at first
  • Get partners to complement
  • Link and leverage across markets and products
psychological positioning
Psychological positioning

Scare rivals

  • Pre-announcements
  • Threatened alliances
  • Technology preening
  • Future partnerships
  • Vaporware
the importance of pricing decisions
The Importance of Pricing Decisions

Hyper-Competition on Price


Concerns of



Loss Leader Pricing

to build Installed Base

Consumer Price Sensitivity on the Net

Cost Transparency

determinants of price
Determinants of Price

(1) Product Quality

- e.g. Lexus versus Corolla

(2) Service level

- e.g. Merrill Lynch vs. E*Trade

(3) Purchase conditions (Cash vs. Credit)

- e.g. gasoline, automobile financing, etc.

(4) Location and Transportation

- e.g. hypermarche’s in France, warehouse stores.

(5) Brand Image

- e.g. McAfee versus


McKinsey Marketing Solutions

Big difference between what people say and what they do.

Most visit only 1 site prior to purchase

Books 89%

Toys 84%

Music 81%

Electronics 76%

Computers 65%

Travel 55%


McKinsey Marketing Solutions, April 2000

  • Simplifiers 29%
  • Connectors 36%
  • Bargainers 8%
  • Routiners 15%
  • Surfers 8%
  • Sportsters 4%
  • 29 percent of users are “Simplifiers,” looking more for the promise of superior “end-to-end” convenience rather than price.
  • The 36 percent who use the Internet primarily to connect with friends and family generally default to their offline brand preferences if they do buy online.
  • Only 8 percent of users are “Bargainers,” finding entertainment
3 ways to profit from flexible pricing
3 ways to profit from flexible pricing
  • Precision in price levels and price communication
    • Better understanding of zone of price indifference
      • Engg. products – 10%, financial product – 0.2%
      • Testing is easy - every 50th customer gets a different price.
    • More precise communication to influence customer choice
      • For clearance items observe faster sales rate if you show scheduled price reductions
      • If you show available quantity, customers likely to delay purchases
    • Greater precision in setting optimal price
Faster adaptiveness in response to market changes
    • B2B – faster price changes
    • B2C – tickets are priced far in advance and cannot be changed dynamically
    • Faster response to competitive and cost changes
    • Ability to choose creative and accurate segmentation dimensions
    • Ease of identifying which segment a buyer belongs to
    • Ability to create barriers between segments


Internet has the feature that has high fixed costs and low or zero marginal costs

A and B develop software spending $500 million a year in marketing, R&D, and promotion.

Variable cost is $5 to sell each copy.

Price = $200

Firm A has 80% market share and firm B has 20% share

Market size is 10 million units in 1999.

Profit for Firm A = 200*8M - (500M+8M*5) = 1060M

Profit for Firm B = 200*2M - (500M+2M*5) = -110M

Market share is key!

Margins and growth rates are also important in determining the profits.

why cannot b reduce the price
Why cannot B reduce the price?

There are a number of lock-in factors:

  • Switching costs
  • Complementary products that are not compatible
  • Network externalities
  • Inertia and lack of differentiation
  • B has to recover high fixed costs too.
types of pricing menu pricing
Types of pricing : Menu pricing
  • It does not extract the entire value that the customers may be willing to pay.
  • It may cut off some buyers with a high price.
  • Once set, these prices are sticky? Why?

Costs to implement price changes

- Time

- Money

- Confusion to customers

  • Not easy to detect changes in customer's preferences quickly to change prices
one to one bargaining
One-to-one bargaining
  • Not practical for regular stores
  • Seller not sure that it has the buyer willing to pay the worth of the product
  • Buyer not sure that seller wants to sell at the price he/she wants - uncertainty

 Most efficient mechanism from a welfare point of view

  • Need to bring together a number of bidders to one location.
  • Sellers could collude to hold down the price of an item
  • Need to establish reputation of the bidders.

Internet overcomes some of the problems associated with the above pricing strategies.


Ebay revenue 88 million/qtr

Small operators – liquidators, small retail shops, entrepreneurs

4 million items listed

Top 20 sellers 72000 listings

Top 38000 – 2.7 million items listed

15.8 million registered users

commissions 1.25 – 5% of the value of the item sold


Yahoo has 2.5 million items listed

Power seller Bronze $ 2,000 per month

Silver $10,000

Gold $25,000

Must have received 100 comments from customers and 98 % positive.

Ebay has 20-25K power sellers

Power sellers get full time customer service support and permission to display an official power seller logo.

10% of sellers sold 80% of sales

Sellers made a 40% margin

Amazon spent 25% sales on marketing

pricing environments
Pricing environments





Bargaining / Menu pricing

Reverse auction





key players
Key players





Bargaining / Menu pricing

Reverse auction

BarterTrust, BigVine

Intellibarter, Ubarter, SwitcHouse

Free Markets




Exchange, Ebay, Mercata

MobShop, Yahoo auctions

Altra Energy, CheMatch

E-Steel, Gofish

MetalSite, PaperExchange


technology providers
Technology providers

Degree of Customization



Proprietary Auctions


Yahoo! Auctions

Source of








3rd Party

bots cooking
Bots cooking !
  • Software that aggregates information from multiple sources into one easy to use interface.
  • Buyer’s Perspective
  • 800 auction sites, 3-7 million items listed
  • Time constraints for searching
  • Buyers gain access to larger # of sellers, auction trends, bids
  • If unavailable, a bot will inform when item is available.
  • Can also make bids on your behalf
  • Seller’s Perspective
  • Can list seller’s items across multiple auction sites
  • Keeps track of their auctions
  • Sellers gain access to larger base of buyers
  • Manages post sale track of transactions
bot landscape
Bot Landscape

Auction Management Services





Bidder’s Edge


Auction Watch




why auctions succeed on the web
Why auctions succeed on the web?
  • Easy to get many bidders to participate - raises price and profits for the auctioneer
  • Efficient mechanism to extract all the surplus from the consumer.
  • Easy to provide in-depth information to consumers about the product making them more realistic in bidding prices.
  • Different locations reduces collusive behaviors
auction types
Auction types
  • English auction: Price starts low and goes up. Highest bidder gets the item and pays his bid

E.g., eBay, Ubid

  • Dutch auction: Price starts high and gradually declines. The first bidder gets the item and the quantity desired. Used for flower auctions and perishable items. The entire consignment has to be cleared.


Reverse auctions : You specify the price and firms will decide whether to serve you at that price
    • e.g. (loans)
    • (airline tickets)
  • First price sealed bid - Submit sealed bids. Highest bidder wins, pays his price.
    • E.g. Mineral rights
  • Second price sealed bid – Submit sealed bids. Highest bidder wins, pays second highest bidder’s price.
yield management
Yield management
  • Matching of prices and available capacity as in airline tickets pricing.
    • higher returns to airlines
    • mitigated ruinous direct price competition.

This works if:

    • There is fixed and perishable capacity
    • There is a high level of fixed cost and relatively small variable costs
    • Clearly Identifiable segments
    • Uncertain demand and availability of sophisticated information technology systems
demand uncertainty
Demand uncertainty
  • Cross (1997) identifies several reasons for demand uncertainty:
    • Perishable products or opportunities
    • Seasonal demand and peaks
    • Different segments value products differently
    • Product waste
    • Competition between individual and bulk purchasers
    • Discounting to meet competition
    • Rapidly changing market conditions.
price elasticity
Price elasticity
  •  = Price Elasticity of Demand - % change in quantity due to 1% change in price.

= (dQ/dp)*p/Q

  • =(Q1-Q0) * ­­­ P0
  • Q0 (P1-P0)
  • Price elasticity > 1 means demand is elastic
  • Price elasticity < 1 means demand is inelastic
Inverse elasticity rule
  • CMR* = (p* -c)/ p* = -1/(p*)
  • p* = profit maximizing price
  • c = incremental cost of the next unit
  • CMR* = Optimal contribution margin ratio
unique value or features
Unique value or features
  • Differentiation
    • can achieve this by doing the following
      • Provide hard facts of quality
      • Testimonials
      • Hands-on trial usage
  • It is better to get customers to your own web-site rather than let others control the information about your firm. The price comparisons on other web-sites may be unfair to your product as they may omit relevant information.
availability of substitutes
Availability of substitutes

e.g. Non differentiated products

Awareness of local restaurants

  • Internet increases consumer's awareness of alternatives.
    • e.g. Computers - Price Watch (
    • Mortgage rates - Quicken Financial Network (
    • Books - ACSES (
difficulty in comparison of quality
Difficulty in comparison of quality

e.g. Technical products

Different pack sizes

Experience goods

  • On the web, quality cues are missing. Some solutions are:
    • Co-branding
    • Testimonials
who is paying
Who is paying?

Business expense or personal ?

  • Web sites should decide which segment to target and provide information accordingly.
    • Hyatt versus HoJo
  • The practice of offering different varieties of products at different price points.


- Segment consumers by their price-consciousness;

- keep the sales within the company;

- allow consumers to trade-up.

types of versioning
Types of Versioning
  • Delay – 20 min delayed stock quotes versus real time quotes
  • User interface – professional version vs free
  • Convenience – high price version easy to use
  • Image resolution
  • Speed of operation
  • Capability, features
  • Annoyance – “Nagware”
  • Level of technical support
policy issues
Policy Issues
  • Versioning involves making the complete product and degrading it?
  • Is this OK?
  • Yes, if it improves consumer welfare
loyalty programs
Loyalty programs
  • Need to build loyalty –
    • Freebies
    • Customer service
    • Community
    • Other products
    • Frequency programs
  • Frequency programs must be non-linear i.e., as a consumer uses more, he should get proportionately greater rewards
price competition
Price competition
  • With shopbots will prices rise on the internet?
  • No. Why?
  • There is no incentive to price discount.