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Decreasing returns

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  1. 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.

  2. Increasing returns • Upfront costs • Network effects • Customer groove-in Leads to: • Market instability – winner takes all • Unpredictable • Fat profits for the winner

  3. 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

  4. 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

  5. Psychological positioning Scare rivals • Pre-announcements • Threatened alliances • Technology preening • Future partnerships • Vaporware

  6. The Importance of Pricing Decisions Hyper-Competition on Price Price Concerns of E-Marketing Managers Loss Leader Pricing to build Installed Base Consumer Price Sensitivity on the Net Cost Transparency

  7. 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 Command.com

  8. 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%

  9. 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

  10. 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

  11. 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

  12. Segmentation • Ability to choose creative and accurate segmentation dimensions • Ease of identifying which segment a buyer belongs to • Ability to create barriers between segments

  13. Pricing 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.

  14. 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.

  15. 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

  16. 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

  17. Auctions  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.

  18. Auctions

  19. 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

  20. 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

  21. Pricing environments Sellers One Many One Bargaining / Menu pricing Reverse auction Buyers Exchange Auction Many

  22. Key players Sellers One Many One Bargaining / Menu pricing Reverse auction BarterTrust, BigVine Intellibarter, Ubarter Swap.com, SwitcHouse Free Markets Priceline Buyers Auction Exchange Amazon.com, Ebay Fob.com, Mercata MobShop, Yahoo auctions Altra Energy, CheMatch E-Steel, Gofish MetalSite, PaperExchange Many

  23. Technology providers Degree of Customization Low High Proprietary Amazon.com Auctions eBay Yahoo! Auctions Source of Auction Engine Technology Ariba CommerceOne Moai OpenSite 3rd Party

  24. 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

  25. Bot Landscape Auction Management Services Extensive Limited B2C Andale Bidder’s Edge AuctionRover Auction Watch Market Sector Bizbots.com B2B

  26. 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

  27. 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. E.g., Basement.com, Outletzoo.com

  28. Reverse auctions : You specify the price and firms will decide whether to serve you at that price • e.g. Lendingtree.com (loans) • Priceline.com (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.

  29. 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

  30. 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.

  31. 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

  32. 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

  33. What factors affect Price elasticity ?

  34. 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.

  35. Availability of substitutes e.g. Non differentiated products Awareness of local restaurants • Internet increases consumer's awareness of alternatives. • e.g. Computers - Price Watch (www.pricewatch.com) • Mortgage rates - Quicken Financial Network (www.quicken.com/mortgage) • Books - ACSES (www.acses.com)

  36. 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

  37. Who is paying? Business expense or personal ? • Web sites should decide which segment to target and provide information accordingly. • Hyatt versus HoJo

  38. Versioning • The practice of offering different varieties of products at different price points. Benefits: - Segment consumers by their price-consciousness; - keep the sales within the company; - allow consumers to trade-up.

  39. 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

  40. Policy Issues • Versioning involves making the complete product and degrading it? • Is this OK? • Yes, if it improves consumer welfare

  41. 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

  42. Price competition • With shopbots will prices rise on the internet? • No. Why? • There is no incentive to price discount.