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Welcome. B2C eCommerce Trends in Pricing Jonathan Wareham j.wareham@esade.edu. Price Levels. Assumption that electronic markets have less friction than comparable markets. Search costs lower Competition increases Average prices should fall, converging on market level

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  1. Welcome B2C eCommerce Trends in Pricing Jonathan Wareham j.wareham@esade.edu

  2. Price Levels • Assumption that electronic markets have less friction than comparable markets. • Search costs lower • Competition increases • Average prices should fall, converging on market level • Study of prices of books and CDs and software sold on internet: • Higher prices & greater variance in electronic channel !!!!!

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  5. Possible Causes • Superior disc. pricing techniques: lower registration and menu costs • Heterogeneity: wine in store or restaurant • Versioning • Temporal preference: consumer behavior and types • Imperfect information: bait and switch • Neural real estate: 5% sites/75% traffic • Market immaturity: eMarkets too young

  6. Fixed Prices P $1.00 1 Coke Q

  7. Fixed Prices Consumers Surplus Dead Weight Loss MC

  8. Get a little more revenue

  9. 2nd Degree Price Discrimination • “product line pricing”, “market segmentation”, “versioning” • Gold Club, Platinum Club, Titanium Club, Synthetic Polymer Club • First Class, Business Class, World Traveler Class • Professional Version, Home Office

  10. 3rd Degree Price Discrimination • The practice of charging different groups of consumers different prices for the same product • Examples include student discounts, senior citizen’s discounts, regional & international pricing, coupons

  11. Maximize the Revenue ! Perfect (1st degree) Price Disc.

  12. Perfect Price Discrimination Price $ Profits: .5(4-0)(10 - 2) = $16 10 8 6 4 Total Cost 2 MC D 1 2 3 4 5 Quantity

  13. Prefect Price Discrimination • Practice of charging each consumer the maximum amount he or she will pay for each incremental unit • Permits a firm to extract all surplus from consumers • Difficult: airlines, professionals and car dealers come closest

  14. Caveats: • In practice, transactions costs and information constraints make this is difficult to implement perfectly (but car dealers and some professionals come close). • Price discrimination won’t work if you cannot control three things: • Preference profiles • Personalized billing; (anonymous transactions lesson seller’s discriminatory power over consumers) • Consumer arbitrage

  15. What is different about this site?

  16. Conclusions • Internet double edged sword: • Consumers enjoy lower search costs, but… • eMarketers have superior tools to register your consumption patterns and price sensitivity • The end of fixed pricing??? • Fixed pricing as an institution only 100 years old!! • Developed in response to large scale economies/production models….with standard products !!!!

  17. Horizontal Differentiation • The game of location (proximity to customer’s tastes) Alice Bob 1/2 Alice Bob

  18. Vertical Differentiation High Price Low Quality

  19. How??? • Versions • Timing and delays • Ease of use • Pathways into site • Segregation of markets and users • Analysis of click stream and previous purchasing history

  20. Making Self-Selection Work • May need to cut price of high end • May need to cut quality at low end • Value-subtracted versions • May cost more to produce the low-quality version. • In design, make sure you can turn features off!

  21. How Many Versions? • One is too few • Ten is (probably) too many • Two things to do • Analyze market • Analyze product

  22. Analyze Your Market • Does it naturally subdivide into different categories? AND • Are their behaviors sufficiently different? • Example: Airlines • Tourists v. Business travelers • “This created visible differentiation in customer service. It was essential for our customers to see the perks that the others were getting.”

  23. Analyze Your Product • Dimensions to version • High and low end for each dimension • Design for high end, reduce quality for low end • Low end advertises for high end in service industries – Cheap rates • High end – Flagship products -advertises for low end in many products.

  24. Goldilocks Pricing • Mass market software (word, spreadsheets) • Network effects • User confusion • Default choice: 3 versions • Extremeness aversion • Small/large v. small/large/jumbo

  25. Extremes Aversion • Bargain basement at $109, midrange at $179 • Midrange chosen 45% of time • High-end at $199 added • Mid-range chosen 60% of time • Wines • Second-lowest price • “Framing effects”-example

  26. Cross-Subsidies • Prices charged for one product are subsidized by the sale of another product • May be profitable when there are significant demand complementarities effects • Examples • Browser and server software • Drinks and meals at restaurants • Long distance and local access • Auto spare parts • Razor & Blades • Burger, fries, drinks • Auto financing

  27. Lessons • Version your product • Delay, interface, resolution, speed, etc. • Add value to online information • Use natural segments • Otherwise use 3 • Control the browser, access, comparisons, etc. • Bundling & cross subsidies may reduce dispersion

  28. Down & Dirty • First degree (perfect) price discrimination • “market of one” • Second degree price discrimination • “product line pricing”, “market segmentation”, “versioning” • Third degree price discrimination • “different prices to different groups” • Other definitions in literature…

  29. Tickets; $7.95 $1.00 Discount for Children & Seniors Tickets; $6.95 $1.00 Extra for Middle Aged People ...Decisions Are Not Always “Rational”

  30. More Acceptable Pricing Product-Based Open Discretionary Discounts and Promotions Rewards Less Acceptable Pricing Customer-Based Hidden Imposed Surcharges Penalties Price Perception Issues are Complex...

  31. RM coming of age • Airline deregulation in the U.S. • People Express vs. American Airlines • Edelman Award: RM for AA $1.4 billion in 3 years • virtually every airline has implemented RM • National Car Rental (vs. GM) • Edelman Award: RM for SNCF • AA: $1 billion incremental revenues from RM • Marriott Int’l RM: 4.7% increase in room revenue • Deregulation Europe: telecom, media,energy … • e-distribution supports dynamic pricing & profiling • Dell, Amazon & Coca Cola experiment dynamic pricing • RM spans wide range of industries … 1978: 1985: 1992: 1997: 1999: 2000-01: 2003:

  32. HealthCare/ Hospitals Insurance/ banking Sports Parks Entertainment Car rental Freight, Cargo Manufact. Rail Transp. Hotels Tour Operators Retailers Airlines 1980 1985 1990 1995 RM Evolution Telco/ISP Cruise lines Energy Media 2000

  33. YM: Where and When? • Perishable: impossible to store excess resources • Choose now: future demand is uncertain (how many rooms to sell at low price) • Customer segmentation with different demand curves • Same unit of capacity can be used to deliver different services • Producers are profit driven and price changes are accepted socially

  34. Major Types • Revenue Management (EMSR) • Peak-Load Pricing • Markdown Management • Customized Pricing • Promotions Pricing • Dynamic List Pricing • Auctions

  35. Revenue Management • Set of techniques use to manage • Constrained, perishableinventory (time) • When customer willingness to pay increases towards departure • Applications: • Airlines, Hotels, Car Rentals, News Vendors • Main techniques: Open and close certain rate categories (rate fences) based on historical probabilities and forecasts of future demand

  36. The RM Challenge Arrivals of high paying customers… Closer to departure! Arrivals of low paying customers…Earlier!

  37. Peak-Load Pricing • Tactic of varying the price of constrained and perishable capacity to reflect imbalances between supply and demand • Based on changing prices only, not availability like RM. No perishable inventory • Simple= when demand increases, raise prices • Industries= utilities (electricity, telephones) theme parks, toll bridges, theatres (afternoon showings)

  38. Markdown Management • Techniques used to clear excess, perishable inventory over time • Customer demand decreases over time (opposed to RM) • Used in retailing of fashion apparel and consumer electronics where there is a high obsolescence

  39. Customized Pricing • Occurs when the seller has the opportunity to offer a unique price to a buyer • Equivalent to first degree price discrimination • Used by car dealers, professional services, industrial sales, made to order manufacturing, person to person negotiation of non-standardized products

  40. Promotions Pricing • Similar to markdown management • Portfolio of tools to address different customer segments. • Example Automobile Sales • Low income like cheap financing and low down payment • High income like cash back, additional add-ons, services warranties/agreements

  41. Dynamic List Pricing • Dynamically move prices up and down according to perceived changes in demand. • Products not constrained, can reorder more. • Not traditionally used because of high menu costs • Now used in Internet and traditional retailing due to new technologies.

  42. Auctions • Variable pricing mechanisms • Often used for instances when prices are not easily determined • English • First price sealed bid • Vickrey • Dutch

  43. The RM Challenge Arrivals of high paying customers… Closer to departure! Arrivals of low paying customers…Earlier!

  44. Expected Marginal Seat Revenue • “ESMR” Kernel in many YM systems • Peter Belobabba, MIT • Belobaba, P. “Application of a Probabilistic Decision Model to Airline Seat Inventory Control,” Operations Research, vol 37(2) 1989.

  45. EMSR a simple example • Hotel; 210 rooms • Business Customers = 159$ night • Leisure Customers = 105$ night • We are now in February, the hotel has 210 rooms available for March 29. • Leisure Customers book earlier • Business Customers book later • How many rooms to sell at low price now? • How many to save to try and sell a high price later? • What if we don not sell them all at 159$ - then we lost 105$ per room!!!!

  46. Terms • Booking limit: Maximum number of rooms to be sold at low price • Protection level: Number of rooms to be saved for the business customers who arrive later • Booking limit = 210 – protection level

  47. Depiction: What should Q be? 210 rooms Q+1 rooms protected (protection level) Q 210- (Q-1) rooms sold at discount (booking limit)

  48. Decision Tree Revenue Yes – sell (Q+1) room now 105 $ Lower protection level from Q+1 to Q? Sold at full price later 159 $ No – protect (Q+1) rooms Not sold by March 29 0 $

  49. Historical Demand

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