Pricing Policy & Strategic Thinking
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Transcript of Pricing Policy & Strategic Thinking
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PRICING POLICY & STRATEGIC THINKINGMBA NCCU Managerial EconomicsJack Wu
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PRICING POLICY
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CASE: EMIRATES AIRLINE, DUBAI-MUMBAI, ECONOMY CLASS, MAY 2004
Fare Restrictions Price
Year KRTAE1 None AED 2250(US$ 613)
Special Excursion QEE4MAE1
Min. 7 days, max. 4 mths stay
AED 1900
Basic Season Special Excursion LLE4MAE1
Low season; min. 7 days, max. 4 mths stay
AED 1550
Basic Season Special Excursion VLE4MAE1
Low season; min. 7 days, max. 4 mths stay
AED 1200
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EMIRATES AIRLINE, MUMBAI-DUBAI, ECONOMY CLASS, MAY 2004
Fare Restrictions Price
Economy unrestricted LRT
None INR 25,600(US$ 557)
Economy restricted LRTIN1
None INR 22,700
Regular Excursion LEE3M1
Min. 7 days, max. 3 mths stay
INR 20,100
Special Excursion VEE3MIN1
Max. 3 mths stay. INR 17,000
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EMIRATES AIRLINE Why does Emirates charge lower fare for
passengers originating from Mumbai? How is this discrimination possible?
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PRICING POLICY uniform pricing complete price discrimination direct segment discrimination indirect segment discrimination bundling
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0
30
55
80
2500 5000marginal revenue
marginal cost
demand
Quantity (Units a year)
Price
(Tho
usan
d Ye
n pe
r uni
t)
UNIFORM PRICING
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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
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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
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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?
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UNIFORM PRICING: SHORTCOMINGSSHORTCOMINGS
leaves buyers with a lot of surplus
does not sell to every potential buyer
marginal cost
price
buyer surplus
potential buyers
$
0 quantity
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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
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COMPLETE PRICE DISCRIMINATION: PRACTICE
bargaining auctions
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DIRECT SEGMENT DISCRIMINATION, I price by segment implementation
� fixed identifiable characteristic --- basic for segmentation
� no re-sale
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DIRECT SEGMENT DISCRIMINATION, IIsimple case: uniform price within each segment
� within each segment IM% = -1/e� for segment with more elastic
demand, then lower incremental margin percentage (IM%)
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0
30
55
80
25003000
Quantity (Units a year)
Price
(Tho
usan
d Ye
n pe
r uni
t)
(a) Men’s demand
0
30
50
Quantity (Units a year)
Price
(Tho
usan
d Ye
n pe
r uni
t)
(b) Women’s demand
marginal revenue
demand
40
1000marginal revenue
demand
marginalcost
DIRECT SEGMENT DISCRIMINATION, III
marg.cost
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NYNEX TELEPHONE SERVICENew York City residential -- $16/month business -- $23/monthHow is discrimination possible?
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ASIAN WALL STREET JOURNAL
Price for annual subscription, May 2006
Print: Hong Kong (HK$ 2,700)
US$ 348
Print: Singapore (S$ 525) US$ 331Print: Tokyo (Yen 94,500) US$ 845 Interactive: Worldwide US$ 99
Why different prices for print edition but not interactive edition?
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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
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Traveler
Segment
Unrestricted Travel ($)
Restricted Travel ($)
Maria Business 1000 200 Tom Business 900 180 Robin Vacation 500 400 Leslie Vacation 280 224
AIR TRAVEL: BENEFITS
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Product
Fare ($)
Sales
Total Rev. ($)
Total Cost ($)
Profit ($)
Unrestricted
900 2 1800 400 1400
Restricted 399 1 399 200 199
*MC=200
AIR TRAVEL: INDIRECT SEGMENT DISCRIMINATION
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CHINESE EMBASSY: VISA FEES
Application period1 day 3 days 7 days
Single entry $75 $60 $25Double entry $85 $70 $35
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Profitability Policy Information Requirement
Highest Complete price discrimination
Highest
Direct segment discrimination
Indirect segment discrimination
Lowest Uniform pricing Lowest
PRICING POLICIES: RANKING
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BUNDLING strategy
pure bundling mixed bundling
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CABLE TELEVISION: BENEFITS
“if every segment … was wild about one thing and hated the rest, they have done their job” (Economist) Segment Education
channel Music channel
Conservatives $20 $ 2
Middle of road $11 $11
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PURE OR MIXED BUNDLINGWhat is the profit-maximizing pricing policy if marginal cost per channel = 0 marginal cost per channel = $5
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PURE OR MIXED BUNDLING Generally, if item is costless, no loss from giving it to
every consumer --> pure bundling; if item is costly, then should avoid providing
it to low-benefit users --> use mixed bundling to screen out low-benefit users.
Mixed bundling is form of indirect segment discrimination
structured choice between bundle and separates
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STRATEGIC THINKING
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Nov. 16: Coca-Cola raised price 7% Nov. 22: Pepsi raised price 6.9% “Coke and Pepsi will move now
from price-based competition to marketing-based competition”,
Andrew Conway, Morgan Stanley
CASE: COKE VS. PEPSI, 1999
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COMPETITIVE DILEMMA
Pepsi Raise price Discount
Raise price
C: 3, P: 3
C: 0, P: 5
Coke Discount C: 5, P: 0
C: 1, P: 1
What should Coke do?
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STRATEGIC SITUATIONS parties actively consider the interactions with
one another in making decisions game theory -- set of ideas and principles to
guide strategic thinking simultaneous actions: strategic form sequential actions: extensive form
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DOMINATED STRATEGYgenerates worse consequences than another strategy, regardless of the choices of the other parties
never use dominated strategy
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NASH EQUILIBRIUMGiven that the other players choose their Nash equilibrium strategies, each party prefers its own Nash equilibrium strategy
• No one is willing to deviate unilaterally from a Nash equilibrium
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SOLVING FOR NASH EQUILIBRIUM eliminate dominated strategies, then check
remaining cells “arrow” technique
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NASH EQUILIBRIUM: COMPETITIVE DILEMMACOMPETITIVE DILEMMA
PepsiRaise price Discount
Coke
Raise priceC: 3, P: 3
C: 0, P: 5
DiscountC: 5, P: 0
C: 1, P: 1
What should Coke do?
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COKE AND PEPSI GAME Nash equilibrium: for both parties, “raise
price” is dominated by “discount”. but discounting is bad for both -- if only they
could agree somehow to raise price. Coke and Pepsi stuck in this situation for four
years until November 1999.
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NASH EQUILIBRIUM: PRISONERS’ DILEMMAPRISONERS’ DILEMMA
SamDo not confess
Confess
IanDo not confess
I: 0, S: 0
I: -10, S: 0
ConfessI: 0, S: -10
I: -5, S: -5
What should Sam do?
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No Nash equilibrium in pure strategies
Competitor.com NBA NHL
NBA W: 4, C: 3
W: 3, C: 4
We.com NHL W: 3, C: 4
W: 4, C: 3
WHERE TO ADVERTISE?
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RANDOMIZED STRATEGIES choose among pure strategies according to
probabilities must be unpredictable Example: where to advertise _ We.com: ½ NBA and ½ NHL _ Competitor.com: ½ NBA and ½ NHL
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RANDOMIZED STRATEGIES: RETAIL PRICE COMPETITIONRETAIL PRICE COMPETITION
Pricing trade-off: high price to extract buyer surplus of loyal
customers low price to get store switchers
Solution: randomized discounts
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COORDINATION/COMPETITION: EVENING EVENING NEWSNEWS
Delta7.30pm 8.00pm
Zeta
7.30pm A: 1, B: 1
A: 3, B: 4
8.00pmA: 4, B: 3
A: 2.5, B: 2.5
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COORDINATION AND COMPETITION Prime time for news is 8:0pm; second best is
7:30pm; since audience is limited, get maximum
viewership if two channels schedule at different times.
Question: which station gets 8:0pm? Situation has elements of
coordination -- avoiding same time slot competition -- getting the 8:0pm slot
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ZERO/POSITIVE SUM zero-sum games: pure competition -- one
party better off only if other is worse off positive-sum games: coordination -- both can
be better off or both worse off co-opetition: competition and coordination
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COORDINATION/COMPETITION:FUTURE DVD STANDARD
ConsumersBlu-ray HD-DVD
DVD player manuf-acturers
Blu-ray M: 1, C: 1
M: -1, C: -1
HD-DVDM: -1, C: -1
M: 1, C: 1
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COORDINATION/COMPETITION: FOCAL FOCAL POINTPOINT
Single Nash equilibrium - clear focal point Multiple Nash equilibria - look for focal point to
see which one to play
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SEQUENCINGGame in extensive form – sequence of moves:
nodesbranchesoutcomes
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EXTENSIVE FORM: EQUILIBRIUMbackward induction
final nodes intermediate nodes initial node
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SEQUENCING: EXTENSIVE FORMEXTENSIVE FORM - TV NEWS- TV NEWS
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STRATEGIC MOVEAction to influence beliefs or actions of other parties in a favorable way
• credibility– first mover advantage– second mover advantage
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EXAMPLES Examples: Evening TV news -- both stations want to move first: which one can?
Use strategic move, eg, contracts with advertisers to deliver news at 8pm.
Famous Chinese general: after crossing a river, burnt his ships -- strategic move to force soldiers to fight harder.
Issue: Is the move credible? Will it convince the other players?
Advantage doesn’t always go to first mover; In war, better to see opponent’s move, and then take action, eg is
enemy moving south or north? new product category -- let competitor test the market and
educate the customers
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consumer
Litho
LithoMake prints
Do not
Buy
Do not
Make more prints
Do not
(1) serial number (2) destroying the plate(3) other solution?
LITHOGRAPHER
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CONDITIONAL STRATEGIC MOVES
Threats – if it succeeds, then it needn’t be carried out
Promises – if it succeeds, then it needn’t be carried out
Ideal strategic move doesn’t impose costs
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MORGAN STANLEY:“SHAREHOLDER RIGHTS PLAN”
If any party acquires 10% or more of company’s shares, other shareholders get right to buy additional shares at 50% discount. Impact on hostile bidder?
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SHAREHOLDER RIGHTS PLAN This shareholder rights plan is a threat to
potential bidders: most hostile bidders begin with small stake; with shareholder rights plan, if bidder
acquires more than 10%, then rights triggered, and bidder will be diluted.
Nickname: poison pill. Actually works against shareholder rights --
by entrenching existing management.
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Sharon
Hilda
acquires 100,000shares
doesn’t bid
does not
activates rights
Hilda loses on initial stake + cost of takeover rises
POISON PILL
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Union
Employer
reject union demand
accept
do not
strike Lose current wageand possibly gain infuture wage
Maintain current wage
Why are strikes rare inAmerican professional football?
STRIKE
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CONDITIONAL STRATEGIC MOVE: WITHOUT DEPOSIT INSURANCE
depositor
maintains deposit
withdraws deposit
bank insolvent
bank remains solvent
principal + interest
zero
depositor
principal
principal
bank remains solvent
bank insolvent
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CONDITIONAL STRATEGIC MOVE: WITH DEPOSIT INSURANCE
depositor
maintains deposit
withdraws deposit
bank insolvent
bank remains solvent
principal + interest
principal
depositor
principal
principal
bank remains solvent
bank insolvent