Transcript With price discrimination

Chapter 9
Pricing
1
Chapter 9
Pricing
2
Pricing

Pricing is the mechanism by which the business
acquires revenue;

Most profitable businesses pay great attention to pricing
 in this chapter, focus on pricing as segmentation tool
 other aspects of pricing – relation to marketing mix,
new products, …
Pricing is especially difficult and profitable for
information goods, like software, music CDs, databases.
 marginal cost of production is almost zero
 marginal cost of copying is almost zero.

3
Qantas

QF403, Sydney to Melbourne, July 20, 2011
 Fully flexible fare: A$499
 Flexi Saver fare: A$219
 Red e-Deal: A$199 (from Sydney), $175 (from
Melbourne)
 Why not fill all seats and earn more profit?
 What impose different conditions for change in Flexi
Saver and Red e-Deal fares?
 Why charge different prices for travelers originating in
Melbourne vis-a-vis Sydney?
4
Learning objectives

Apply uniform pricing.
 Appreciate how price discrimination can
increase profit beyond uniform pricing.
 Understand complete price discrimination.
 Apply direct segment discrimination.
 Apply indirect segment discrimination.
 Appreciate the choice between alternative
pricing policies.
5
Outline

Uniform pricing
 Complete price discrimination
 Direct segment discrimination
 Location
 Indirect segment discrimination
 Selecting the pricing policy
6
Uniform pricing

Uniform pricing: charging the same price for
every unit of the product and to every buyer
7
Uniform pricing

In airline business, when flight is about to take
off, marginal cost of empty seat is almost zero
 It
doesn’t mean that the airline should try to fill the
plane
 to fill the plane, may have to cut price and lose
revenue from people willing to pay relatively high
price.
8
Profit- maximizing price

MR = MC
 Equivalently, set the incremental margin
percentage equal to the inverse of absolute
value of price elasticity of demand,
 p q 
p 1 

 q p 
q p
 1
MR  p 1   with  
p q
 
MR  p 
p
q
q
1

p  1    MC



p  MC
1

p

(c) 1999-2011, I.P.L. Png
9
Uniform pricing: Price elasticity

Always set price so that demand is elastic
 If
demand not elastic, raising price would increase
profit.
 Higher price + lower quantity (but proportionately
less) => higher revenue
 Lower quantity => lower cost
 If
demand more elastic, then lower incremental
margin percentage (IM%)
 e = –2  IM% = 1/2
 e = –1.5  IM% = 2/3
10
Minibar


Hotel room minibar has market power
 barriers to competition, demand is inelastic
Compare pricing of Coca Cola with Carlsberg beer
 Demand for both is inelastic: elasticity => IM%
(not price)
 Price = cost + margin
 Different cost with the same margin 
different prices
11
Outline

Uniform pricing
 Complete price discrimination
 Direct segment discrimination
 Location
 Indirect segment discrimination
 Selecting the pricing policy
12
Complete price discrimination

Shortcomings of uniform pricing:
 Leaves buyers with surplus
 Does not sell to every potential buyer
 Example: airline pricing leaves business travelers with a
lot of surplus
13
Complete price discrimination
14
Complete price discrimination


Sell down the demand
curve
 Quantity MB = MC
 Price each unit at
buyer’s benefit
Maximizes profit
 Leaves no buyer with
any surplus
 Sells to every potential
buyer
$
total benefit
= total price
marginal
unit
marginal
cost
0
quantity
15
Complete price discrimination

Contrast
 Complete
price discrimination: Price each unit at
buyer’s benefit and sell quantity where MB = MC
 Maximum profit: theoretical ideal
 Uniform pricing: MR = MC => smaller scale

Implementation:
 Must
know entire marginal benefit and marginal cost
curves
 Must prevent resale:
 price
discrimination is more widespread in the sale of
services
16
Complete price discrimination: Practice

Bargaining
 Auctions: an institutional practice to approximate
complete price discrimination
 Online bidding
Google
keyword auctions
eBay
 Name
your price
Priceline
17
Outline

Uniform pricing
 Complete price discrimination
 Direct segment discrimination
 Location
 Indirect segment discrimination
 Selecting the pricing policy
18
Direct segment discrimination

Setting different prices to various segment of
buyers.

Implementation
 It is based on fixed identifiable characteristic
Age,
gender, nationality
movie theatres, bus and subway service,
airlines
 No re-sale
19
Direct segment discrimination


Homogeneous segments – all consumers identical
within segment
 Price = total benefit
Heterogeneous segments – consumers differ within
segment
 Uniform
pricing within segment, or
 Indirect segment discrimination within segment
 Within each segment: IM% = ‒1/e
 For segment with more elastic demand, then lower
incremental margin percentage (IM%)
20
Direct segment discrimination

Heterogeneous segments – consumers differ
within segment: Uniform pricing within segment
 Within each segment: IM% = ‒1/e
 For segment with more elastic demand, then
lower incremental margin percentage (IM%)
21
Direct segment discrimination:
Uniform pricing within segments
22
Direct segment discrimination:
“Not for retail sale”

Heinz serves
 institutional customers
(food service, restaurants)
directly
 retail customers indirectly
through supermarkets and
grocery stores
23
Direct segment discrimination: “Not for retail
sale”
Demand from institutional customers is more price
sensitive (corporate buyers specialize in negotiating good
deals)
Heinz sets lower margin  lower price to institutional
customers (lower margin  lower price because marginal
cost is the same);
Heinz concerned that supermarkets will buy through food
service companies and restaurants; so marks each bottle
“Not for Retail Sale”.
24
Direct segment discrimination:
Government and non-profit sector

University tuition
 Citizens/non-citizens

Health care
 Citizens/non-citizens

Value added tax
 Refund to foreigners
25
Direct segment discrimination( third
degree price discrimination)

We can also verify:

P1
P Q 
Q1  P1  1  1 1 
Q1
Q1 P1 


1
Q1 P1
MR  P1  1   with  1 
1 
P1 Q1

MR1  P1 

1 
Similarly MR2  P2 1 
 2 


With price discrimination: MR1=MR2, and thus;
1
1


1
1 
P1
 2 1 2  1
P1  1    P2  1 
or



1


P
1 2   2


1 
2 
2
1

1
If the demand curve is elastic  ε<-1 and if the demand curve is
inelastic  -1<ε<0. Thus, price will be lower in the market with
higher elasticity of demand.
26
Outline

Uniform pricing
 Complete price discrimination
 Direct segment discrimination
 Location
 Indirect segment discrimination
 Selecting the pricing policy
27
Location

Price discrimination by buyer’s location:
 Should
not set price in foreign market = price in
domestic market + freight charge
 Such pricing ignores differences in price elasticity

Set price according to
 Elasticity
of demand
 Marginal cost (production + transportation)

Microsoft – cheaper versions of Windows for
Thailand, Brasil

difference in language prevents cannibalization
28
Wall Street Journal Asia
Price for annual subscription, March 2010
Print & online: Hong Kong (HK$ 2,800)
US$361
Print & online : Japan (Yen 94,500)
US$1044
Print & online : Singapore (S$ 600)
US$430
Online only: Worldwide
US$ 104
Why different prices for print edition but
not online edition?
29
Wall Street Journal Asia

Why different prices for print edition but not
online edition?



product is perishable: buyer in Tokyo won’t
subscribe in Singapore to get newspaper a day
later
buyer won’t switch locations just to get lower
price
It is difficult to identify the location of an internet
subscriber
30
Location: Gray markets

Price differential between price and transportation cost;

Retailers/consumers buy cheap products in one market
and ship them to another market -- parallel imports
 parallel imports of car, cosmetics, branded cigarettes

With e-commerce, on-line retailers become major gray
market channel;
(c) 1999-2011, I.P.L. Png
31
Location: Gray markets


How manufacturers cope with parallel imports –
product and distribution
Product
 Technical
differentiation, eg, DVD encoding
 Packaging and labeling
 Limit warranty service
 Distribution
 Limit sales to “suspect” channels
 Pharmaceutical manufacturers limit sales to
Canadian pharmacies
32
Location: Managing gray markets



How manufacturers cope with parallel imports – product
and distribution
Product
 Technical differentiation, eg, DVD encoding
 Packaging and labeling
 Limit warranty service
Distribution
 Limit sales to “suspect” channels: Pharmaceutical
manufacturers limit sales to Canadian pharmacies
33
Outline

Uniform pricing
 Complete price discrimination
 Direct segment discrimination
 Location
 Indirect segment discrimination
 Selecting the pricing policy
34
Indirect segment discrimination

Direct segment discrimination may not be feasible
 How

to distinguish business and leisure travellers?
Use product attributes to discriminate indirectly
among various buyer segments
 restrictions

on tickets
Structure a choice to earn different incremental
margins from each segment
 Segments
differ in elasticity of demand
35
Indirect segment discrimination

Self-selection
 Business traveller – buy unrestricted fare
 Leisure traveller – buy restricted fare
36
Indirect segment discrimination
unrestricted fare
Price ($ per unit)
restricted fare
non-refundable fare
marginal cost
demand
0
Quantity (Units a year)
37
Qantas

QF403, Sydney to Melbourne, July 20, 2011
 Fully flexible fare: A$499, Flexi Saver fare: A$219,
Red e-Deal: A$199 (from Sydney), $175 (from
Melbourne)
 The more expensive the fare, the more flexibility it
provides.
 Business travelers willing to pay more for flexibility
 Use more flexible fares to target business travelers
 Differences in leisure demand
 Higher price for outbound travel (from Sydney)
 Lower price for return travel (from Melbourne)
38
Implementation of indirect segment
discrimination

Seller controls some variable to which segments are
differentially sensitive. e.g., flexibility

Buyers cannot circumvent the discriminating
variable
 E.g., airlines strictly enforces the conditions of
restricted fares.
39
Outline

Uniform pricing
 Complete price discrimination
 Direct segment discrimination
 Location
 Indirect segment discrimination
 Selecting the pricing policy
40
Selecting pricing policy
Complete price
discrimination
Highest
profit
Direct segment
discrimination
Indirect segment
discrimination
Least
information
and admin
required
Uniform pricing
41
Selecting pricing policy

Direct vs indirect segment discrimination:



if airline could directly identify business/leisure
traveller, then no need to structure a choice of
restricted/unrestricted fare;
if consumer products manufacturer could directly
identify customer with higher benefit, no need to
use coupons;
if Microsoft could directly identify high and lowvalue users, no need to create different versions
of Office – academic/regular
42
Selecting pricing policy: Product

Generally, resale of
services is more difficult
than resale of goods,
 More price
discrimination in
services than goods
 Price discrimination is
especially prevalent in
personal services
(c) 1999-2011, I.P.L. Png
Recommendation
Transform good
into service
• customization
• technical support
• consulting
43
Transforming goods into service

Advantage: more scope for price discrimination
 Contrast




selling data vis-à-vis consulting
selling PCs vis-à-vis integrating systems
selling books vis-à-vis providing education
Disadvantage – more labor-intensive, less
economies of scale
44
Information technology

The impact of information technology on price
discrimination
 conflicting effects

For sellers: easier to customize/re-configure



real-time/delayed stock prices
various versions of business software –
professional, regular,…
For buyers, easier to search and compare prices
45
Information technology

More
discrimination
 more data on
buyers
 easier to
customize
products
 online auctions
More price
competition (less
discrimination)
easier to
compare prices
46
Cannibalization

Low-margin item draws customers away from
higher-margin product.
 Resolving cannibalization
 Product design
Degrade
low-end item
Upgrade high-end item
Use multiple discriminating variables
 Supply: Limit availability of low-end item
 Distribution: Use separate channels
(c) 1999-2011, I.P.L. Png
47
Cannibalization

Mobile phone service:
 High-income customers: sell post-paid service
through direct channel
 Low-income customers: sell pre-paid through
secondary channels, eg, convenience stores
48
Pricing policies: Versioning



Information, music, computer software, book: once
content is created, marginal cost is almost zero
Offer multiple versions – direct discrimination
 HP inkjet cartridges – region
 Pre-recorded DVDs – region
Offer multiple versions – indirect discrimination
 On-line stock prices – real-time/delayed:
professional/personal
 Books – hard cover/paperback
(c) 1999-2011, I.P.L. Png
49
Pricing policies:
Microsoft Office 2007
US$
Regular price
Home and
student price
Excel
$229
n.a.
Powerpoint
$229
n.a.
Word
$229
n.a.
$399.95
$149.95
Office Suite
(c) 1999-2011, I.P.L. Png
50

Microsoft pricing illustrates:

direct segment discrimination -- cashier requires
identification for academic discount

bundling – Office Suite (includes Excel,
PowerPoint and Word) cheaper than two of the
components.
51
Pricing policies: Bundling

Strategy
 Pure bundling – only offer bundle
 Mixed bundling – offer bundle and separates
 Example:
 uniform
pricing -- airline ticket for $300, two
nights’ hotel for $150
 pure bundling -- airline ticket and two night’s hotel
for $400
 mixed bundling -- airline ticket for $300, two
nights’ hotel for $150, or package for $400.
(c) 1999-2011, I.P.L. Png
52
Pricing policies: Bundling

Bundling examples
 IT: PC + printer
 telecommunications: telephony + broadband
+ cable TV
 software: MS Win+ Office
 When to bundle?
 Cost: economies of scope in provision or use
 Indirect segmentation discrimination:
segments are differentially sensitive to
separate products and low marginal cost
(c) 1999-2011, I.P.L. Png
53
Key takeaways




To maximize profit with uniform pricing, set the price so
that the incremental margin percentage equals the
reciprocal of the absolute value of price elasticity of
demand.
Price discrimination can increase profit by taking buyer
surplus and providing a quantity closer to economically
efficient.
Complete price discrimination charges a different price
for each unit of the product.
Direct segment discrimination sets prices to earn
different incremental margins from each segment.
54
Key takeaways

Indirect segment discrimination structures a choice for
buyers to earn different incremental margins from each
segment.
 Location is one profitable basis for segment
discrimination.
 The ranking of pricing policies from most to least
profitable is complete price discrimination, direct
segment discrimination, indirect segment discrimination,
and uniform pricing.
55