Transcript Flexibility Management - Faculty Directory | Berkeley-Haas

Pricing Policy:
Time Customization
I. Economic and Behavioral
Foundations of Pricing
II. Power Pricing Concepts
October 8, 2003
Teck H. Ho
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Outline
Time customization of prices: The short term
Trial and accelerate purchase
Potential demand buildup
Peak and off-peak pricing
Demand probing and yield management
Potential negative consequences
The long-term dynamic effects
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Examples
Campbell offered trade deals to retailers during summer (a
eight-week period)
Introductory offer on a new product
Varying airfares over time
Early bird specials
Hotels’ winter specials
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Basic Motivations
1. Trial
Not Time
driven
Known
2. Purchase
Acceleration
3. Potential Build-up
4. Peak Load
Time
driven
5. Peak Load with
Demand Shift
Information
About Demand
6. Demand probing
Initially
Limited
7. Yield
Management
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1. Trial and 2. Purchase
Acceleration
On Saturday, 11/22, 1986, Ho Camera offered 5 rolls of
Fuji film (24 exposures) at $15.98 less a $10
manufacturer’s mail-in rebate valid until 12/21, 1986.
The offer highlighted Fuji’s $5.98 “Final Cost After
Rebate” or $1.20 per roll – approximately 60% less than
the regular price.
The vast majority of consumers have been loyal to Kodak
even though Consumer Reports citing virtually
indistinguishable quality differences in their films.
Two goals:
To persuade consumers to switch and try Fuji
To accelerate purchase and “load pantry”
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1. Trial and 2. Purchase
Acceleration
Two other mechanisms for enacting price customization:
Coupon
On-shelf price cut
 These mechanisms differ in two important respects:
Reference price
Selectivity (areas, price-sensitive consumers, and Kodak
consumers)
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Coupon redemption
A panel-level study of how shoppers redeem coupon
when they purchase consumer packaged goods
Regular users are more likely to redeem coupons than
previous nonusers
Prior
Prob. of
Redemption
% of Total
Redemptions
Accounted for
Nonuser
4.2%
28.5%
Infrequent User
17.8%
50.4%
Frequent User
31.3%
21.1%
 What is the motivation behind coupon offers?
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Purchase Acceleration vs.
Forward Buying
Shipments and Consumption versus Time
Shipments
Consumption
Shipments or
Consumption
40
30
20
10
0
JUN
SEP
DEC
MAR
Month
How do you resolve this problem?
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EDLP versus HILO Stores
An examination of 3,000 common SKUs across
5 supermarkets (2 EDLPs and 3 HILO stores)
(Ho, Tang, Bell, Management Science, 1998)
HILO stores have a higher price variance and a
higher expected price
EDLP versus HILO stores
Number of trips
Average spending per trip
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Mean and Standard Deviation
of Basket Prices
Tang, Bell, and Ho (California Management Review, 2002)
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Shopping Behavior
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3. Potential Buildup of LowWTP Customers
Mr. Coffee coffee maker (unit variable cost = $32)
The goal is to charge maximum WTP of a growing proportion of the
market that would buy at regular price
Suppose customers for a coffee maker are of two types, one
valuing the product at $60 and the other at $40.
Each group has a “birth” rate of 100 per month
Price
$60
$40
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Time
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3. Potential Buildup of LowWTP Customers
Unit Variable Cost = $32
Month
N($60)
N($40)
Contribution
if P=$60
Contribution
If P=$40
1
100
100
$2800
$1600
2
100
200
$2800
$2400
3
100
300
$2800
$3200
4
100
100
$2800
$1600
5
100
200
$2800
$2400
6
100
300
$2800
$3200
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Example of Value Variation
Over Different Time Periods
Time of Day
Value change with work / leisure status NYNEX rate of initial minute of
telephone call (Boston to Philly)
- 0.098 (11:00 p.m. - 8:00 am)
- 0.178 (5:00 p.m. - 11:00 p.m.)
- 0.29 weekday (8 a.m. - 5:00 p.m.)
Day of Week
Work Day vs. Not
Breakers Resort in West Palm Beach,
Florida
- $279/Night for Sunday - Thursday
- $295/Night for Friday & Saturday
Week
Holiday Periods
EuroDisney Hotel Pricing
Month
High season for resorts, demand for
product influenced by weather
conditions
Hilton Head - 3 Bedroom - Ocean Front
- March - August: $2100
- September - October: $2000
- November - February: $1450
Special Event Events causing convergence of people: Parking in China Town was
Conventions and sporting events
$20 per entry (instead of $3/hour)
during special event
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EuroDisney Hotel Pricing
Hotel
Rating
Hotel
****
****
***
***
**
**
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Adjacent
Holiday
Premium
(Francs)
(Francs)
Hotel New York
2395
2480
6%
Disneyland Hotel
2035
2455
21%
Newport Bay Club
965
1330
38%
Sequoia
865
1230
42%
Hotel Cheyenne
735
1120
52%
Hotel Santa Fe
635
1020
61%
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4. Peak and Off-Peak
Load Pricing
Peak
Sales
Volume
Sales
Volume
Sales  150  1.5  price
Sales  150  price
100
Off-Peak
75
50
37.5
$50
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$100
$50 $75
$150
$100
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5. Peak Load with Demand
Shifts
Oakland to Chicago
Professionals
Students
Number Day Flight Redeye
100
$1,000
$100
100
$600
$400
If we charge $600 for both day flight and redeye, we
receive $120,000 (leading to zero demand for redeye)
If we charge $1000 for day flight and $400 for redeye,
we receive $140,000 (shifting the students’ demand to
the redeye)
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Uncertain Demand
 Consider selling a product to a single customer and
three scenarios on information about a potential
customer’s valuation of a product
 You know she values the product at $5
 You know she values it somewhere between $4.00 and $6.00
 You know she values it somewhere between $0 and 10.00
(each value is equally likely)
 Note the customer’s expected valuation is $5.00
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6. Demand Probing: Single
Price
Mean
Value spread
Optimal Price
Value
Prob. Of
Expected
Transaction
Revenue
$5
$5
$5
1.0
$5
$5
$5 + - $1
$4
1.0
$4
$5
$5 + - $2
$3.5
0.875
$3.06
$5
$5 + - $3
$4
0.667
$2.66
$5
$5 + - $4
$4.5
0.563
$2.53
$5
$5 + - $5
$5
0.500
$2.50
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Optimal Price
(Variable Cost = 0)
1.0
1.0
Prob.
of a Sale
Prob.
of a Sale
X
Y
$4 $5 $6
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$5
$10
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Optimal Two-day Sale Pricing
Unit variable cost =0
1.0
Prob.
of a Sale
1.0
X
Prob.
of a Sale
Y
$5
$10
$3.33
Day 2
$6.67
Day 1
$10
Charge $6.67 in Day 1 and $3.33 in Day 2
Expected Revenue = 1/3 (6.67) + 1/3 (3.33)
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7. Yield Management
 American Airlines pioneered the concept in the late
1970s
 Leisure: Book well in advance, price oriented, and
flexible on schedule
 Business: Book on short notice, less price sensitive,
and inflexible on schedule
 Yield management system is to price and manage the
availability of specific fare types over time as demand
for a particular flight reveals itself
 If bookings are above the norm, this is a signal to shut
off availability of highly discounted fares
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Airline YM Operations
transaction
data
YM System
- forecasting
- allocation
inquiry
Reservation
System
implemented
allocations
forecasts
recommended allocations
bid price
availability
display
Point of sale
YM Analyst
- limited domain (O-D pair)
- revenue performance incentive
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Basic Ideas: Chicago 
SFO
United
(nonstop)
$525
Full Coach
(unrestricted)
Discount
(highly restricted)
$177
 Based on initial forecasts, start with initial allocations
(number of seats) for the two fare classes.
 Adjust the allocations based on demand realizations.
 For example, if the demand for Full Coach looks
promising, “close” the allocation for Discount.
 If later the demand is lower than expected, move
allocations to Discount again.
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Examples: What
motivations?
Campbell offered trade deals to retailers during summer (a
eight-week period)
Introductory offer on a new product
Varying airfares over time
Early bird specials
Hotels’ winter specials
October 8, 2003
Teck H. Ho
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Potential Negative
Consequences
Incremental or substitute sale (e.g., negligible
increase in consumption)
Cost of customization (e.g., production and
inventory costs)
System effect
Reference price effect
Wait for sale mentality
Fairness
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Long Term Dynamic Effects
Current
Period Price
Competitive
Situation
Current
Sales Volume
Future Price
Response Curve
and Price/Profit
Realization
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Price Response Curve
Current
Cost
Current
Contribution
Future Cost
Position
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Punch-line
Clearly understand the underlying motivation
Design the time-customization plan based on
the motivation
Consider the potential negative consequences
and long-term dynamic effects
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