Transcript u - esade

Welcome
Strategies of Network Companies
Jonathan D. Wareham
[email protected]
Agenda




Pricing
Standards
Auctions
Bundling
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 !!!!!
u
u
u
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Possible Causes
1. Superior disc. pricing techniques: lower
registration and menu costs
2. Heterogeneity: wine in store or restaurant
• Versioning
3. Temporal preference: consumer behavior
and types
4. Imperfect information: bait and switch
5. Neural real estate: 5% sites/75% traffic
6. Market immaturity: eMarkets too young
Fixed Prices
P
$1.00
1 Coke
Q
Fixed Prices
P
P Consumers Surplus
Dead Weight Loss
Q
MC
Q
Get a little more revenue
P
P1
P2
P3
Q1
Q2
Q3
Q
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
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
Maximize the Revenue !
Perfect (1st degree) Price Disc.
P
Q
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
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
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
What is different about this site?
Conclusions
1. Internet double edged sword:
•
Consumers enjoy lower search costs, but…
•
eMarketers have superior tools to register
your consumption patterns and price
sensitivity
2. 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 !!!!
But lets mix things up a bit more..
•Product heterogeneity, Make the products different!!!!
•Available from different locations and time periods (wine
served in store or restaurant)
•Levels of customer service, “Mass Customization”
•Search engines, product reviews, samples may create
stickiness - charge price premium.
•Outstanding product information or compelling web
design. Colors, wall paper, or exposure cycles may also
influence buying behavior.
Customer Info and Economic Effects
 Personalized product => highest price
charged.
 Price comparison is impossible.
 Sellers may be in a better position to
bargain.
 All consumers’ needs are met.
 Some configurations of industrial goods
may not be feasible.
 All consumers may be served efficiently.
Market Segmentation through Quality
Differentiation
 Different classes of service (1st class, 2nd
class)
 Basic, expanded basic and premium cable
services
 Economy, family and luxury automobiles
 Standard, professional subscription plans
 Educational, professional, enterprise
versions of software
The key consideration is
how to charge high-income
group more without making them
switch to lower-class goods
Differentiated Products
 Homogeneous products in the
industrial age
 Competition through differentiation
 Horizontal differentiation (brand
proliferation)
 Vertical differentiation (quality)
 Reasons for differentiation
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Reduce substitutability
Segment the market
Entry into the market
“price control”
Market power
Horizontal Differentiation
 The game of location (proximity to
customer’s tastes)
1/2
Bob
Bob
Alice
Alice
Vertical Differentiation
Price
High
Low
Quality
How???
1. Versions
2. Timing and delays
3. Ease of use
4. Pathways into site
5. Segregation of markets and users
6. Analysis of click stream and previous purchasing
history
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 lowquality version.
 In design, make sure you can turn
features off!
How Many Versions?
 One is too few
 Ten is (probably) too many
 Two things to do
 Analyze market
 Analyze product
Analyze Your Market
 Does it naturally subdivide into
different categories? AND
 Are their behaviors sufficiently
different?
 Example: Airlines
 Tourists v. Business travelers
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.
Goldilocks Pricing
 Mass market software (word,
spreadsheets)


Network effects
User confusion
 Default choice: 3 versions
 Extremeness aversion
 Small/large v. small/large/jumbo
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
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
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
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…
Standards: Examples

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
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RR gauges
Edison v. Westinghouse
NBC v. CBS in color TV
3Com v. Rockwell/Lucent
Qwerty
What is going on now in wireless???
Examples
 Rival evolution
 Video machines
 Rival revolutions
 DVD-A v. SACD
 Evolution v. Revolution
Recent Standards Wars
 AM stereo
 Auto industry invested, radio didn’t
 Digital wireless phones
 Europe: GSM
 US: GSM, TDMA (cousin of GSM), CDMA
 TDMA: 5 million
 CDMA: 2.5 million
 GSM: 1 million
Standards Wars
 Ericsson (TDMA) has AT&T, SBC ,
Bellsouth
 Qualcom (CDMA) has Bell Atlantic,
US West, etc
 Performance play strategy
 How big are the network
externalities?
 Geographic scope
 Investment is sunk, systems
interconnect
Key Assets
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Control over an installed base
Intellectual property rights
Ability to innovate
First-mover advantages
Manufacturing
Strength in complements
Reputation and brand name
Network Externalities
 Direct Network Effects Xn
 The value of a product is a direct
function of the number of others that
own the product
 Telephones, Fax machines
 Indirect Network Effects
 Your DVD player is not interdependent
with my DVD player. However, more
people who demand DVD players will
increase the number of DVDs available.
Demand & Supply for a Network
Good
Diffusion and Price
What is an auction ?
 A method for allocating scarce resources
based on competition
 Bidding mechanism:
 the seller (auctioneer) defines the auction
rules:
 how the winner is determined
 how much he must pay
 each buyer chooses a bidding strategy
 The auction rules define a game among
buyers
 should use game-theoretic concepts to analyze
auctions
Examples
 Ancient cases:
 500BC: Herodotus mentions about auctions in
Babylon
 Ancient Rome: commercial trading, selling war
booty
 193 A.D.: auction for the entire empire
 More recent cases: auctions




for rare collective items
in wholesale markets of fish, flowers, etc.
for public contracts
in stock market
 Very recent cases: auctions
 over Internet (E-bay, ONSALE, etc.)
 for bandwidth (Interxion, RateX, etc.) ,
spectrum
Auctions and resource allocation
 An auction is a market mechanism that
 allocates resources (goods) to buyers
 generates value for the consumers
 generates revenue for the seller
 generates revenue for the producer
 Is used where traditional market
mechanisms (e.g. fixed price) can not be
used
 can serve as an internal mechanism
value
Seller
revenue
Vi
buyers
Performance Measures
 When choosing an auction design, a variety of
assessment criteria and measures may be used:
 social efficiency (maximize the total value to buyers:
Vickrey)
 revenue (seller profit)
 bidder profit
 time, complexity, susceptibility to collusion
 Why is it hard to design? Due to lack of
10
 Auction: incentive mechanism
information!
seller
20
 buyer: maximizes expected profit
 seller: maximizes performance
measure
Bidder and seller characteristics
 Valuation
 private
values
 common
values
 correlation
U i  Vi
Buyer i
U i  V , Vi  V  xi
i
U i  aVi  b V j
Vi
j i
U (h)
 Risk
assessment
 risk neutral
 risk averse
 Symmetry
V
 symmetric 1
 asymmetric
h V  p
h
V2
Auctions
 Uses
 Major types of Auction




English
First-price, sealed-bid
Second-price, sealed-bid (Vickrey)
Dutch
English Auction
 An ascending
sequential bid auction.
 Bidders observe the
bids of others and
decide whether or not
to increase the bid.
 The item is sold to the
highest bidder.
English Auction
V
 ascending bid, open-outcry
 item is sold at least at the reservep  V
2
price
V
 best strategy for ibidder
3
4
 bid a small amount more than the
previous high bid until bidder’s valuation
is reached, then stop
 auctioneer has great influence
 most emotional and competitive of
auctions
 much information regarding demand
is revealed
V2
V1
r
First-Price, Sealed-bid
 An auction whereby
bidders simultaneously
submit bids on pieces
of paper.
 The item goes to the
highest bidder.
 Bidders do not know
the bids of other
players.
First price, sealed-bid
 first price wins
 sealed (each bidder is ignorant of
other bids)
 usually each participant is allowed
one bid
 two parts
 bidding period
 resolution (winner determination)
phase
 bidder’s strategy: shade bids
 to generate positive profit
 to avoid winner’s curse (for
common value)
 little information on demand is
V1
b1
p
V2
b2
V3
b3
Vn
bn
Second Price, Sealed-bid
 The same bidding
process as a first
price auction.
 However, the high
bidder pays the
amount bid by the
2nd highest bidder.
Developed for Social Efficiency: Vickrey
auction
 second price wins, sealed
 the item is awarded to the highest
bidder at a price equal to the second
highest bid
 dominant strategy: submit a bid
equal to true valuation 
incentive compatibility
V1
b1
b2
b3
p
V2
V3
 less fear of winner’s curse (for
common value)
b
b
V
b
b
b
b
V
bn
Vn
Why???? Asymmetric Cases
 Different distributions for bidders’
valuations
 Revenue equivalence does not apply
 First price auctions not socially
optimal
 Public authorities should use second
price auctions for efficiency purposes
 otherwise, possibility for inefficiency
u
Intuition
1. Aggressive bidders receive sure and certain
awards but pay a price closer to market
consensus.
2. The price that winning bidder pays is
determined by competitors' bids alone and does
not depend upon any action the bidder
undertakes
3. Hence, closer to real market valuation and
socially optimal
4. Less bid shading or collusion occurs because
people don't fear winner's curse.
5. Hence, they may adjust bid upwards.
6. Bidders are less inclined to compare notes
before an auction.
Dutch Auction
 A descending
price auction.
 The auctioneer
begins with a
high asking price.
 The bid decreases
until one bidder is
willing to pay the
quoted price.
 Strategically
equivalent to a
first-price auction
Dutch Auction
 descending price (often by “Dutch clock”),
open-outcry
 first price wins
 auctioneer usually has no influence
 little information on demand is revealed
price
V1
V2
V3
V4
b1
b2
b3
b4
Information Structures
 Independent private values
 Bidders know their own valuation of the item, but not
other bidders’ valuations
 Bidders’ valuations do not depend on those of other
bidders
 Affiliated (or correlated) value estimates
 Bidders do not know their own valuation of the item or
the valuations of others
 Bidders use their own information to form a value
estimate
 Value estimates are affiliated: the higher a bidder’s
estimate, the more likely it is that other bidders also
have high value estimates.
 Common values is the special case in which the true
(but unknown) value of the item is the same for all
bidders
Optimal Bidding Strategy in an English
Auction
 With independent private valuations,
the optimal strategy is to remain
active until the price exceeds your
own valuation of the object.
Optimal Bidding Strategy in a First-Price, SealedBid Auction
 If there are n bidders who all
perceive valuations to be evenly (or
uniformly) distributed between a
lowest possible valuation of L and a
highest possible valuation of H, then
the optimal bid for a risk-neutral
player whose own valuation is v is
v L
b v
.
n
Example
 Two bidders with independent private
valuations (n = 2)
 Lowest perceived valuation is unity (L
= 1)
 Optimal bid for a player whose
valuation is two (v = 2) is given by
v a
2 1
b v
 2
 $1.50
n
2
Optimal Bidding Strategy in a Second-Price
Sealed-Bid Auction
 The optimal strategy is to bid your
own valuation of the item.
 This is a dominant strategy.
 You don’t pay your own bid, so bidding
less than your value only increases the
chance that you don’t win.
 If you bid more than your valuation, you
risk buying the item for more than it is
worth to you.
Optimal Bidding Strategies with Affiliated Value
Estimates
 Difficult to describe because
 Bidders do not know their own valuations
of the item, let alone the valuations
others.
 The auction process itself may reveal
information about how much the other
bidders value the object.
 Optimal bidding requires that players
use any information gained during
the auction to update their own value
estimates.
The Winner’s Curse
 In a common-values auction, the
winner is the bidder who is the most
optimistic about the true value of the
item.
 To avoid the winner's curse, a bidder
should revise downward his or her
private estimate of the value to
account for this fact.
 The winner’s curse is most
pronounced in sealed-bid auctions.
Common value auctions
 Value of bidder is not fixed before the
auction
 True value of item is not known ex-ante,
although defined
 Value to bidder i depends on other bidder’s
values
 examples: sealed box with coins, oil-lease
 Complex strategies, no general results
 Winner’s curse: the winner discovers that
he overestimated the value of the item
 Strategic approach: shade the bid to
account for the adverse selection bias
Expected Revenues in Auctions with Risk Neutral
Bidders
 Independent Private Values
 English = Second Price = First Price =
Dutch
 Affiliated Value Estimates
 English > Second Price > First Price =
Dutch
 Bids are more closely linked to other
players information, which mitigates
players’ concerns about the winner’s
curse.
Collusion
 Bidders make collusive agreements to get
the item at a lower price:
 they select their designated winner (the one
with the highest valuation)
 others promise to follow a specific strategy
(abstain from bidding)
 Which auctions are more collusive than
others ?
 Enforcement issue: incentives for non-winners
to keep their promise
Collusion (cont.)
 First price sealed bid and Dutch auctions:
not self-enforcing! no possibility for
pmin   ,
punishment
 In FP: winner places bid =
other
bidders may abstain or break the ring by bidding
slightly higher
 In Dutch: one of the others may shout “mine”
and win!
 English and Second price auctions: selfenforcing!
 In English: if one of the others bids higher than
promised, then the winner may overbid again
 In SP: winner’s bid = valuation of others’ bid
What would you pay for all this stuff?
Desired Revenue
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
= 35
Your Valuation
3
4
3
6
3
= 35
2
4
3
4
3
But If Price = 3.5
Revenue = 14
Solution: Bundle it!!!
3
4
3
6
3
= 35
2
4
3
4
3
Revenue = 35
Someway, somehow, you will find a combination of products equal to 35
Why Bundle?
 Technological complementarities in
production, distribution, and
consumption
 Sunday newspaper
 A bundle of articles – we do not read
them all, but which ones??
 Economies of scale in production and
distribution
Why Bundle?
 Price discrimination
 Intuition different
 Price discrimination based on ability to
identify and segregate customers
 But we can’t always do that – hence 2nd
degree price discrimination
 But when marginal costs are low –
bundling may be better!
Bundling
 Price discrimination
 Increases the menu of prices to better
match heterogeneous distribution of
consumers
 Bundling reduces the effective
heterogeneity of consumers’ willingness
to pay.
 Someway, somehow – out of these 10
goods, you will find some combination
that you will value at 20$ - we just do
not know which ones.
Key Variables
 Production Costs: cost of producing
additional units for the bundle
 Distribution Costs: Costs of
distributing a bundle
 Transaction Costs: Costs of
administrating the transaction –
arranging for payment
 Binding Costs: cost of binding
components together as a bundle
 Menu Costs: Costs of administering
multiple prices of bundle
Production Costs
When production costs – specifically
marginal costs are low – bundle.
The inclusion of an additional product
does not cost much, so why not do it
anyway and increase your chances of
addressing consumers valuation
profile.
Software, magazines, cable packages
Hi marginal costs: un-bundle
Distribution Costs
When distribution costs are high bundle.
Newspapers
Low distribution costs: un-bundle
Pay per view TV
Buying single articles on internet
Transaction Costs
If cost of administering small payments
is sufficiently low – use micropayments
Pay per view
Buying single articles on internet
If cost of administering payments is
highuse long term payment/subscriptions
Magazines, Cable TV
Binding and Menu Costs
 If binding costs are high – don’t
bundle
 High menu costs may make
discriminatory pricing difficult and
may favor bundling by default –
Neither of these are as determinative as
the others.
To Bundle or to Un-Bundle?
 It depends on a combination of all
factors
 Marginal cost most important
 Distribution costs secondary
 Transaction costs: are micro
payments feasible?
 Binding and Menu costs peripheral
but an issue.