Transcript Pricing Policy

PRICING POLICY & STRATEGIC
THINKING
MBA NCCU
Managerial Economics
Jack Wu
PRICING POLICY
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
EMIRATES AIRLINE, MUMBAI-DUBAI,
ECONOMY CLASS, MAY 2004
Fare
Restrictions
Price
Economy unrestricted
LRT
None
INR 25,600
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
(US$ 557)
EMIRATES AIRLINE
Why does Emirates charge lower fare for
passengers originating from Mumbai?
 How is this discrimination possible?

PRICING POLICY
uniform pricing
 complete price discrimination
 direct segment discrimination
 indirect segment discrimination
 bundling

Price (Thousand Yen per unit)
UNIFORM PRICING
80
55
marginal cost
30
marginal revenue
0
2500
Quantity (Units a year)
5000
demand
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
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
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?
UNIFORM PRICING:
SHORTCOMINGS
$


buyer surplus
potential buyers
price
marginal
cost
0
quantity
leaves buyers with a
lot of surplus
does not sell to every
potential buyer
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
COMPLETE PRICE DISCRIMINATION:
PRACTICE
bargaining
 auctions

DIRECT SEGMENT DISCRIMINATION, I
price by segment
 implementation

•
•
fixed identifiable characteristic --- basic for
segmentation
no re-sale
DIRECT SEGMENT DISCRIMINATION, II
simple case: uniform price within each segment
•
•
within each segment IM% = -1/e
for segment with more elastic
demand, then lower incremental
margin percentage (IM%)
DIRECT SEGMENT DISCRIMINATION,
III
demand
80
55
30
(b) Women’s demand
marginal
revenue
marg.
cost
Price (Thousand Yen per unit)
Price (Thousand Yen per unit)
(a) Men’s demand
50
marginal
cost
40
30
demand
marginal revenue
0
2500 3000
Quantity (Units a year)
0
1000
Quantity (Units a year)
NYNEX TELEPHONE SERVICE
New York City
 residential -- $16/month
 business -- $23/month
How is discrimination possible?
ASIAN WALL STREET JOURNAL
Price for annual subscription, May 2006
Print: Hong Kong (HK$ 2,700)
US$ 348
Print: Singapore (S$ 525)
US$ 331
Print: Tokyo (Yen 94,500)
US$ 845
Interactive: Worldwide
US$ 99
 Why
different prices for print edition but not
interactive edition?
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

AIR TRAVEL: BENEFITS
Unrestricted Restricted
Traveler Segment Travel ($)
Travel ($)
Maria
Business
1000
200
Tom
Business
900
180
Robin
Vacation
500
400
Leslie
Vacation
280
224
AIR TRAVEL: INDIRECT SEGMENT
DISCRIMINATION
Product
Unrestrict
ed
Restricted
*MC=200
Fare
($) Sales
900
2
399
1
Total
Rev.
($)
1800
Total
Cost
($)
400
Profit
($)
1400
399
200
199
CHINESE EMBASSY: VISA FEES
Application period
1 day
3 days
7 days
Single entry
$75
$60
$25
Double entry
$85
$70
$35
PRICING POLICIES: RANKING
Profitability
Policy
Highest
Complete price
discrimination
Direct segment
discrimination
Indirect segment
discrimination
Uniform pricing
Lowest
Information
Requirement
Highest
Lowest
BUNDLING

strategy
pure bundling
 mixed bundling

CABLE TELEVISION: BENEFITS
“if every segment … was wild about one
thing and hated the rest, they have done
their job” (Economist)
Segment
Conservatives
Education
channel
$20
Music
channel
$2
Middle of road
$11
$11
PURE OR MIXED BUNDLING
What is the profit-maximizing pricing policy if
 marginal cost per channel = 0
 marginal cost per channel = $5
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

STRATEGIC THINKING
CASE: COKE VS. PEPSI, 1999
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 marketingbased competition”,
Andrew Conway, Morgan Stanley
COMPETITIVE DILEMMA
Pepsi
Raise price Discount
Raise
price
Coke
C: 3,
P: 3
Discount C: 5,
P: 0
What should Coke do?
C: 0,
P: 5
C: 1,
P: 1
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

DOMINATED STRATEGY
generates worse consequences than another
strategy, regardless of the choices of the other
parties

never use dominated strategy
NASH EQUILIBRIUM
Given 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
SOLVING FOR NASH EQUILIBRIUM
eliminate dominated strategies, then check
remaining cells
 “arrow” technique

NASH EQUILIBRIUM:
COMPETITIVE DILEMMA
Pepsi
Raise price
Raise price
Coke
What
Discount
C: 3,
P: 3
C: 5,
P: 0
should Coke do?
Discount
C: 0,
P: 5
C: 1,
P: 1
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.

NASH EQUILIBRIUM:
PRISONERS’ DILEMMA
Sam
Do not confess
Ian
Do not
confess
Confess
What
I: 0,
S: 0
I: 0,
S: -10
should Sam do?
Confess
I: -10,
S: 0
I: -5,
S: -5
WHERE TO ADVERTISE?
Competitor.com
NBA
We.com
NHL
NBA
W: 4,
C: 3
W: 3,
C: 4
NHL
W: 3,
C: 4
W: 4,
C: 3
No Nash equilibrium in pure strategies
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

RANDOMIZED STRATEGIES:
RETAIL PRICE COMPETITION
 Pricing
trade-off:
high price to extract buyer surplus of loyal customers
 low price to get store switchers

 Solution:
randomized discounts
COORDINATION/COMPETITION:
EVENING NEWS
Delta
7.30pm
7.30pm
Zeta
8.00pm
A: 1,
B: 1
A: 4,
B: 3
8.00pm
A: 3,
B: 4
A: 2.5,
B: 2.5
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
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

COORDINATION/COMPETITION:
FUTURE DVD STANDARD
Consumers
Blu-ray
DVD player
manufacturers
Blu-ray
HD-DVD
M: 1,
C: 1
M: -1,
C: -1
HD-DVD
M: -1,
C: -1
M: 1,
C: 1
COORDINATION/COMPETITION:
FOCAL POINT


Single Nash equilibrium - clear focal point
Multiple Nash equilibria - look for focal point to see
which one to play
SEQUENCING
Game in extensive form – sequence of moves:
nodes
branches
outcomes

EXTENSIVE FORM: EQUILIBRIUM
backward induction

final nodes  intermediate nodes  initial node
SEQUENCING:
EXTENSIVE FORM - TV NEWS
STRATEGIC MOVE
Action to influence beliefs or actions of other
parties in a favorable way
• credibility
first mover advantage
– second mover advantage
–
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
LITHOGRAPHER
Make more prints
Buy
Make prints
consumer
Litho
Do not
Do not
Litho
Do not
(1) serial number
(2) destroying the plate
(3) other solution?
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

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?
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.

POISON PILL
activates rights
acquires 100,000
shares
Hilda
Sharon
does not
doesn’t bid
Hilda loses on
initial stake +
cost of
takeover rises
STRIKE
reject union
demand
Employer
strike
Lose current wage
and possibly gain in
future wage
do not
Maintain current
wage
Union
accept
Why are strikes rare in
American professional football?
CONDITIONAL STRATEGIC MOVE:
WITHOUT DEPOSIT INSURANCE
depositor
bank remains
solvent
maintains
deposit
depositor
withdraws
deposit
principal
+ interest
bank
insolvent
zero
bank remains
solvent
principal
bank
insolvent
principal
CONDITIONAL STRATEGIC MOVE:
WITH DEPOSIT INSURANCE
depositor
bank remains
solvent
maintains
deposit
depositor
withdraws
deposit
principal
+ interest
bank
insolvent
principal
bank remains
solvent
principal
bank
insolvent
principal