10/20/08
10/22/08
What is the relationship between price and demand? Why is it important for a firm to price at the point at which marginal revenue is equal to marginal cost?
•Why should a firm consider fairness when pricing its goods?
•How has the Internet enhanced opportunities for dynamic pricing strategies?
•Why would a firm want to implement a price-discrimination strategy?
•What is the difference between static and dynamic markets? Why must a firm consider its pricing strategies within the context of a dynamic market?
The Economics of Pricing
Key variables of basic demand-curve pricing:
•Price
•Substitute Offerings/ Prices
•Complementary Offerings/ Prices
•Income
•Market Size
•Taste
•Marginal Revenue
•Marginal Cost
Basic Pricing Strategies
•Cost Plus
•Target Profit Growth
•Target-Return Pricing
•Prestige Pricing
•Price as a Sign of Quality
•Cyclical Promotional Pricing (Hi-Lo)
•Everyday Low Pricing
•Fairness in Pricing
•Promotional Low-Cost Pricing
Dynamic Pricing Strategies
•Dynamic Pricing is one of the most significant contributions the Internet and the 2Is have made to pricing strategy.
•The Internet has enhanced dynamic pricing in two ways:
–Decreased Menu Costs
–Interactivity
Auction Types
•English Auctions
–Reverse-Price English Auction
•Dutch Auctions
•First Price Sealed-Bid Auctions
•Reverse First Price Sealed-Bid Auctions
•Group Buying
•Exchanges
Advanced Pricing Strategies
•Price Discrimination
–first-degree, second-degree and third-degree
•Volume Discount Pricing
•Two-Part Pricing
•Bundling
•Price Discrimination Over Time
•Frenzy Pricing
Strategic Responses to Competitor Price Cuts
®Enhance the Value Proposition
®Battle
®Cross-Parry Attack
®Targeted Response
®Fighter Brands
®Justify the Price Differential
Pricing Process
®Set pricing goal
®Differentiate value relative to substitute products
®Strategically select target customer segments
®Strategic pricing/ competitor reaction
®Select a pricing structure and price point
Pricing and Market Making on the Internet
(Dolan & Moon, HBS Case 9-500-065)
•The Internet will create downward pressure on prices:
•Potential buyers can speedily search the net
•Low consumer search costs will lead to greater price competition.
The Internet will create downward pressure on prices:
•The same technology that reduces customer search costs also:
•Facilitates buyer acquisition of quality information
•Enables suppliers to update price dynamically in response to observed demand
•Allows sellers to create meaningful markets for potential buyers with price being the outcome of the auction process
•Permits prospective buyers to specify in detail the product’s requirements and put fulfillment out to bid to an organized market of potential sellers.
In an Internet era the challenge is not only setting the price for knowledgeable consumers; but, also, how to select the most advantageous combination of market making mechanisms via which to transact exchange.
Type 1: The Set Price Mechanism
•Take it or leave it price involves horizontal interactions between buyers and sellers.
•Low transaction costs.
•Sense of fairness.
•In traditional retail markets, buyer ignorance is a source of profits, but in an Internet world search costs are low and search agents are increasing.
•Internet examples, Amazon, etoys.com, Compare.net, R U Sure, NECX.
•Internet has created set of companies that sell product below costs, e.g.,
Buy.com (but ?)
Type 1: The Set Price Mechanism
(Con’t)
•Others, like Amazon, do not offer the lowest price, but leverage other
dynamics such as:
•Branding and trust – most on-line transactions are not instantaneous and consumers have fear of being ripped-off
•The shopping experience – superior product information and search tools.
•Lock-in – activities that increase customer switching (customize customer interactions).
•Dynamic pricing – low menu costs and increased customer information.
Type II: The Buyer/Seller Negotiated Price Mechanism
•One-to-one vertical negotiations takes place around the world, from the fruit markets in Taipei, to car dealers in the NYC; however, they have some disadvantages:
•It takes longer than fixed price exchanges to complete.
•Price tends to dominate over features.
•For negotiations to be effective, the customer contact person must have some degree of pricing authority.
The Internet provides an efficient mechanism that mitigates each of these problems.
•Start with a specific price: NexTag.com gives listing of products and allows the customer to counteroffer. Advantages of the process are that negotiations can be done with multiple sellers at once and the customer is always in control.
•Another alternative is Hagglezone for real time negotiations and entertainment.
•Buying-power based negotiations
•Product aggregators, get volume discounts, sites like Accompany.
Type III: Auctions and Exchanges
•Three types of auctions based on competition across buyers and/or sellers producing prices that can be highly variable across transactions:
•(a) Classic auctions – competition across buyers lead to price
•(b) Reverse auctions – competition across sellers lead to price
•(c) Exchanges – multiple buyers and sellers interact to set price.
Classic Auctions IIIa
•Basic demand aggregation model that functions to deliver the best price for
sellers, given the market demand the seller has been able to assemble.
•Types of auctions include: C-2-C (eBay-like); B-2-C (Egghead); B-2-B (Tradeout). Related items of trust, community and relationships. Barriers of entry are relatively low, but success breeds success.
The Internet increases the economic efficiency associated with auction models. More specifically:
•The Internet lowers the search costs for sellers looking for buyers (transforms niche market segments into mainstream segments).
•The Internet lowers the cost associated with making inventory available to buyers immediately (bypass liquidation broker fees).
•For buyers, the Internet lowers the cost associated with accessing hard-to-find items (auctions aggregate supply for buyers).
•The interactive nature of the Internet facilitates the creation of a buyer community (eBay is actually the creation of something that could not have been done in the real world).
Classic Auction IIIb
•The buyer is more proactive and specifies what it is that will be purchased; then, supplier’s bid indicates the price of fulfilling that demand.
•Reverse auctions have been the main tool in B-2-B. RFP and RFQ are generated and transmitted to qualified buyers for bid. B-2-B examples include Freemarkets and CommerceOne,
•B-2-C auctions of Type IIb are less well developed, but some are forming like “imandi” where individuals put out a RFQ for a product or service.
Buyers remain anonymous to sellers and can choose to follow-up via e-mail.
•The Priceline-type variant: In many ways the service represents a sacrifice of consumer power in favor of solving a vendor’s problem of selling off excess capacity.
•By requiring customers to be flexible with regard to brand, sellers and/or product features, sellers are able to generate incremental revenues without disrupting their existing distribution channels or retail pricing structure.
Classic Auction IIIc
•IIIc exchanges are electronic marketplaces where a group of buyers and a group of sellers interact to trade and set prices for transactions.
•The general purpose of exchanges is for each product to dynamically update a list of offers to buy and offers to sell. These buys and sells are matched through the market making process.
•A major advantage of these exchanges, e.g., Fast Parts, ESteel, ChemConnect, is that they bring together buyers and sellers on a global scale.
Summary
•The Internet has changed the way many markets are organized and consequently the mechanisms via which price is set.
•Markets are now more efficient, i.e., they cut the ignorance premium, and different forms of market mechanisms will operate, but we can not unequivocally say that price will go down.
•The Internet can increase prices for time sensitive commodities in inefficient markets, e.g., airlines.
•The Internet can also be a price boom for differentiated commodities; it allows suppliers to provide more requested consumer information.
•However, the Internet can be a disaster for those with a commodity selling mentality.