14 Price DiscriminationThe law of demand tells us that demanders are different, and so are willing to pay different amounts (elasticity of demand differs and values are differentso different willingness to pay)

What it means:Charge different prices to different demanders in an effort to increase market and profits

It Is Done Everywhere (Especially to Foreigners)

P&G products for upper income & middle income customers

Is this a sale?

The Goal: Higher Profits by Serving the CustomerWhether its a deli or SAP, its always about differentiating and serving the customers so they want to come back to you.Bill McDermott, CEO of SAP Americas

SAP Americas tripled market share in four years by: segmenting customers into different groups based on their size, industry, location and needsby getting to know their customers better.

The Grand Masterof Price Discrmination!

Google runs a continuous auction where demanders (advertisers) bid against each other and Google adjusts price based on results.E.g., surfer who googles digital camera and then clicks - $0.75 charge. Surfer who googles digital cameras and then clicks - $1.08. Based on experiencedifferent likelihood of a purchase.Mobile phone user ads have different prices than computer users. I.e., ad for smartphone user near a particular store at certain time of day.

A simple exampleSuppose demand for your productis Q = 100 - PCould beOne demander with declining willingnessto pay, orDifferent demanders with different willingness topay for one unit eachMC is zero (all fixed costs)The single price solution isP = $50, Q = 50So thatTR = $2500$Q010050DMR10050

The ideal solutionCharge a different price for each unit (assume MC = $0)

Thus, P = $100, $99, $98, $97, , $1

Yields an average price of $50 per unit; 100 units soldThen, TR = $5000 (think of a real world example)

Suppose there is one demander, then all or nothing pricingTake all 100 at a fixed fee of $5000, or take nothing (a bag of diamonds at de Beers)

In practice, multiple pricing classes are commonFor example, an airplane with 100 seats may have 43 different prices

A common problemHow to change different prices?There are two key issues:Correctly identify demandersAge (retired or students)Appearance (local or not; rich or poor)Time (day of weekairline tix cost less on certain daysCookie informationPrevent resale (and be polite)Picture ID (airlines)Arbitrage difficult or not worthwhile (hotel rooms)

Been There; Done That

http://disneyworld.disney.go.com/florida-resident-tickets-passes/* 1-Day Magic Your Way Ticket Special online savings for Florida Residents*** 3-Day Play Pass (Save 39% off the price of a 3-Day ticket)Proof of a Florida residential address for each Guest age 18 or older is required for purchase and use.

Dilbert Has It Right

Remember this sale?

No sale at allthe discount was built into the priceNo discount on Black Fridayall well planned.Ex: Retailer pays $14.50 for sweater. Suggested retail price, $50. Initial sale is $44.99. Most sell for with a huge markdown for $21.99 (average retail price for this good was $28.Over time, discounts larger as retailers compete on that marginso begin with higher listed price.Amazon holiday special 2013: Samsung 60 HDTV 45% off $1799 price for $999. Same price can be found via search of other retailers.

Moving a went away from it does not produce good resultsDelta tried simple faresno fare over $499 one way and most restrictions eliminated. Result: Delta ended up earning only 86% of industry average revenue per aircraft mile-seat.JC Penney went to no coupons, no salesused fair and square fixed pricing. No 99 cent pricesround prices at 00. Result: Profits/sales fell, stock price fell from $42 to $17 by early 2013.People say they want clear pricingnot so in practice.

Example from BelkinEthernet cables made in a factory in China for a U.S. company sold for:$29.95 with brand name wrapper$19.95 with chain store wrapper$15.95 on eBay under no nameExact same product (purchased for $3)

Cost Is Not Pricing:iPhone 4S$188 parts for 16-GB model, $649$207 parts for 32-GB model, $749$245 parts for 64-GB model, $849($30-40 cost differential relates to $100 higher priceother costs assumed same)

* Carriers may cover $450 of price with 2-year contract

A Common Successful PracticeTesco, the largest supermarket in UK with 31% share of grocery sales. Third largest retailer in the world; $120 billion sales. It uses barcode information from sales to learn how to improve service and profits.What goods are complementary? Diapers and beer. High quality toilet paper and skin care products.12 million UK customers have Clubcards. Six million versions of a newsletter go to customers based on buying history and personal characteristics. Each newsletter offers slightly different discounts. Know your customers.After annual minimum purchase made, 1% discount received for using Clubcard.

Tesco: Data UsesLocation of products on shelves adjusted in each store and product mix changed.High-income shoppers wanted higher quality goods.Asian customers wanted large sacks of rice and certain spices. The spices attracted non-Asian upper-income buyers, so were then added in upper-income area stores.Database is sold to Tesco suppliers such as Coca-Cola and Procter & Gamble so they can study data.Result: Tesco beat Wal-Mart in UK and in South Korea.

How to differentiate in U.S.?Big Box Discounts without the Big Box2007 launch in Southern California, Arizona, and Nevadajust as crash hit. 2010announced plans to open 400 stores by 2013. Built less than 200.Stores did poorly; 2/13 Tesco exit with $1.6 b. loss.Some analystsstores not American enougha cross between convenience and regular grocery with ready-to-eat meals and house brands.

Dynamic Pricing:Follow the Internet Leader

Price Based on Location of Online Searcher

Cost-Side Data UseWal-Mart and other large retailers use sales data (15 minute increments) from one year to forecast for the next year when peak customer loads will occur.Employee schedules are set based on when they are likely to be most needed, getting away from traditional eight hour shifts. Customers served better; higher output per employee.

Price Discrimination:Get Higher ProfitsCoke customers can buy one Coke for $1 (the profit maximizing price) or a pack of six cans for $3. Why would Coke offer the six cans for $3?$$1QuantityMCDQ*MR0$0.25

Price DiscriminationWhy would Coke offer the 6 pack for $3?It sells to all customers at $1 for one can, but also moves down the D curve and sells 5 more cans for $0.40 each. Extra consumer surplus (profit) captured.$$1QuantityMCDQ*MR0$.25$.40

Give consumers what they want: Potato Chipsone company with two brands. One brand focused on natural and other so-called health claims. Charge higher price even though identical to its regular chips.

Reward and Keep Loyal CustomersCellphone companies rank the value of current customers to decide on price to charge.Based on history of revenue and problems, loyal customers are offered better deals on new phones and more service. Bad customers are offered no special deals.The company can predict expected future revenue (and cost of service) from customers history. Sophisticated customers order over Internetget better price than in-store customers.

Dump High Cost Customers?When we sell products for the same price to all customers we price discriminate because some customers cost more to service. It may be more profitable to charge higher-cost customers more or get rid of them. Does the additional (marginal) revenue justify the additional (marginal) cost?

Example from website companyWebsmith Group develops and maintains websites for various firms.Some were high-maintenance and others were chronic late payers.Eliminating 5% of its clients reduced time costs by 20%, leading to 10% growth in 2009 during the recession.

Example from Mail-Order CompanyThe best customers buy the most. 16% of customer base, but 40% of profits.25% of customers generate almost no profits.

Other customer groups in between these two.

Management must decideshould the worst (high cost) customers be dropped or made to bear more of their costs by price discrimination? Is that possible?

Some Customers More Costly to Serve: Price Discriminate Between the Two High maintenance customers Low maintenance customers impose greater costs on seller.impose fewer costs on seller.

D Higher cost customersLower cost customersDMCMCMRMRQ highQ lowPPQ/timeQ/time

ExampleCoach, a maker of expensive leather handbags and other goods, has two methods of sale:1. Full price at its own stores and at selected retailers (and on the web). Full price only; never any discounting. Average age of shopper is 35; average expenditure is $1,100.2. Discount outlet stores that sell last seasons products for less. Stores usually long way from nearest full-price retailer. Average age of shopper is 45; average expenditure is $770.

Example: Jewelry RetailingSignet Group (U.K.) operates two sets of jewelry stores in the U.S.:Kay Jewelers focuses on middle class with lower price diamonds, etc. 781 stores average $1.65 million sales.Jared focuses on upper income with expensive diamonds and Swiss watches.110 stores with $5.6 million avg. sales.

Kindle: Price Discrimination Over TimeKindle 1, 11/07, $399, sold out instantlyKindle 2, 2/09, $399; 7/09, $29910/09, $2596/10, $189Kindle 3, 8/10, $1399/11, $798/13, $69 (better tech)

Avoiding consumers using price apps such as RedLaserSmartphone apps allow instant price comparisons by shoppers. How to avoid? Private label goods and variations on a theme from major suppliers.

Be Careful About Internal CompetitionCommon form of price discriminationdifferent brands from same company.Presume a parent company has three brands of shampoo.If one is a discount brand, or if discounts offered on one brand, how much will that cut sales of other brands? Suppose price is cut 10% on one brand and result is 30% increase in sales. Is that good? How much does that add to the net revenue of the parent company? If sales of two other brands fall as customers move to cheaper brand, may be a net loss. Know your elasticities.

BundlingConsumer A will pay $100 a year for Disney.Consumer B will pay $10 a year for Disney.Consumer A will pay $10 a year for ESPN.Consumer B will pay $100 a year for ESPN.Solution: Bundle Disney & ESPN for $109 per year ($218 revenue from A&B). If sell Disney and ESPN for $99 per year, then only $198 revenue.BUTSpirit Airlines does anti-bundlingbase ticket price very low; add on for every little service. Works very well for it.

Does Headquarters Know Best?CEO centralized buying for Home Depot in 2001. Local managers could not order what they believed customers wanted. Lock step for stores: too many snow shovels in Arizona; not enough power tools. Good managers left; Lowes moved in.Mixing buying power and standardization with local interests is tough.

How Do You Want Your Drink?Starbucks menu:Regular coffee$2.05Tall (small) cappuccino$2.55Caffe Mocha$2.75Grande (medium) latte$3.35Venti (large) cappuccino$3.85Venti mocha w/ vanilla$4.25

Cost difference to make these different drinks?

Why would they do that?Travelers, Farmers and others announce they will discount up to 10% on car insurance rates for hybrid and electric cars.

Applauded for being sensitive to the environment. Are they really?

Coupon QuestionWhen Disney sells a new DVDs of a movies, it often has a mail-in coupon that allows the customer to get a rebate (price discount). On a $20 DVD, there may be a $5 mail-in coupon. These are expensive to process, so why does Disney not just sell the movies for $15?

Common Mistakes (Thanks to Peter Drucker)1. Short term high profit margins.Rememberthe competition is coming. Xerox dominated copier market in early 1970s. High prices and profit margins. Canon entered with simpler, cheaper machines and swept the market away from Xerox.High profit margins today do not mean maximum profits over time. Price elasticity of demand drops over time due to alternatives.

Common Mistakes2. Cost-Driven Pricing.Many companies derive prices based on cost recovery plus profit margin.The goal should be price-led costing. What will customers pay, given current and future competition? That is, what is the demand? Can your costs fit within those prices? Toyota and Nissan use that model and have taken larger and larger market shares away from German and American auto makers.

Common Mistakes3. Using revenues to feed problems and starve opportunities.Many firms incur high costs trying to solve problems (often assigning the best people to solve problems). Problems are usually due to changes in competition and changes in technologya sign that demand has changed. Opportunities should be the focuslook forward. GE dumps weak products rather than trying to fix them.

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