PRICING POLICY & STRATEGIC THINKINGMBA NCCU Managerial EconomicsJack 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(US$ 557)
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
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
0
30
55
80
2500 5000marginal revenue
marginal cost
demand
Quantity (Units a year)
Price
(Tho
usan
d Ye
n pe
r uni
t)
UNIFORM PRICING
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: SHORTCOMINGSSHORTCOMINGS
leaves buyers with a lot of surplus
does not sell to every potential buyer
marginal cost
price
buyer surplus
potential buyers
$
0 quantity
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, IIsimple case: uniform price within each segment
� within each segment IM% = -1/e� for segment with more elastic
demand, then lower incremental margin percentage (IM%)
0
30
55
80
25003000
Quantity (Units a year)
Price
(Tho
usan
d Ye
n pe
r uni
t)
(a) Men’s demand
0
30
50
Quantity (Units a year)
Price
(Tho
usan
d Ye
n pe
r uni
t)
(b) Women’s demand
marginal revenue
demand
40
1000marginal revenue
demand
marginalcost
DIRECT SEGMENT DISCRIMINATION, III
marg.cost
NYNEX TELEPHONE SERVICENew York City residential -- $16/month business -- $23/monthHow is discrimination possible?
ASIAN WALL STREET JOURNAL
Price for annual subscription, May 2006
Print: Hong Kong (HK$ 2,700)
US$ 348
Print: Singapore (S$ 525) US$ 331Print: 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
Traveler
Segment
Unrestricted Travel ($)
Restricted Travel ($)
Maria Business 1000 200 Tom Business 900 180 Robin Vacation 500 400 Leslie Vacation 280 224
AIR TRAVEL: BENEFITS
Product
Fare ($)
Sales
Total Rev. ($)
Total Cost ($)
Profit ($)
Unrestricted
900 2 1800 400 1400
Restricted 399 1 399 200 199
*MC=200
AIR TRAVEL: INDIRECT SEGMENT DISCRIMINATION
CHINESE EMBASSY: VISA FEES
Application period1 day 3 days 7 days
Single entry $75 $60 $25Double entry $85 $70 $35
Profitability Policy Information Requirement
Highest Complete price discrimination
Highest
Direct segment discrimination
Indirect segment discrimination
Lowest Uniform pricing Lowest
PRICING POLICIES: RANKING
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 Education
channel Music channel
Conservatives $20 $ 2
Middle of road $11 $11
PURE OR MIXED BUNDLINGWhat 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
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 marketing-based competition”,
Andrew Conway, Morgan Stanley
CASE: COKE VS. PEPSI, 1999
COMPETITIVE DILEMMA
Pepsi Raise price Discount
Raise price
C: 3, P: 3
C: 0, P: 5
Coke Discount C: 5, P: 0
C: 1, P: 1
What should Coke do?
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 STRATEGYgenerates worse consequences than another strategy, regardless of the choices of the other parties
never use dominated strategy
NASH EQUILIBRIUMGiven 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 DILEMMACOMPETITIVE DILEMMA
PepsiRaise price Discount
Coke
Raise priceC: 3, P: 3
C: 0, P: 5
DiscountC: 5, P: 0
C: 1, P: 1
What should Coke do?
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’ DILEMMAPRISONERS’ DILEMMA
SamDo not confess
Confess
IanDo not confess
I: 0, S: 0
I: -10, S: 0
ConfessI: 0, S: -10
I: -5, S: -5
What should Sam do?
No Nash equilibrium in pure strategies
Competitor.com NBA NHL
NBA W: 4, C: 3
W: 3, C: 4
We.com NHL W: 3, C: 4
W: 4, C: 3
WHERE TO ADVERTISE?
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 COMPETITIONRETAIL 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 EVENING NEWSNEWS
Delta7.30pm 8.00pm
Zeta
7.30pm A: 1, B: 1
A: 3, B: 4
8.00pmA: 4, B: 3
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
ConsumersBlu-ray HD-DVD
DVD player manuf-acturers
Blu-ray M: 1, C: 1
M: -1, C: -1
HD-DVDM: -1, C: -1
M: 1, C: 1
COORDINATION/COMPETITION: FOCAL FOCAL POINTPOINT
Single Nash equilibrium - clear focal point Multiple Nash equilibria - look for focal point to
see which one to play
SEQUENCINGGame in extensive form – sequence of moves:
nodesbranchesoutcomes
EXTENSIVE FORM: EQUILIBRIUMbackward induction
final nodes intermediate nodes initial node
SEQUENCING: EXTENSIVE FORMEXTENSIVE FORM - TV NEWS- TV NEWS
STRATEGIC MOVEAction 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
consumer
Litho
LithoMake prints
Do not
Buy
Do not
Make more prints
Do not
(1) serial number (2) destroying the plate(3) other solution?
LITHOGRAPHER
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.
Sharon
Hilda
acquires 100,000shares
doesn’t bid
does not
activates rights
Hilda loses on initial stake + cost of takeover rises
POISON PILL
Union
Employer
reject union demand
accept
do not
strike Lose current wageand possibly gain infuture wage
Maintain current wage
Why are strikes rare inAmerican professional football?
STRIKE
CONDITIONAL STRATEGIC MOVE: WITHOUT DEPOSIT INSURANCE
depositor
maintains deposit
withdraws deposit
bank insolvent
bank remains solvent
principal + interest
zero
depositor
principal
principal
bank remains solvent
bank insolvent
CONDITIONAL STRATEGIC MOVE: WITH DEPOSIT INSURANCE
depositor
maintains deposit
withdraws deposit
bank insolvent
bank remains solvent
principal + interest
principal
depositor
principal
principal
bank remains solvent
bank insolvent