3 Today’s Agenda: Background Mechanics of Coke’s Pricing Strategy Economic RationaleCritique of Coke’s Pricing StrategyRecommendationsConclusion
4 Background Importance of vending machines Accessibility and convenience“Smart” vending machines
5 Media’s Reactions …“A cynical ploy to exploit the thirst of faithful customers”(San Francisco Chronicle)“Lunk-headed idea” (Honolulu Star-Bulletin)“Soda jerks” (Miami Herald)“Latest evidence that the world is going to hell in a handbasket” (Philadelphia Inquirer)“Ticks me off” (Edmonton Sun)
6 Mechanics of Coke’s Strategy/ Economic Rationale Price DiscriminationSelling the same product to different groups of buyers at different prices.“Hot” day v.s. “Cold” day pricesEconomic RationaleHigher price (hot) higher profitLower price (cold) induces sales higher profitThe “Numbers” Game …Economists use the term "price discrimination" to describe the practice of selling the same product to different groups of buyers at different prices in recognition of the fact that consumers assign a different value to the same product based on varying degrees of need. If possible, a company would prefer to charge a high price to those who place a high value on the good, while charging less to those that do not.In the case of Coke, its consumers were segmented based on their buying habits during hot & cold days. Based on these buying habits, Coke would adjust its prices accordingly. When it was hot outside, Coke earned a higher profit by selling its products at a higher price. Similarly, Coke could generate higher profits even when it was cold outside by sufficiently lowering its prices to induce customers to buy more of its products (See Appendix I for detailed calculations).
7 The “Numbers” Game (Slide 1 of 3) Demand function when temperature is high:QH = p , where p is priceDemand function when temperature is low:QL = pThe demand functions were derived from empirical studies based on budget lines and utilities of overall consumers.Assumption:high temperature / low temperature day is equally likelythe marginal cost (c) of a can of Coke is assumed to be $0.20.Lastly, Coke is assumed to be risk neutral.
8 The “Numbers” Game (Slide 2 of 3) Normal Vending MachinesExpected price is 70 cents per can.Expected profit is 5,000 cents per machine.“Smart” Vending MachinesPrice on a HOT day is 85 cents per canPrice on a COLD day is 55 cents per canExpected profit is 5,450 cents per machine.
9 The “Numbers” Game (Slide 3 of 3) Incremental profit per day per machine= 5,450 – 5,000 = 450 centsAssuming 200,000 “smart” vending machines,Annual incremental profit= 450 * 200,000 * 365 days= $328.5 million
10 Critique of Coke’s Strategy Similar to strategy employed byBook publishersAirlinesFlawsFailure to recognize availability of substitutesPublic announcement of its plans
11 Recommendations No public announcement Execute pricing strategy discretely likeCrate & BarrelVictoria’s SecretStrategic placement of machinesHigh traffic areas with few repeat customersExamples: Rest areas & tourist traps
12 Conclusion Highly profitable strategy if: Applies to both: Executed with extreme cautionGreed is NOT goodApplies to both:Dot coms“Bricks & mortar” companies