Presentation on theme: "CH 4 Signaling and Managing Competition"— Presentation transcript:
1 CH 4 Signaling and Managing Competition Kent B. Monroe (2007). Pricing: Making Profitable Decisions.3rd Edition (Singapore: McGraw-Hill) .
2 02Chapter ObjectiveTo learn how to acquire, process, and utilize relevant and correct information about customers, competitors, and their environment to successfully manage competition.
3 03 Market Failure Asymmetric Information MARKET FAILURE Market Power Public GoodsExternalitiesAsymmetric InformationPerfect CompetitionMany sellers , Same Product, no seller can influence price
4 04 Asymmetric Information (P.78) Occurs when one party in a transaction or competitive situationhas more information than the other party.- Hidden information- Hidden action
5 05 Asymmetric Information (P. 78) External INCENTIVES SIGNALS How to avoid incorrect inferences about one’s behavior & intentions ?ExternalSIGNALSSellerBuyersINCENTIVESSellerBuyersSIGNALINCENTIVES
6 06 Two Forms of Asymmetric Information (P. 78) Adverse Selection occurs when buyers cannot detect product quality prior to purchase and use.ExternalSIGNALSMoral Hazardoccurs when the seller can change quality of their offerings withoutdetection by buyers prior to purchase or trial.INCENTIVES
7 07 Signals (P. 79) External Cues It is the actions or announcements conveying information about a firm’s intentions or abilities.It is a piece of information that can be revealed to the market at some cost to the providersIt has meaning to the receiver only if it can be interpreted.Timing is important as to how signals are interpreted.External Cues
8 08Signals (P. 29)For the external cues to be perceived as a signal, there must be:Observable differences in the product characteristic or cue across sellers.Differences between the quality and quality sellers in the cost of providing the cue.Perceptions of product quality in the market that vary directly with the characteristic or cue.
9 09Quality Signals (P. 80)What can sellers of high quality products do ?1. Provide information about qualityBuyers are skeptical about claims2. Provide other information, signals about the truthfulness of claimsSuch a signal alerts others about product quality, reputation, intentions, future actions, or forecasts.signals clear, consistent with other signals and convey commitment.
10 Default-Independent Signals Default-Contingent Signals 10Types of Quality Signals (P. 80)1. Default-Independent SignalsThe seller incurs the signal cost regardless of whether it fails to perform as promised2. Default-Contingent SignalsThe seller incurs the signal cost only when they fail to perform as promised.Default-Independent SignalsDefault-Contingent SignalsSale IndependentSale DependentRevenue RiskingCost IncurringTypesPublicly visible expenditures prior to transactionsPrivate expenditure related to sales transactionsFuture revenues at riskFuture costs at riskExamplesInvestment in:AdvertisingBrand EquityStore nameStore/Facility decorationsEmployees’ uniformCapital expendituresLow introductory priceTemporary price reductionDistribution allowancesHigh priceUmbrella brandingProduct/Brand bundlingWarrantiesMoney-back guarantees
11 11 Brand Equity (P. 83) Represents value of brand name to the buyers Brand name signals relative quality level (e.g., Hyatt, Marriott etc).Brand name reduces buyers’ search and information processing costs, and perceived risk.To be credible, maintain consistent marketing and delivery of quality.Advertising claims must be consistent with actual quality delivered.
12 12Warranties (P. 85)It is a promise made by the seller that the product, or its performance related attributes, is free from defects in materials and workmanship.It provides a commitment to correct problems if they occur during the warranty period.Should be used for products whose quality-determining attributes are revealed over time
13 13Guaranties (P. 85)A money-back guarantee promises to return the buyer’s purchase priceif the product fails to satisfy the buyer during the period covered by the guaranteeShould be available for a limited period of time after purchase and used with products whose quality-determining attributes are revealed quickly after purchase
14 14 Signals are Important (P. 86) Signals work to separate the overall market intoa high-quality and a low-quality market only…If the cost of signaling is too high for the low-quality firm to profitably mimic it.If the promise of the high-quality firm is enforceable either by buyer action or legal action
15 15Seat Work 2 (P )Read the case given at Box 4.3 and answer the questions carefully.Among the two firms, which one was the most successful?2. What are the major “Quality Signals” the winner was using?3. What are the major reasons for the failure brand ?
16 16 Two Forms of Asymmetric Information (P. 78) Adverse Selection occurs when buyers cannot detect product quality prior to purchase and use.ExternalSIGNALSMoral Hazardoccurs when the seller can change quality of their offerings withoutdetection by buyers prior to purchase or trial.INCENTIVES
17 17Moral Hazard (P. 86)It occurs when sellers can change the quality of their offerings without detection by buyers prior to purchase or trial.Buyers provide a profit incentive through a willingness to pay a “premium” price and to pay this price every time so long as quality remains at the desired level
18 18Price Premiums (P. 87)Buyers’ willingness to pay a price premium and their willingness and ability to punish the seller if quality is compromised, provides incentives to solve this moral hazard problemHigh-quality sellers receive price premiums
19 19Price Premiums (P. 87)We expect the magnitude of price premiums to increase when…The relative quality of the product or service increasesThe variability of product quality increases in the marketplaceBuyers find it difficult to assess quality before purchase or useThe time lag between purchase and the buyers’ ability to detect actual quality increasesThe length of time between repeat purchases increasesInterest rates increase
20 20Price Premiums (P. 87)We expect the magnitude of price premiums to decrease whenThe seller’s investments in establishing a reputation for quality increasesThe number of competitors in the seller’s market increasesThe seller becomes more vulnerable to the threat of buyers terminating the relationshipThe seller’s compromises on quality can quickly be made public
21 21 Product Warranties and Guarantees (P. 88) If the warranty provides for full replacement of the product, then the buyer has little incentive to care for and maintain the product properlyProviding a warranty or guarantee provides an incentive to the seller to maintain quality and thereby avoid or reduce the costs of warranty and guarantee problems
22 22Price War (P. 92)Firms battle for the patronage of customers, try to take business from a rival, or seek to drive a competitor out of the marketWhen competition is gaining in these battles, price reductions occurleading to price wars
24 24 Causes of Price Wars (P. 93) Intentional strategic actions. Failure to seek price premiums for benefit advantages.Firm increases benefits, but does not increase price commensurate with increased value.Competitive or market misreads or over-reactionsNot considering qualifiers of competitive dealsMisunderstanding incomparability of pricesMisinterpreting competitors’ price movesMisreading market and/or market share change
25 25 Negative Effects of Price Wars (P. 92) Sensitivity of profits to price decreasesPrice advantages disappear quicklyLong term effects of customers’ reference pricesIncreases customers’ price sensitivityDecrease customers’ benefit and value sensitivityIndustry shakeouts seldom occur
26 26 Avoiding Price Wars (P. 94) Explain the various ways of Avoiding the price war? SELF STUDY TOPICAvoid strategies that force a competitive price responseAvoid your competitive misreadsAvoid pricing over-reactionUnderstand the value relationshipsCommunicate prices properlyUse price-market segmentationDevelop long-term customer relationshipsDevelop a flexible pricing structureReact to competitive price moves directly and in kind