Copyright  1999, Sandeep Krishnamurthy. All rights reserved. E-Marketing Lecture 6 Sandeep Krishnamurthy

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Pricing q How should a company set the price for its products? q Traditional answer- –Obtain demand curve. –Understand elasticity. –Price will be directly proportional to elasticity- the more elastic the market, the lower the price.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Demand Curve Quantity Demanded Price Q1 Q2 P1 P2

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Demand Curve Quantity Demanded Price Q1Q2 P1 P2

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Demand Curve Quantity Demanded Price Q1Q2 P1 P2

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Demand Curve Quantity Demanded Price Q1Q2 P1 P2

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Price Elasticity q Sensitivity of demand to price Defined as: q (Change in Demand/Original demand)/ (Change in Price/Original price)

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Implications of Price Elasticity q If when price drops there is a huge surge in demand and vice versa then the demand function is said to be very elastic. q If when price drops there is little change in demand, the demand is said to inelastic.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Implications of Price Elasticity q In High-elastic markets: –Price drops lead to an increase in revenue, i.e., the increase in demand offsets the loss in revenue. q In inelastic markets: –Price drops lead to a decrease in revenue, i.e., the increase in demand does not offset the loss in revenue.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What determines price elasticity? q The Unique Value Effect q The Substitute Awareness Effect q Total Expenditure Effect q Shared Cost Effect q Price-Quality Effect q Inventory Effect

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What determines price elasticity? q The Unique Value Effect –Unique features and benefits lower price sensitivity and increase consumer’s willingness to pay. –For the same feature constellation, consumers are less price sensitive and willing to pay more for stronger brands.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What determines price elasticity? q The Substitute Awareness Effect –In real space, consumers may not be aware of the universal set. –Awareness of what competitors are doing can raise your price sensitivity. –If consumers are unaware of competitors, they may pay more. But, if they are aware of competitors’ price, they may be willing to pay less. –e.g.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What determines price elasticity? q The Total Expenditure Effect –Individuals are more price sensitive for items which make up a large portion of an individual’s budget. –Top categories for US households- Housing, transportation, food, personal insurance, health care, apparel and services, entertainment, education.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What determines price elasticity? q Shared Cost Effect –Split between product user and the person paying the bill. –e.g. Business Travel. –In this case, the user is price insensitive and the payer is price sensitive!

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What determines price elasticity? q Price-Quality Effect –Consumers are less price sensitive for high quality products and vice versa. –Judging quality may be hard on the web. –Once again, strong brands have an advantage.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What determines price elasticity? q Inventory Effect –Price elasticity is much higher on items that are nonperishable with low holding costs. –E.g. If Costco has a sale on a packet of 48 toilet paper rolls, individuals may buy only one because it is hard to store.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Real-time Pricing q Modifying prices constantly to meet market requirements. q Visualize –A Vending Machine –It charges 50c during winter. –It charges 95c during summer. –It charges 50c during day and 15c from 11p.m. to 6 a.m.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Fact is stranger than fiction! q Coca-Cola Co. has begun testing a vending machine that can automatically raise prices for its drinks. q It plans to raise prices in- –Hot weather. –Sports championships. q It plans to raise prices in- –Office buildings in evenings –Other low-traffic areas

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Rationales for Real-time Pricing q Shifting Demand –You have a peak demand and an off-peak demand. –Pricing high at peak demand and low at off- peak demand will smooth demand out. q Creating consumer excitement. q Utilizing changing demand elasticity.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Demand Curve Quantity Demanded Price T1 T3 T2 P1 P3 P2 Q1Q3 Q2

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Single Price Model Quantity Demanded Price T1 T3 T2 P3 Q1(new) Q3 Q2(new)

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Multiple-price model Quantity Demanded Price T1 T3 T2 P1 P3 P2 Q1Q3 Q2

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Yield Management q Has been used by airlines. q Expensive seats have few restrictions. q Low-cost fares have several restrictions- –Advance purchase –Required Saturday-night stays –off-peak travel times q Also, see

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Yield Management Works When q Perishable products/opportunities q Seasonal or other demand peaks q Product’s value differ across segments q Rapidly changing market q Product goes to waste if not used q Competition between individual and bulk purchasers q High level of price competition

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What is an Auction? q Market of Buyers and Sellers. q No fixed price. q Purchase based on bids placed by buyers. q There could be a mediator (e.g. auctioneer).

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Top Product Categories Product Category% of Web Sites Computer Hardware & Accessories55% Computer Software46% Consumer Electronics29% Household18% Office Equipment21% Sporting/Fitness Goods25% Toys26% Books/Music/Movies22% Jewelry & Watches25% Antiques & Collectibles62%

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. What does the auctioneer do? Role of Auction Sites% of Web Sites Intermediary70% Direct Seller20% Both10%

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Types of Auctions q English/Straight/Yankee q Open/Sealed Reserve q Dutch Auction q Reverse Auction

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. English/Straight/Yankee q The auctioneer begins the bidding at the minimum price (or reserve price). q Subsequent bids are in bid-up format. q The item is sold to the highest bidder who pays the price that he bid.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Open/Sealed Reserve  This refers to Straight auction which has a minimum price established by the seller before the auction begins.  If the top bid does not meet the reserve price, the seller may withdraw the item and no sale will occur.  The reserve price may be publicly announced before the auction begins (Open), or hidden from all bidders (Sealed).

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Dutch Auction  Bid-down principle  Auctioneer progressively bid down the price of an item until a bidder stops the auction by claiming the item at that price.

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Reverse Auction q Process starts with asks from buyers. q Sellers bid. q Top bid accepted. q E.g. Priceline.com

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Types of Auctions q English / Straight / Yankee88% q Open/Sealed Reserve8% q Dutch1% q Others3%

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Types of Auction Models q B to B q B to C q C to C

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. How do auction sites make money? q Insertion Fee q Final Value Fee

Copyright  1999, Sandeep Krishnamurthy. All rights reserved. Discussion Questions q What are the benefits of selling through auction? q What are the benefits of buying through auction? q Will the price be lower in an auction sale vis-à-vis a fixed price sale? What would determine that?