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CH 4 Signaling and Managing Competition

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1 CH 4 Signaling and Managing Competition
Kent B. Monroe (2007). Pricing: Making Profitable Decisions. 3rd Edition (Singapore: McGraw-Hill) .

2 02 Chapter Objective To 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 Goods Externalities Asymmetric Information Perfect Competition Many sellers , Same Product, no seller can influence price

4 04 Asymmetric Information (P.78)
Occurs when one party in a transaction or competitive situation has 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 ? External SIGNALS Seller Buyers INCENTIVES Seller Buyers SIGNAL INCENTIVES

6 06 Two Forms of Asymmetric Information (P. 78) Adverse Selection
occurs when buyers cannot detect product quality prior to purchase and use. External SIGNALS Moral Hazard occurs when the seller can change quality of their offerings without detection 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 providers It has meaning to the receiver only if it can be interpreted. Timing is important as to how signals are interpreted. External Cues

8 08 Signals (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 09 Quality Signals (P. 80) What can sellers of high quality products do ? 1. Provide information about quality Buyers are skeptical about claims 2. Provide other information, signals about the truthfulness of claims Such 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
10 Types of Quality Signals (P. 80) 1. Default-Independent Signals The seller incurs the signal cost regardless of whether it fails to perform as promised 2. Default-Contingent Signals The seller incurs the signal cost only when they fail to perform as promised. Default-Independent Signals Default-Contingent Signals Sale Independent Sale Dependent Revenue Risking Cost Incurring Types Publicly visible expenditures prior to transactions Private expenditure related to sales transactions Future revenues at risk Future costs at risk Examples Investment in: Advertising Brand Equity Store name Store/Facility decorations Employees’ uniform Capital expenditures Low introductory price Temporary price reduction Distribution allowances High price Umbrella branding Product/Brand bundling Warranties Money-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 12 Warranties (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 13 Guaranties (P. 85) A money-back guarantee promises to return the buyer’s purchase price if the product fails to satisfy the buyer during the period covered by the guarantee Should 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 into a 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 15 Seat 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. External SIGNALS Moral Hazard occurs when the seller can change quality of their offerings without detection by buyers prior to purchase or trial. INCENTIVES

17 17 Moral 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 18 Price 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 problem High-quality sellers receive price premiums

19 19 Price Premiums (P. 87) We expect the magnitude of price premiums to increase when… The relative quality of the product or service increases The variability of product quality increases in the marketplace Buyers find it difficult to assess quality before purchase or use The time lag between purchase and the buyers’ ability to detect actual quality increases The length of time between repeat purchases increases Interest rates increase

20 20 Price Premiums (P. 87) We expect the magnitude of price premiums to decrease when The seller’s investments in establishing a reputation for quality increases The number of competitors in the seller’s market increases The seller becomes more vulnerable to the threat of buyers terminating the relationship The 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 properly Providing 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 22 Price 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 market When competition is gaining in these battles, price reductions occur leading to price wars

23 23 Price War (P. 92)

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-reactions Not considering qualifiers of competitive deals Misunderstanding incomparability of prices Misinterpreting competitors’ price moves Misreading market and/or market share change

25 25 Negative Effects of Price Wars (P. 92)
Sensitivity of profits to price decreases Price advantages disappear quickly Long term effects of customers’ reference prices Increases customers’ price sensitivity Decrease customers’ benefit and value sensitivity Industry shakeouts seldom occur

26 26 Avoiding Price Wars (P. 94)
Explain the various ways of Avoiding the price war? SELF STUDY TOPIC Avoid strategies that force a competitive price response Avoid your competitive misreads Avoid pricing over-reaction Understand the value relationships Communicate prices properly Use price-market segmentation Develop long-term customer relationships Develop a flexible pricing structure React to competitive price moves directly and in kind

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