2. chapter 8 Pricing McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

3. Pricing — Today’s Objectives Objectives will be to: Discuss how the 2Is affect pricing strategy Discuss the economics of pricing Explore basic, dynamic and advanced pricing strategies Examine strategic responses to competitor price cuts Review the pricing process Discuss the implementation of pricing levers across the four relationship stages

4. How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion Chapter 8: Pricing

5. How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion

6. Exhibit 8.1: The Effects of the 2Is on Pricing Easy to convey prices to individuals Allows more targeted price promotions Different websites cater to different segments Dynamic pricing sites can keep individuals informed Allows a larger buying and selling community Facilitates dynamic pricing strategies Allows prices to be changed easily Allows consumers to easily check prices Easier to understand and measure consumers’ reactions to price promotions Easier to receive customer feedback on price, understand customers’ willingness to pay, and implement price- discrimination strategies Individualization Interactivity Pricing

7. Retail Price Decisions Basic Pricing Strategies Dynamic Pricing Strategies Advanced Pricing Strategies Cyclical Promotional Pricing (Hi-Lo) Everyday Low Pricing Retail/Outlet Pricing Cost Plus Brand Pricing Promotions English Auctions Reverse-Price English Auctions Dutch Auctions First-Price Sealed- Bid Auctions Reverse First-Price Sealed-Bid Auctions Exchanges Volume Discount Pricing Two-Part Pricing Bundling Price Discrimination Over Time Frenzy Pricing Three Categories of Price Discrimination Exhibit 8.2: Key Pricing Strategies

8. Will the Internet Commoditize Prices? Point-Counterpoint

9. Chapter 8: Pricing How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion

10. Exhibit 8.3: Music Download Demand Price Quantity $12 $6 6 12 11 9 7 5 3 1 -3 -5 -7 -9 -11 Typical teenager’s semi-annual demand for pop-music downloads $8 $4.50 4 Marginal Cost Optimal Price (Q=4, P=8)

11. Exhibit 8.4: Key Variables That Affect Demand Curve Slope and Position Price Quantity Price Substitute Offerings / Prices Complementary Offerings / Prices Income Market Size Taste Substitute Offerings / Prices Complementary Offerings / Prices Income Market Size Taste

12. Exhibit 8.5: Extremes of Demand Curve Slopes & Degrees of Flexibility No Pricing FlexibilityComplete Pricing Flexibility Price Quantity Price Quantity (a)(b)

13. Chapter 8: Pricing How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion

14. Exhibit 8.6: Hi-Lo vs. EDLP vs. Retail/Outlet Hi-Lo EDLP Product prices high most of the time Occasionally, prices are set low (generally lower than prices at EDLP retailers) Everyday prices are set low (generally lower than the high price in Hi-Lo strategy) Occasionally, EDLP prices are discounted (generally not lower than low prices in Hi- Lo strategy) Retail/Outlet Regular prices at retail stores (prices rarely discounted at retail stores) Merchandise discounted at outlet stores

15. Exhibit 8.7: Promotional Low-Cost Pricing Promotiona l Pricing Trial Loss Leader Benefits of Rapid Acceptance Switching Costs Well-Known Brands Staples Seasonal/ Holiday/ Special-Demand Items

16. Exhibit 8.8: Fairness in Pricing Past prices Close substitute prices Context or purchase environment Market clearing price much higher than some well-established reference price Ongoing pecuniary relationship between buyer and seller Key Components of Reference Price Environments in Which to Consider Underpricing (Fairness Pricing) When there is an ongoing relationship between buyers and sellers When the seller has significant market power over buyers When Fairness Is Important

17. Exhibit 8.9: Effects of the Internet on Dynamic Pricing Decreased Menu Costs (Prices can be easily changed) Interactivity (Easy for buyers and sellers to interact and negotiate prices) Effects of the Internet on Dynamic Pricing Effects of the Internet on Dynamic Pricing

18. Exhibit 8.10: Dynamic Pricing English Reverse-Price English Dutch First Price Sealed-Bid (Priceline Version) English Reverse-Price English Dutch First Price Sealed-Bid (Priceline Version) Exchanges Dynamic Pricing Auctions

19. Exhibit 8.11: Priceline Auction Process Consumer submits non- refundable bid Priceline checks if any of its participating airlines are willing to offer roundtrip flight at bid price or lower Checks airline’s seat availability Priceline accepts or rejects bid

20. Exhibit 8.12: Price Discrimination First Degree — Charge consumers exactly what they are willing to pay for product (e.g., 1–1 price haggling) Second Degree — Charge consumers exactly what they are willing to pay for first unit of good as well as additional units (e.g., volume pricing) Third Degree — Divide consumers into distinct segments, charging different prices to different segments (e.g., movie-theater pricing) Price Discrimination

21. Consumer’s Demand for Electronic Music Value of... First Single:$6.00 Second Single:$5.00 Third Single:$4.00 Fourth Single:$3.00 Fifth Single:$2.00 Sixth Single:$1.00 Seventh Single:$0.50 Production cost of a single:$1.50 Buy first three singles at $4 per single After three singles have been purchased, buy two additional singles for $2 each $4 is “left on the table” (consumer was willing to pay $20 for five songs) –Revenue: $16 –Profit: $8.50 A flat subscription fee of $12.50 can be charged. In addition to the flat subscription fee, a fee of $1.50 per single can be charged. Given its demand schedule, the consumer is willing to pay the subscription fee and purchase five singles at $1.50 per single; recall that the consumer values the five singles at $20 –Total Revenue: $20 –Total Profit: $12.50 Economically speaking, it is optimal to use a flat fee subscription model only when the marginal cost of producing the good is equal to zero Exhibit 8.13: Volume Discounts and Two-Part Pricing Simple Volume Discount Pricing Plan Two-Part Pricing

22. Strategy Net Result Company A: Purchases value bundle. Implicitly pays $1,500 for legal news, $500 for current news. Company B: Purchases value bundle. Implicitly pays $750 for legal news, $1,250 for current news. Company C: Purchases financial news. Pays more ($3,250 vs. $3,000) for financial news relative to Companies A and B. Exhibit 8.15: E-Information’s Mixed- Bundling Strategy

23. Exhibit 8.16: Frenzy Pricing Frenzy Pricing Demand Uncertainty Efficient Selling Method Fairness Signal of Quality Marketing

24. Chapter 8: Pricing How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion

25. Competitor Price Cuts Financial Trouble Decreasing prices may be a desperate attempt to raise cash, or signal to competitors an interest in being acquired Financial Trouble Decreasing prices may be a desperate attempt to raise cash, or signal to competitors an interest in being acquired Attempting to Become an Industry Leader Decreasing prices is sometimes a show of strength to indicate that a firm is doing well enough to withstand the lower prices Attempting to Become an Industry Leader Decreasing prices is sometimes a show of strength to indicate that a firm is doing well enough to withstand the lower prices Signaling Displeasure Over a Competitor’s Strategy A firm can use a price cut to punish a competitor for a change in its strategy Signaling Displeasure Over a Competitor’s Strategy A firm can use a price cut to punish a competitor for a change in its strategy Typical motives for price cutting:

26. Responding to Competitor Price Cuts Enhance Value Proposition General Price Cut Cross Parry Targeted Price Cut Fighter Brand Battle Justify Price Differential Exhibit 8.17: Responding to Competitor Price Cuts

27. Chapter 8: Pricing How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion

28. Exhibit 8.18: The Seven Deadly Sins of Pricing

29. Exhibit 8.19: The Pricing Pentagon

30. Exhibit 8.21: Estimate Competitor Response Select potential prices Game out competitors reactions Estimate revised price Pick at least three potential prices Must be prices that the firm could actually charge Do industry research to brief managers before game Construct a scenario- planning exercise Use a multiperiod game for best results Use game results to estimate both the firm’s final price as well as competitors’ price points

31. Exhibit 8.24: Pricing Strategy Framework Hi-Lo Pricing Everyday Low Pricing No Pricing Flexibility Price at market Corporate Mandate Target return pricing Target profit return Target return pricing Target profit return High Initial Demand Fairness pricing Bundling Frenzy pricing Price discrimination over time Fairness pricing Bundling Frenzy pricing Price discrimination over time Correlated Demand Bundling Volume discount pricing Two-part pricing Bundling Volume discount pricing Two-part pricing Dynamic Pricing English auction Reverse English auction Dutch auction (regular and eBay type) First price sealed-bid auction (regular and Priceline type) Reverse first price sealed-bid auction Group buying Electronic exchange English auction Reverse English auction Dutch auction (regular and eBay type) First price sealed-bid auction (regular and Priceline type) Reverse first price sealed-bid auction Group buying Electronic exchange Price as Marketing Strategy Prestige Sign of quality Promotional Prestige Sign of quality Promotional Select Retail Pricing Strategy Select Pricing Strategy

32. Chapter 8: Pricing How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion

33. Four Key Stages of Customer Relationships Click-through promotions Web-referral promotions Specialty negotiated promotions (e.g., hotels) Bricks-and-clicks promotions Web price discounts Bundle Frenzy pricing Prestige Price as a sign of quality Hi-Lo Dynamic pricing EDLP Targeted Promotions Future price promotions Justify prices Loyalty programs Tiered loyalty programs Wide variety of pricing plans Become affiliates Profit-enhancing programs Volume-discount promotions Targeted promotions Future price promotions Fairness Two-part pricing EDLP Discontinue pricing promotions Reconfigure loyalty programs Decrease profit programs Exhibit 8.25: Pricing Levers & the Four Key Stages of Customer Relationships Awareness Exploration/ Expansion Exploration/ Expansion Commitment Dissolution

34. Chapter 8: Pricing How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion

35. Exhibit 8.27: EBay’s Insertion Fee Scale

36. Exhibit 8.28: EBay’s Listing Option Fees

37. Exhibit 8.29: EBay’s Final Value Fee Schedule

38. Chapter 8: Pricing How the 2Is Affect Pricing Strategy Economics of Pricing Basic, Dynamic and Advanced Pricing Strategies Strategic Responses to Competitor Price Cuts Pricing Process Implementation of Pricing Levers Across the Four Relationship Stages EBay Example Conclusion

39. Pricing — Conclusion Firms have a wide variety of potential pricing strategies and price points to consider when deciding how to best implement profit- maximizing strategies. Firms face multiple pricing decisions including basic, dynamic, and advanced pricing strategies. There are a variety of pricing levers for firms to employ in their pricing strategies. Each stage of the customer relationship has a set of appropriate pricing levers that should be used.