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14 Price DiscriminationThe law of demand tells us that demanders
are different, and so are willing to pay different amounts
(elasticity of demand differs and values are differentso different
willingness to pay)
What it means:Charge different prices to different demanders in
an effort to increase market and profits
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It Is Done Everywhere (Especially to Foreigners)
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P&G products for upper income & middle income
customers
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Is this a sale?
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The Goal: Higher Profits by Serving the CustomerWhether its a
deli or SAP, its always about differentiating and serving the
customers so they want to come back to you.Bill McDermott, CEO of
SAP Americas
SAP Americas tripled market share in four years by: segmenting
customers into different groups based on their size, industry,
location and needsby getting to know their customers better.
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The Grand Masterof Price Discrmination!
Google runs a continuous auction where demanders (advertisers)
bid against each other and Google adjusts price based on
results.E.g., surfer who googles digital camera and then clicks -
$0.75 charge. Surfer who googles digital cameras and then clicks -
$1.08. Based on experiencedifferent likelihood of a purchase.Mobile
phone user ads have different prices than computer users. I.e., ad
for smartphone user near a particular store at certain time of
day.
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A simple exampleSuppose demand for your productis Q = 100 -
PCould beOne demander with declining willingnessto pay, orDifferent
demanders with different willingness topay for one unit eachMC is
zero (all fixed costs)The single price solution isP = $50, Q = 50So
thatTR = $2500$Q010050DMR10050
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The ideal solutionCharge a different price for each unit (assume
MC = $0)
Thus, P = $100, $99, $98, $97, , $1
Yields an average price of $50 per unit; 100 units soldThen, TR
= $5000 (think of a real world example)
Suppose there is one demander, then all or nothing pricingTake
all 100 at a fixed fee of $5000, or take nothing (a bag of diamonds
at de Beers)
In practice, multiple pricing classes are commonFor example, an
airplane with 100 seats may have 43 different prices
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A common problemHow to change different prices?There are two key
issues:Correctly identify demandersAge (retired or
students)Appearance (local or not; rich or poor)Time (day of
weekairline tix cost less on certain daysCookie informationPrevent
resale (and be polite)Picture ID (airlines)Arbitrage difficult or
not worthwhile (hotel rooms)
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Been There; Done That
http://disneyworld.disney.go.com/florida-resident-tickets-passes/*
1-Day Magic Your Way Ticket Special online savings for Florida
Residents*** 3-Day Play Pass (Save 39% off the price of a 3-Day
ticket)Proof of a Florida residential address for each Guest age 18
or older is required for purchase and use.
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Dilbert Has It Right
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Remember this sale?
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No sale at allthe discount was built into the priceNo discount
on Black Fridayall well planned.Ex: Retailer pays $14.50 for
sweater. Suggested retail price, $50. Initial sale is $44.99. Most
sell for with a huge markdown for $21.99 (average retail price for
this good was $28.Over time, discounts larger as retailers compete
on that marginso begin with higher listed price.Amazon holiday
special 2013: Samsung 60 HDTV 45% off $1799 price for $999. Same
price can be found via search of other retailers.
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Moving a went away from it does not produce good resultsDelta
tried simple faresno fare over $499 one way and most restrictions
eliminated. Result: Delta ended up earning only 86% of industry
average revenue per aircraft mile-seat.JC Penney went to no
coupons, no salesused fair and square fixed pricing. No 99 cent
pricesround prices at 00. Result: Profits/sales fell, stock price
fell from $42 to $17 by early 2013.People say they want clear
pricingnot so in practice.
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Example from BelkinEthernet cables made in a factory in China
for a U.S. company sold for:$29.95 with brand name wrapper$19.95
with chain store wrapper$15.95 on eBay under no nameExact same
product (purchased for $3)
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Cost Is Not Pricing:iPhone 4S$188 parts for 16-GB model,
$649$207 parts for 32-GB model, $749$245 parts for 64-GB model,
$849($30-40 cost differential relates to $100 higher priceother
costs assumed same)
* Carriers may cover $450 of price with 2-year contract
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A Common Successful PracticeTesco, the largest supermarket in UK
with 31% share of grocery sales. Third largest retailer in the
world; $120 billion sales. It uses barcode information from sales
to learn how to improve service and profits.What goods are
complementary? Diapers and beer. High quality toilet paper and skin
care products.12 million UK customers have Clubcards. Six million
versions of a newsletter go to customers based on buying history
and personal characteristics. Each newsletter offers slightly
different discounts. Know your customers.After annual minimum
purchase made, 1% discount received for using Clubcard.
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Tesco: Data UsesLocation of products on shelves adjusted in each
store and product mix changed.High-income shoppers wanted higher
quality goods.Asian customers wanted large sacks of rice and
certain spices. The spices attracted non-Asian upper-income buyers,
so were then added in upper-income area stores.Database is sold to
Tesco suppliers such as Coca-Cola and Procter & Gamble so they
can study data.Result: Tesco beat Wal-Mart in UK and in South
Korea.
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How to differentiate in U.S.?Big Box Discounts without the Big
Box2007 launch in Southern California, Arizona, and Nevadajust as
crash hit. 2010announced plans to open 400 stores by 2013. Built
less than 200.Stores did poorly; 2/13 Tesco exit with $1.6 b.
loss.Some analystsstores not American enougha cross between
convenience and regular grocery with ready-to-eat meals and house
brands.
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Dynamic Pricing:Follow the Internet Leader
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Price Based on Location of Online Searcher
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Cost-Side Data UseWal-Mart and other large retailers use sales
data (15 minute increments) from one year to forecast for the next
year when peak customer loads will occur.Employee schedules are set
based on when they are likely to be most needed, getting away from
traditional eight hour shifts. Customers served better; higher
output per employee.
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Price Discrimination:Get Higher ProfitsCoke customers can buy
one Coke for $1 (the profit maximizing price) or a pack of six cans
for $3. Why would Coke offer the six cans for
$3?$$1QuantityMCDQ*MR0$0.25
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Price DiscriminationWhy would Coke offer the 6 pack for $3?It
sells to all customers at $1 for one can, but also moves down the D
curve and sells 5 more cans for $0.40 each. Extra consumer surplus
(profit) captured.$$1QuantityMCDQ*MR0$.25$.40
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Give consumers what they want: Potato Chipsone company with two
brands. One brand focused on natural and other so-called health
claims. Charge higher price even though identical to its regular
chips.
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Reward and Keep Loyal CustomersCellphone companies rank the
value of current customers to decide on price to charge.Based on
history of revenue and problems, loyal customers are offered better
deals on new phones and more service. Bad customers are offered no
special deals.The company can predict expected future revenue (and
cost of service) from customers history. Sophisticated customers
order over Internetget better price than in-store customers.
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Dump High Cost Customers?When we sell products for the same
price to all customers we price discriminate because some customers
cost more to service. It may be more profitable to charge
higher-cost customers more or get rid of them. Does the additional
(marginal) revenue justify the additional (marginal) cost?
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Example from website companyWebsmith Group develops and
maintains websites for various firms.Some were high-maintenance and
others were chronic late payers.Eliminating 5% of its clients
reduced time costs by 20%, leading to 10% growth in 2009 during the
recession.
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Example from Mail-Order CompanyThe best customers buy the most.
16% of customer base, but 40% of profits.25% of customers generate
almost no profits.
Other customer groups in between these two.
Management must decideshould the worst (high cost) customers be
dropped or made to bear more of their costs by price
discrimination? Is that possible?
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Some Customers More Costly to Serve: Price Discriminate Between
the Two High maintenance customers Low maintenance customers impose
greater costs on seller.impose fewer costs on seller.
D Higher cost customersLower cost customersDMCMCMRMRQ highQ
lowPPQ/timeQ/time
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ExampleCoach, a maker of expensive leather handbags and other
goods, has two methods of sale:1. Full price at its own stores and
at selected retailers (and on the web). Full price only; never any
discounting. Average age of shopper is 35; average expenditure is
$1,100.2. Discount outlet stores that sell last seasons products
for less. Stores usually long way from nearest full-price retailer.
Average age of shopper is 45; average expenditure is $770.
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Example: Jewelry RetailingSignet Group (U.K.) operates two sets
of jewelry stores in the U.S.:Kay Jewelers focuses on middle class
with lower price diamonds, etc. 781 stores average $1.65 million
sales.Jared focuses on upper income with expensive diamonds and
Swiss watches.110 stores with $5.6 million avg. sales.
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Kindle: Price Discrimination Over TimeKindle 1, 11/07, $399,
sold out instantlyKindle 2, 2/09, $399; 7/09, $29910/09, $2596/10,
$189Kindle 3, 8/10, $1399/11, $798/13, $69 (better tech)
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Avoiding consumers using price apps such as RedLaserSmartphone
apps allow instant price comparisons by shoppers. How to avoid?
Private label goods and variations on a theme from major
suppliers.
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Be Careful About Internal CompetitionCommon form of price
discriminationdifferent brands from same company.Presume a parent
company has three brands of shampoo.If one is a discount brand, or
if discounts offered on one brand, how much will that cut sales of
other brands? Suppose price is cut 10% on one brand and result is
30% increase in sales. Is that good? How much does that add to the
net revenue of the parent company? If sales of two other brands
fall as customers move to cheaper brand, may be a net loss. Know
your elasticities.
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BundlingConsumer A will pay $100 a year for Disney.Consumer B
will pay $10 a year for Disney.Consumer A will pay $10 a year for
ESPN.Consumer B will pay $100 a year for ESPN.Solution: Bundle
Disney & ESPN for $109 per year ($218 revenue from A&B). If
sell Disney and ESPN for $99 per year, then only $198
revenue.BUTSpirit Airlines does anti-bundlingbase ticket price very
low; add on for every little service. Works very well for it.
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Does Headquarters Know Best?CEO centralized buying for Home
Depot in 2001. Local managers could not order what they believed
customers wanted. Lock step for stores: too many snow shovels in
Arizona; not enough power tools. Good managers left; Lowes moved
in.Mixing buying power and standardization with local interests is
tough.
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How Do You Want Your Drink?Starbucks menu:Regular
coffee$2.05Tall (small) cappuccino$2.55Caffe Mocha$2.75Grande
(medium) latte$3.35Venti (large) cappuccino$3.85Venti mocha w/
vanilla$4.25
Cost difference to make these different drinks?
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Why would they do that?Travelers, Farmers and others announce
they will discount up to 10% on car insurance rates for hybrid and
electric cars.
Applauded for being sensitive to the environment. Are they
really?
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Coupon QuestionWhen Disney sells a new DVDs of a movies, it
often has a mail-in coupon that allows the customer to get a rebate
(price discount). On a $20 DVD, there may be a $5 mail-in coupon.
These are expensive to process, so why does Disney not just sell
the movies for $15?
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Common Mistakes (Thanks to Peter Drucker)1. Short term high
profit margins.Rememberthe competition is coming. Xerox dominated
copier market in early 1970s. High prices and profit margins. Canon
entered with simpler, cheaper machines and swept the market away
from Xerox.High profit margins today do not mean maximum profits
over time. Price elasticity of demand drops over time due to
alternatives.
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Common Mistakes2. Cost-Driven Pricing.Many companies derive
prices based on cost recovery plus profit margin.The goal should be
price-led costing. What will customers pay, given current and
future competition? That is, what is the demand? Can your costs fit
within those prices? Toyota and Nissan use that model and have
taken larger and larger market shares away from German and American
auto makers.
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Common Mistakes3. Using revenues to feed problems and starve
opportunities.Many firms incur high costs trying to solve problems
(often assigning the best people to solve problems). Problems are
usually due to changes in competition and changes in technologya
sign that demand has changed. Opportunities should be the focuslook
forward. GE dumps weak products rather than trying to fix them.
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