Download Chapter 9 material - Loyola University Maryland

Chapter 9 material
Segmented Pricing
The major issue is not letting a price break for one customer affect the price for other customers. In
the case of the general economics monopoly model, Marginal revenue falls below price to the
extent that I am giving everyone the same price. As I drop price to attract more customers, I
decrease price to the customers I already have. To the extent that I can separate (segment) markets,
marginal revenue is higher, since I can decrease price in one market to attract customers without
diluting price in another. Most of the discussion in this section of material is about how to segment.
General principles
1. I need to be able to identify separate markets for which the price elasticity is different.
2. I need to be able to keep these markets separate.
Missing either of these, I run into trouble. Without #1, there is no value in segmentation.
Without # 2, there is limited ability to capitalize on #1.
A single price strategy under-prices to some customers--those willing to pay well above the market
price. It leaves unserved the price sensitive customers who value the product less than the current
market price. The average poorly serves the customer base and the company.
Possible Causes of differing elasticities (Chapter 4, Nagle)
1. Reference Price Effect
If the customer considers the product comparable to an expensive product, they will
consider the value high and the price can be set high without appreciable loss of quantity sold. For
example, Nike shoes will not be found in Walmart because the customer assumes anything in
Walmart is inexpensive and potentially low quality. Nor will Bic pens be found in a jewelry store.
Ex 2: Presenting the highest priced model in a family of products first tends to increase the
reference value for the less expensive models.
2. Difficult Comparison Effect
Structuring products (or quantities of given products) such that customers have difficulty
comparing across brand or size will make segmentation and varying margins for the products
possible. Example: BJ's and Sam's Club use large (and often non- standard) sizes to make
comparison with prices in other types of stores more difficult. This allows Walmart to separate the
Walmart customer from the Sam's Club Customer and allows different pricing in these two stores.
Walmart prices Colgate by the pound and Crest by the ounce to make the per volume (required by
law) prices to be difficult to compare. This makes pricing of these two direct substitutes to be
somewhat independent.
3. Switching Cost Effect
If the customer faces a larger expenditure to avoid a particular purchase (e.g., blades for a
Gillette razor are cheaper, even with a fairly high margin than replacing both razor and blades),
they will be less sensitive to the price of the good (blades). Car parts are expensive because it is
cheaper to buy the part than to replace the car. Hence, you are willing to pay high prices for parts.
4. Price-Quality Effect
The difference in the price of an economy car and a luxury car is more than the difference in
their costs because (among other things) there is a perception that the higher price signals a higher
quality. The more expensive product is seen as qualitatively different than the less expensive
product. "Snob appeal," "image," "status," etc.
5. Expenditure Effect
The larger the purchase price relative to my budget, the more price sensitive I am. Hence
family discounts, children's discounts, senior discounts, etc. Luxury items are bought by high
income individuals. To the extent that income rises more than the price, the customer is less
sensitive to price.
6. End-Benefit Effect
To the extent that the product is only a small part of the end-benefit, the customer will be
less sensitive to the price. This is why Michelin advertises safety of babies in their ads. How much
is the child's safety worth? Doesn't this make the price difference between a Michelin and another
brand seem small? This is especially useful as a tool for segmentation since many products can be
used in a variety of markets. Careful placement and advertising can take advantage of this variety
to make the product look like multiple products rather than one.
7. Share-Cost Effect
Economists usually call this third-party-pay. The idea is that if I pay none or only part of the
cost, I am less sensitive to the cost of a product. Business travel vs. vacation travel will be
separable and have different price elasticities. The health industry is rampant with these issues.
8. Fairness Effect
Historical pricing sets what the customer thinks is reasonable or fair. The higher the past
prices, the less sensitive the customer is a high price. Segmentation using this would be possible by
adding features that are desired by the rich, warranting a higher price (with the increment being
greater than the additional cost). One could also segment between previous purchasers and new
purchasers as they might feel different about the fairness of the price.
9. Framing Effect
Customers view gains differently than losses. This allows some segmentation through how
the price is stated. Does it include service and transportation? Is there a rebate (rather than a lower
price)? Are the radio, the braking system, A/C, tinted windows, etc., options or included? "Cash
back" etc.
Markets can be segmented by
Buyer Identification
Logic: Some customers, or types of customers are more price sensitive than others. Find
characteristics that separate them and use this for segmentation.
Examples: Coupons, memberships (AAA, AARP, credit union, residents/non-residents, regular
customers/newcomers, students, seniors, children, etc.
Techniques - price high and offer discounts to identified groups
- price specific services that separate the groups ("over a Saturday" excludes many business
travelers)
- discount for proven "need" e.g., medical, school tuition
- discount for information provided (Senior's card, AAA card, union card,
membership
card)
- discount for knowledge - unadvertised specials or menu items
Location
Logic: Different markets (across space) have different competition. Hence, the customers have
more or less options to your product and therefore greater or less price elasticity. In addition, there
may be cost issues related to space that can cause the cost/benefit to differ.
Examples: Flying to round trip to Boston from BWI is more expensive than flying round trip to
Manchester, New Hampshire, or even California. The second two examples have many more
options than the route to Boston. Southwest flies to Manchester. Almost all airlines fly to the west
coast. USAir is one of a very few airlines that fly from BWI t Boston. Housing in Columbia,
Maryland, is more expensive than housing in Baltimore. This is due to both demand differences
and supply differences. Gas prices are more expensive in Columbia than Baltimore.
Techniques:
- shipping and handling may be included or an extra charge
- "cost justify" differences with the difference being greater than the cost
difference
- national boundaries may be natural segmentation fences (less so now than in the past due to
cheaper transportation, better communication and trading blocs.
Time
Theory - demand is often cyclical. Capacity limitations may be binding at only part of the market.
If these are the case, charge the customers who cause the capacity expansion for the capacity
expansion. Decrease price for those customers using the underutilized capacity at other times. This
will move some customers, saving capacity costs, and will attract customers during the lower
priced, low costs times. Two specific techniques for pricing in a cyclical environment are Peak
Load Pricing and Yield Management. Both are designed to cover the cost of capacity.
The first (Peak Load Pricing) calls for raising price during the peak to move price sensitive
customers out of the peak to the off-peak times and to signal to peak users the full cost of their
usage (and cover the marginal cost of adding capacity). Utility (phone, electricity, natural gas)
pricing is a common example of peak load pricing.
The second (Yield Management) works in markets where prior planning of usage is possible.
Discounts are offered for those who plan ahead and lock in the purchase. The price rises as the
actual service date approaches to capture the (price insensitive) value- added of flexibility and last
minute planning. Real time forecasting of the potential for reaching capacity allows adjusting the
rate of price increase and/or the number of discount customers served. The best example of this is
airline pricing.
Examples - interruptible power - give a discount to customers who can be interrupted. During the
peak, you can have less capacity. Cell phone "free after seven o'clock" if you purchase time during
the peak. The revenue comes from the peak, but the "free" time attracts customers to buy the time.
Matinees are cheaper. Air fares vary during the week. Monday and Friday are more expensive due
to increased business travel.
Combination of products used (bundling)
Theory - Different customers value different products differently. By bundling features or products,
each customer will have a small (marginal) price for the added feature. One concert is expensive.
Buying the concert series decreases the per-concert price for me and the one concert in the package
that may not be my favorite may not cost me much when compared to buying individual tickets.
Examples - Some want the French fries, some the soda, some the hamburger. Bundling them makes
the ad-ons less expensive to each customer. If I want a hamburger and a soda, the additional cost of
the fries is small, so I buy the meal. Someone else might value the value the hamburger and fries,
with a small marginal cost for the soda. Etc.
Optional bundling
Discounts may be contingent on $25 purchase. Individual tickets or series of individual
tickets. The Orioles have a season ticket and various bundles (weekend only, partial plan, etc.).
Value Added Bundling
Add features that are wanted by specific segments (price sensitive or price insensitive). This
allows more than one price to essentially the same product.
Tie-ins would be an example. This is illegal in many contexts, so is not as common as it used to be.
Volume Discounts
This can elicit additional quantity demanded by making the marginal cost of additional volume
lower than the average cost. It also can be used to preclude competition in markets where there is
limited demand. It also may be cost justified if there are economies of scale in production.
Order Discounts
There are fixed costs of an order' independent of volume. These cost savings for fewer, larger
orders can be passed on to create incentives for the customer to modify their behavior, potentially
benefiting both customer and seller.
Price Discrimination
Block pricing - extracts some of the consumer discount and attracts volume customer
Two part pricing - especially good when there are fixed and variable costs associated with a
product (car rental-- age and mileage) Metering is an example.
Product Design
Multiple models on the same product will appeal to different customers. In addition, the
number of these models matters. For example, having an expensive model may not attract many
customers, but it increases the demand for the less expensive models. Black and Decker introduced
a line of contractor tools under a totally different name, not letting people know that they were the
producers. This allowed them to establish a higher quality, higher priced image without bleed
between their two brands.