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8
Pricing
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
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
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
Exhibit 8.1: The Effects of the 2Is on
Pricing
Individualization




Easy to convey prices to
individuals
Allows more targeted price
promotions
Different websites cater to
different segments
Dynamic pricing sites can
keep individuals informed
Interactivity




Pricing


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 pricediscrimination strategies
Exhibit 8.2: Key Pricing Strategies
Basic
Pricing
Strategies
Retail Price
Decisions



Cyclical
Promotional
Pricing (Hi-Lo)
Everyday Low
Pricing
Retail/Outlet
Pricing



Cost Plus
Brand Pricing
Promotions
Dynamic
Pricing
Strategies






English Auctions
Reverse-Price
English Auctions
Dutch Auctions
First-Price SealedBid Auctions
Reverse First-Price
Sealed-Bid
Auctions
Exchanges
Advanced
Pricing
Strategies






Volume Discount
Pricing
Two-Part Pricing
Bundling
Price
Discrimination
Over Time
Frenzy Pricing
Three Categories
of Price
Discrimination
Will the Internet Commoditize Prices?
Point-Counterpoint
The Internet Will Lead to Price
Commoditization
The Internet makes vast amounts of
information available to consumers.
As a result, markets will become
more efficient, and differences in
products and pricing will decrease
Consumers on the Internet are not
restricted by geography when
making their purchases, so they are
free to choose among a wider
range of providers and may switch
more frequently
On the Internet, providers have
difficulty differentiating their
products; they find it hard to
compete on anything but price

The Internet Will Not
Commoditize Prices
Even if all else is equal, brand will
still command a premium
Providers are able to differentiate
their offerings by bundling
products and services; consumers
will place a premium on attractive
"bundles"
The Internet makes it possible for
consumers to create their own
products and bundles
The Internet offers consumers a
new convenient purchasing
experience that they are willing to
pay for

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
Exhibit 8.3: Music Download Demand
Typical teenager’s semi-annual demand for pop-music downloads
$12
Optimal Price
(Q=4, P=8)
$8
$6
Price
$4.50
Marginal Cost
4
6
Quantity
12
Total
Revenue
Marginal
Revenue
Price
Quantity
12
0
0
11
1
11
11
10
2
20
9
9
3
27
7
8
4
32
5
7
5
35
3
6
6
36
1
5
7
35
-1
4
8
32
-3
3
9
27
2
10
20
1
11
11
0
12
0
-5
-7
-9
-11
Exhibit 8.4: Key Variables That Affect
Demand Curve Slope and Position
Price
Price
Price
Substitute
Offerings / Prices
Substitute
Offerings / Prices
Complementary
Offerings / Prices
Complementary
Offerings / Prices
Income
Income
Market Size
Market Size
Taste
Taste
Quantity
Exhibit 8.5: Extremes of Demand
Curve Slopes & Degrees of Flexibility
Complete Pricing Flexibility
Quantity
Quantity
(a)
(b)
Price
No Pricing Flexibility
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
Exhibit 8.6: Hi-Lo vs. EDLP vs.
Retail/Outlet
Hi-Lo

Product prices high
most of the time

Occasionally, prices
are set low
(generally lower
than prices at EDLP
retailers)
Retail/Outlet
EDLP


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 HiLo strategy)

Regular prices at
retail stores (prices
rarely discounted at
retail stores)

Merchandise
discounted at outlet
stores
Exhibit 8.7: Promotional Low-Cost
Pricing
Well-Known
Brands
Trial
Loss Leader
Seasonal/
Holiday/
Special-Demand
Items
Promotiona
l Pricing
Benefits
of Rapid
Acceptance
Staples
Switching
Costs
Exhibit 8.8: Fairness in Pricing
Environments in
Which to Consider
Underpricing
(Fairness Pricing)
Key Components of
Reference Price

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
When Fairness Is
Important

When there is an ongoing
relationship between
buyers and sellers

When the seller has
significant market power
over buyers
Exhibit 8.9: Effects of the Internet on
Dynamic Pricing
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)
Exhibit 8.10: Dynamic Pricing
Auctions
Dynamic
Pricing

English

Reverse-Price English

Dutch

First Price Sealed-Bid
(Priceline Version)
Exchanges
Exhibit 8.11: Priceline Auction
Process
Consumer
submits nonrefundable 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
Exhibit 8.12: Price Discrimination
First Degree — Charge
consumers exactly what they
are willing to pay for product
(e.g., 1–1 price haggling)
Price
Discrimination
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)
Exhibit 8.13: Volume Discounts and
Two-Part Pricing Simple Volume Discount Pricing Plan

Consumer’s Demand for
Electronic Music
Value of . . .
First Single:
Second Single:
Third Single:
Fourth Single:
Fifth Single:
Sixth Single:
Seventh Single:


for five songs)
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.50
– Revenue: $16
– Profit: $8.50
Two-Part Pricing



Production cost of a single:
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
$1.50

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 8.15: E-Information’s MixedBundling Strategy
Financial
News
Legal
News
Current
News
Value Bundle
E-Information’s
Price
$3,000
$1,500
$1,250
$5,000
Company A’s
Valuation
$3,000
$1,500
$500
Company B’s
Valuation
$3,000
$750
$1,250
Company C’s
Valuation
$3,250
$1,000
$500
Strategy Net Result
Company A:
Company B:
Company C:
Purchases value bundle. Implicitly pays $1,500 for legal news,
$500 for current news.
Purchases value bundle. Implicitly pays $750 for legal news,
$1,250 for current news.
Purchases financial news. Pays more ($3,250 vs. $3,000) for
financial news relative to Companies A and B.
Exhibit 8.16: Frenzy Pricing
Demand
Uncertainty
Fairness
Marketing
Frenzy
Pricing
Signal
of
Quality
Efficient
Selling
Method
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
Competitor Price Cuts
Financial Trouble

Typical motives for
price cutting:
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
Signaling Displeasure Over
a Competitor’s Strategy

A firm can use a price cut to
punish a competitor for a change
in its strategy
Exhibit 8.17: Responding to
Competitor Price Cuts
Responding to Competitor
Price Cuts
Enhance
Value Proposition
General Price
Cut
Justify Price
Differential
Battle
Cross
Parry
Targeted
Price Cut
Fighter
Brand
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
Exhibit 8.18: The Seven Deadly Sins
of Pricing
Exhibit 8.19: The Pricing Pentagon
Exhibit 8.21: Estimate Competitor
Response
Select potential prices
• Pick at least three
potential prices
• Must be prices that the
firm could actually
charge
Game out
competitors reactions
• Do industry research to
brief managers before
game
Estimate revised price
• Construct a scenarioplanning 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
Exhibit 8.24: Pricing Strategy
Framework
Select Retail Pricing
Strategy
Hi-Lo Pricing
Everyday Low
Pricing
Select Pricing Strategy
No Pricing
Flexibility

Price at market
Corporate Mandate


Target return pricing
Target profit return
High Initial Demand




Fairness pricing
Bundling
Frenzy pricing
Price discrimination
over time
Correlated Demand



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
Price as
Marketing Strategy



Prestige
Sign of quality
Promotional
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
Exhibit 8.25: Pricing Levers & the Four
Key Stages of Customer Relationships
Four Key Stages of Customer Relationships
Exploration/
Expansion
Awareness

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
Commitment
Dissolution

Tiered loyalty
programs

Discontinue pricing
promotions

Wide variety of
pricing plans
Become affiliates
Profit-enhancing
programs
Volume-discount
promotions
Targeted promotions

Reconfigure loyalty
programs
Decrease profit
programs








Future price
promotions
Fairness
Two-part pricing
EDLP

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
Exhibit 8.27: EBay’s Insertion Fee
Scale
Minimum Bid, Opening Value or
Reserve Price
Insertion Fee
$0.01–$9.99
$10.00–$24.99
$25.00–$49.99
$50.00–$199.99
$200 and up
$0.30
$0.55
$1.10
$2.20
$3.30
Reserve price auctions carry an additional fee, fully refunded if the item
sells:
Minimum Bid, Opening Value or
Insertion Fee
Reserve Price
$0.01-$24.99
$25.00-$199.99
$200 and up
$0.50
$1.00
$2.00
Exhibit 8.28: EBay’s Listing Option
Fees
Listing Option
Description
Fee
Homepage Featured
Item appears in a special featured section
and will most likely be rotated for display on
the eBay homepage
$99.95
Featured Plus!
Item appears in the featured-item section and
in bidder’s search results
$19.95
Highlight
Item listing is highlighted with lavendercolored band
$5.00
Bold
Item listing is displayed in bold
$2.00
Gallery
Item listing includes a small picture in the
Gallery (eBay’s miniature picture showcase)
$0.25
Gallery Featured
Item listed in the Gallery will also be featured
at the top of the Gallery in a larger size
$19.95
List in Two
Categories
Item listing appears in two categories,
increasing visibility
10-Day Auction
Duration
Item listed for the longest listing duration
available
$0.10
Buy It Now
Item available for sale instantly to the first
buyer meeting a specified price
$0.05
Double the insertion and
optional listing fee
Exhibit 8.29: EBay’s Final Value Fee
Schedule
Final Value
$0–$25
Final Value Fee
5.25% of the final value
$25–$100
5.25% of the initial $25 ($1.25) plus 2.75% of the
amount above $25
Over $1,000
5.25% of the initial $25 ($1.25) plus 2.75% of the
initial $25–$1,000 ($24.38) plus 1.5% of the
amount above $1,000
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
Pricing — Conclusion

Firms have a wide variety of potential pricing strategies and price
points to consider when deciding how to best implement profitmaximizing 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.