Download Transfer Pricing with no Outside Market

Strategic Pricing:
Theory, Practice and Policy
Professor John W. Mayo
[email protected]
Pricing Project Presentations
• Logistics - Rest of Course
• Friday: Pricing project presentations, the logistics
•
•
•
•
Affirmative presentations (Power point) 15-20 minutes
Q&A 10 minutes
Student questions encouraged
Professor Borner will help judge
• Today:
• Pricing and “The Sound of Music”
• Pricing in Vertical Settings
• Tomorrow:
• The Psychology of Pricing
2
• Question: What should the price paid by TV
stations (radio stations) be for music they play?
3
Industry Structure
Retail
consumers
Media
TV Stations
Internet
$
PROs
Composers
4
BMI
ASCAP
I
Some options
• TV (radio) stations are losing customers to alternative
(internet) media. With fewer customers and reduced
advertising $, the price should fall.
• What is the value added to TV & Radio stations caused by
the demand for music?
• The alternative? Individual contracting
• The competitive benchmark: Marginal cost
• The “reasonable bounds”
• MC ≤ P ≤ Stand Alone Cost
• Practical: Price Cap
• Pt+1 = Pt + CPI – Productivity Change
5
Vertical relations
• Review of Vertical Relations
• Transfer Pricing
Vertical relations
retail
Downstream
wholesale
Upstream
• Retail
• Demand: Q= Q (Price, advertising, Sales outlets, etc)
• Wholesale
• Demand: Q = Q (wholesale price, downstream demand)
Double Marginalization
P
Insufficient vertical control
can diminish profits
Pr
This creates incentive for
coordination/control across vertical
stages
Pm
Two-part tariff Pw= πm +mc(Q)
Alternatively, could set
maximum retail price
AC=MC
qr
Q
qm
mr
Pricing and Competition in Vertical
Markets
P
What is the relationship between the extent of
downstream competition
and the optimal upstream price?
Pr
Pm
AC=MC
qr
Q
qm
mr
Vertical relations, Retail competition and
externalities
• Assume downstream competition
• Assume that consumers receive valuable (but
costly to deliver) information at the retail stage
• Free-rider problem
• Possible solution: Resale price maintenance
• What about “generic” advertising?
• Possible solution: Territorial restrictions
• What about generic manufacturer investments in
retail stage (e.g. Training staff)
• Possible solution Exclusive dealing
Vertical restraints and the Law
• Resale price maintenance –
• per se illegal until Leegin v. PSKS (2007), now Rule of
Reason
• Territorial restriction – Rule of Reason
• Exclusive Dealing – Rule of reason
• In Europe, Article 85 (1) – vertical restraints are
‘incompatible with the common market.” (but
there is exception for technically or economically
justified restrictions where consumers receive fair
share of benefits.
Transfer Pricing
• Consider FedEX Office (aka Kinkos).
• What price should FedEX Express Charge
FedEX Office for delivering an overnight
package?
Should FedEX Office buy Express
services at retail?
Office
FedEX
Transfer Pricing
• With no outside market
• With a competitive outside market
• With a non-competitive outside market
Transfer Pricing with no Outside Market
• Set transfer price of the input equal to the
marginal cost of the upstream input
• A little economic manipulation shows that that
with prices set equal to marginal cost, the
incentives of decentralized, vertically related
profit-centers are aligned.
Transfer Pricing
To maximize profits, set the Transfer price equal
To the Net Marginal Revenue of the upstream
input
P
MCu
MCd
Pu
D
NMRu
MR
Quantity
Transfer pricing with a competitive
outside market
• Either buy upstream inputs from the market or sell
upstream inputs into the competitive market
depending on the relationship of the market price
and your firm’s marginal input cost
Transfer Pricing with Competitive
market
Assuming a competitive world price of Pu, to
maximize profits, produce qu and then purchase
inputs out to Pu = NMRu)
P
MCu
Pu
MCd
D
qu
q1 Q*
NMRu
MR
Quantity
Transfer Pricing
Competitive market & high price
Assuming a competitive world price of Pu, to
maximize profits, produce qu and sell (qu –Q) in
open market
P
MCu
Pu
Why
equate
Pu and
NMRu?
MCd
D
Q*
qu
NMRu
MR
Quantity
Efficient Component Pricing
Pricing with a non-competitive outside
market: Efficient Component Pricing Rule
At what price should Verizon provide loops to
a Competitive retail provider?
Verizon Retail
Verizon
Telephone loops
Competitive
Local Exchange Company
(CLEC)
The Critical Role of Economic Costs in
Strategic Decision-making
At what price should Verizon provide loops to the CLEC?
Retail:
(R)
Verizon
Retail
Wholesale:
(W)
Verizon Loops
CLEC
Suppose:
PR = $15
ICW = $4
ICR = $5
Efficient Component Pricing Rule :
PW = ICW + (PR – ICW – ICR)