This chapter discusses pricing strategies and concepts. It begins by explaining how the internet affects pricing through individualization and interactivity. It then covers the economics of pricing including demand curves, costs, and profit maximization. The chapter explores basic strategies like everyday low pricing and promotions. It also examines dynamic strategies such as auctions and algorithms. Additionally, the chapter discusses responding to competitor price changes, implementing prices across customer relationships, and concludes with an example of pricing on eBay.

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. 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

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?
The Internet Will Lead to Price
Commoditization
The Internet Will Not
Commoditize Prices

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

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
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
Price Quantity
Total
Revenue
Marginal
Revenue
12 0 0
11 1 11
10 2 20
9 3 27
8 4 32
7 5 35
6 6 36
5 7 35
4 8 32
3 9 27
2 10 20
1 11 11
0 12 0
11
9
7
5
3
1
-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 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 Flexibility Complete Pricing Flexibility
Price
Quantity 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

18. Exhibit 8.10: Dynamic Pricing
 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. 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: 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
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
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
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
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
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
Minimum Bid, Opening Value or
Reserve Price
Insertion Fee
$0.01–$9.99 $0.30
$10.00–$24.99 $0.55
$25.00–$49.99 $1.10
$50.00–$199.99 $2.20
$200 and up $3.30
Reserve price auctions carry an additional fee, fully refunded if the item
sells:
Minimum Bid, Opening Value or
Reserve Price
Insertion Fee
$0.01-$24.99 $0.50
$25.00-$199.99 $1.00
$200 and up $2.00

36. 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 lavender-
colored 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
Double the insertion and
optional listing fee
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

37. Exhibit 8.29: EBay’s Final Value Fee
Schedule
Final Value Final Value Fee
$0–$25 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

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.