Pricing Policy: Time Customization
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Transcript of Pricing Policy: Time Customization
October 8, 20031
Teck H. Ho
Pricing Policy:Pricing Policy:Time CustomizationTime Customization
I. Economic and Behavioral Foundations of Pricing
II. Power Pricing Concepts
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OutlineOutlineTime customization of prices: The short term
Trial and accelerate purchasePotential demand buildupPeak and off-peak pricingDemand probing and yield managementPotential negative consequences
The long-term dynamic effects
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ExamplesExamplesCampbell offered trade deals to retailers during summer (a
eight-week period)
Introductory offer on a new product
Varying airfares over time
Early bird specials
Hotels’ winter specials
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Basic MotivationsBasic Motivations
InformationAbout Demand
Known
InitiallyLimited
Not Timedriven
Timedriven
1. Trial
2. PurchaseAcceleration
3. Potential Build-up4. Peak Load
5. Peak Load withDemand Shift
6. Demand probing
7. Yield Management
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1. Trial and 2. Purchase 1. Trial and 2. Purchase AccelerationAcceleration On Saturday, 11/22, 1986, Ho Camera offered 5 rolls of
Fuji film (24 exposures) at $15.98 less a $10 manufacturer’s mail-in rebate valid until 12/21, 1986.
The offer highlighted Fuji’s $5.98 “Final Cost After Rebate” or $1.20 per roll – approximately 60% less than the regular price.
The vast majority of consumers have been loyal to Kodak even though Consumer Reports citing virtually indistinguishable quality differences in their films.
Two goals:To persuade consumers to switch and try Fuji To accelerate purchase and “load pantry”
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1. Trial and 2. Purchase 1. Trial and 2. Purchase AccelerationAcceleration
Two other mechanisms for enacting price customization:CouponOn-shelf price cut
These mechanisms differ in two important respects:Reference priceSelectivity (areas, price-sensitive consumers, and Kodak consumers)
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Coupon redemptionCoupon redemptionA panel-level study of how shoppers redeem coupon
when they purchase consumer packaged goodsRegular users are more likely to redeem coupons than
previous nonusers
What is the motivation behind coupon offers?
Prior Prob. of
Redemption
% of Total Redemptions Accounted for
Nonuser 4.2% 28.5%
Infrequent User 17.8% 50.4%
Frequent User 31.3% 21.1%
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Shipments and Consumption versus Time
0
10
20
30
40
Month
Ship
men
ts o
r C
onsu
mpt
ion
Purchase Acceleration vs. Purchase Acceleration vs. Forward BuyingForward Buying
SEP DECJUN MAR
Shipments Consumption
How do you resolve this problem?
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EDLP versus HILO StoresEDLP versus HILO StoresAn examination of 3,000 common SKUs across
5 supermarkets (2 EDLPs and 3 HILO stores) (Ho, Tang, Bell, Management Science, 1998)
HILO stores have a higher price variance and a higher expected price
EDLP versus HILO storesNumber of tripsAverage spending per trip
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Mean and Standard Deviation of Mean and Standard Deviation of Basket PricesBasket Prices
Tang, Bell, and Ho (California Management Review, 2002)
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Shopping BehaviorShopping Behavior
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3. Potential Buildup of Low-3. Potential Buildup of Low-WTP CustomersWTP Customers Mr. Coffee coffee maker (unit variable cost = $32)The goal is to charge maximum WTP of a growing proportion of the
market that would buy at regular priceSuppose customers for a coffee maker are of two types, one
valuing the product at $60 and the other at $40. Each group has a “birth” rate of 100 per month
1 2 3 4 5 6 Time
Price$60
$40
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3. Potential Buildup of Low-3. Potential Buildup of Low-WTP CustomersWTP Customers
Month N($60) N($40) Contribution if P=$60
Contribution
If P=$401 100 100 $2800 $16002 100 200 $2800 $24003 100 300 $2800 $32004 100 100 $2800 $16005 100 200 $2800 $24006 100 300 $2800 $3200
Unit Variable Cost = $32
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Example of Value Variation Example of Value Variation Over Different Time PeriodsOver Different Time Periods
Time of Day Value change with work / leisure status NYNEX rate of initial minute oftelephone call (Boston to Philly) - 0.098 (11:00 p.m. - 8:00 am) - 0.178 (5:00 p.m. - 11:00 p.m.) - 0.29 weekday (8 a.m. - 5:00 p.m.)
Day of Week Work Day vs. Not Breakers Resort in West Palm Beach,Florida - $279/Night for Sunday - Thursday - $295/Night for Friday & Saturday
Week Holiday Periods EuroDisney Hotel Pricing
Month High season for resorts, demand for Hilton Head - 3 Bedroom - Ocean Frontproduct influenced by weather - March - August: $2100conditions - September - October: $2000
- November - February: $1450
Special Event Events causing convergence of people: Parking in China Town was Conventions and sporting events $20 per entry (instead of $3/hour)
during special event
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EuroDisney Hotel PricingEuroDisney Hotel PricingHotel Rating
Hotel Adjacent
(Francs)
Holiday
(Francs)
Premium
**** Hotel New York 2395 2480 6%
**** Disneyland Hotel 2035 2455 21%
*** Newport Bay Club 965 1330 38%
*** Sequoia 865 1230 42%
** Hotel Cheyenne 735 1120 52%
** Hotel Santa Fe 635 1020 61%
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4. Peak and Off-Peak4. Peak and Off-PeakLoad PricingLoad Pricing
$100$75$50
37.5
75
Off-PeakSalesVolume
$150$100$50
50
100
Peak SalesVolume
price150Sales price5.1150Sales
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5. Peak Load with Demand 5. Peak Load with Demand ShiftsShifts
Oakland to ChicagoNumber Day Flight Redeye
Professionals 100 $1,000 $100
Students 100 $600 $400
If we charge $600 for both day flight and redeye, we receive $120,000 (leading to zero demand for redeye)
If we charge $1000 for day flight and $400 for redeye, we receive $140,000 (shifting the students’ demand to the redeye)
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Uncertain DemandUncertain DemandConsider selling a product to a single customer and
three scenarios on information about a potential customer’s valuation of a product
You know she values the product at $5 You know she values it somewhere between $4.00 and $6.00 You know she values it somewhere between $0 and 10.00
(each value is equally likely)
Note the customer’s expected valuation is $5.00
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6. Demand Probing: Single 6. Demand Probing: Single PricePriceMean
Value
Value spread Optimal Price Prob. Of
Transaction
Expected
Revenue
$5 $5 $5 1.0 $5
$5 $5 + - $1 $4 1.0 $4
$5 $5 + - $2 $3.5 0.875 $3.06
$5 $5 + - $3 $4 0.667 $2.66
$5 $5 + - $4 $4.5 0.563 $2.53
$5 $5 + - $5 $5 0.500 $2.50
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Optimal Price Optimal Price (Variable Cost = 0)(Variable Cost = 0)
$10$5
1.0
X
Y
Prob.of a Sale
$6$4
1.0
Prob.of a Sale
$5
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Optimal Two-day Sale PricingOptimal Two-day Sale Pricing
$10$5
1.0
X
Y
$10$6.67Day 1
1.0
$3.33Day 2
Charge $6.67 in Day 1 and $3.33 in Day 2Expected Revenue = 1/3 (6.67) + 1/3 (3.33)
Prob.of a Sale Prob.
of a Sale
Unit variable cost =0
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7. Yield Management7. Yield ManagementAmerican Airlines pioneered the concept in the late
1970sLeisure: Book well in advance, price oriented, and
flexible on scheduleBusiness: Book on short notice, less price sensitive,
and inflexible on scheduleYield management system is to price and manage the
availability of specific fare types over time as demand for a particular flight reveals itself
If bookings are above the norm, this is a signal to shut off availability of highly discounted fares
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Airline YM OperationsAirline YM Operations
ReservationSystem
Point of sale
inquiry
availabilitydisplayYM System
- forecasting- allocation
transactiondata
implementedallocations
YM Analyst- limited domain (O-D pair)- revenue performance incentive
forecastsrecommended allocationsbid price
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Basic Ideas: Chicago Basic Ideas: Chicago SFO SFO
Based on initial forecasts, start with initial allocations (number of seats) for the two fare classes.
Adjust the allocations based on demand realizations.For example, if the demand for Full Coach looks
promising, “close” the allocation for Discount. If later the demand is lower than expected, move
allocations to Discount again.
United (nonstop)
Full Coach (unrestricted)
$525
Discount (highly restricted) $177
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Examples: What Examples: What motivations?motivations?Campbell offered trade deals to retailers during summer (a
eight-week period)
Introductory offer on a new product
Varying airfares over time
Early bird specials
Hotels’ winter specials
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Potential Negative Potential Negative ConsequencesConsequencesIncremental or substitute sale (e.g., negligible
increase in consumption)Cost of customization (e.g., production and
inventory costs)System effect
Reference price effect Wait for sale mentalityFairness
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Long Term Dynamic EffectsLong Term Dynamic Effects
CurrentPeriod Price
CompetitiveSituation
Future PriceResponse Curveand Price/ProfitRealization
Future CostPosition
CurrentSales Volume
Current Cost
CurrentContribution
Price Response Curve
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Punch-linePunch-lineClearly understand the underlying motivation
Design the time-customization plan based on the motivation
Consider the potential negative consequences and long-term dynamic effects