MBA201a: Versioning and Packaging

1. MBA201a: Versioning and Packaging

2. Types of price discrimination • First-degree PD: charge every consumer his or her willingness to pay. • Third-degree PD: sort customers into several groups based on observable, exogenous characteristics. • Second-degree PD: present all customers with a menu of prices and allow the customers to self-select. MBA201a - Fall 2009

3. Second-degree price discrimination • Basic idea: Present consumers with a menu of (price, quality) pairs and let them sort themselves into groups. • A consumer’s willingness to pay for quality should be correlated with his or her willingness to pay a high price for the underlying good. • Examples: • Retail: Old Navy, Gap and Banana Republic jeans. • Airlines: first class and coach seats. MBA201a - Fall 2009

4. Specific types of second-degree PD • Versioning: design product lines that appeal to different consumers. • Examples: student and professional software. • Damaged goods: a particular case when the differences between products are obtained by "damaging" basic product. • Examples: Intel’s 486 chip, U.S. Postal Service. MBA201a - Fall 2009

5. Second-degree PD example (versioning 1.0) • Strategy 1: Offer all tickets at price $300 •  Total revenue = $30010 + $3008 = $5,400 • Strategy 2: Offer only unrestricted tickets at price $800 •  Total revenue = $8008 = $6,400 • Strategy 3: Offer Saturday-night-stay at price $300, unrestricted at price $800 • Will the businessperson buy the unrestricted ticket? MBA201a - Fall 2009

6. Second-degree PD example (versioning 2.0) • Strategy 3: Offer restricted tickets at price $300, unrestricted at price $800 • DOESN’T WORK. Businessperson wont buy the unrestricted ticket. • Strategy 4: Offer restricted tickets at price $300, unrestricted at price $699 •  Total revenue = $30010 + $6998 = $8,592 MBA201a - Fall 2009

7. Second-degree price discrimination principles • Induce customers to select into high and low price groups themselves. • Key constraint: you can’t make the inexpensive version too attractive to those willing to pay more. • If there aren’t many customers in the low-valuation group, you may want to ignore this group, since selling to it forces you to lower the price to the high valuation group. MBA201a - Fall 2009

8. More types of second degree price discrimination • Intertemporal price discrimination • Idea: high valuation users are also less patient. • Quantity discounts (price per unit depends on the quantity bought). • Idea: high valuation consumers willing to pay more for more. • Multiple two-part tariffs • Examples of two-part tariffs: cell phone plans with monthly and per minute fees. • Idea: separate between low volume users and high volume users. MBA201a - Fall 2009

9. Takeaways • Firms would prefer to use perfect (aka first-degree) price discrimination, but this may be impossible. • Third-degree PD is one way to approximate perfect PD, but requires that firms can separately identify members of high and low value groups. • Second-degree PD induces customers to sort themselves into groups. • Recall the no arbitrage constraint—consumers can’t resell to others. • Price discrimination and other advanced pricing strategies are powerful tools; you now have the economic models to understand them. MBA201a - Fall 2009