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Basic Pricing Principle & the Internet

Basic Pricing Principle & the Internet. Refer to Ch5-7 of “Pricing Communication networks”. Today’s Agenda. The QUESTION: How to set the price? Basic requirements What Competition Model the Business in Common pricing methods in the internet Ways to grasp the max profit from customers.

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Basic Pricing Principle & the Internet

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  1. Basic Pricing Principle & the Internet Refer to Ch5-7 of “Pricing Communication networks”

  2. Today’s Agenda The QUESTION:How to set the price? • Basic requirements • What Competition Model the Business in • Common pricing methods in the internet • Ways to grasp the max profit from customers

  3. How to Set a Price? A. Basic requirements (in normal cases): • the price <= utility of customers • the price is sustainable (7.1.2) • There is no way that the potential entrant can post price that less than the incumbent’s for some service and the serve all of part of the demand without incurring loss

  4. Welfare Maximization (5.4) The ideal case: welfare maximization (5.4) • Aim: to max total welfare of both customers and providers

  5. Welfare Maximization (5.4) The ideal case: welfare maximization (5.4) Lagrange multiplier Optimal price: Marginal cost pricing

  6. Today’s Agenda The QUESTION:How to set the price? • Basic requirements • What Competition Model the Business in • Common pricing methods in the internet • Ways to grasp the max profit from customers

  7. How to Set a Price? B. What Competition Model the Business in • Monopoly • Unregulated monopoly • Regulated monopoly • Oligopoly • Perfect Competition

  8. Unregulated monopoly Basic criteria: maximize total profit of the business (6.2.1) differentiate r.w.t. pi, we have compared to the welfare maximization curve: (5.5.1) (will mention in Ramsey pricing)

  9. Unregulated monopoly Basic criteria: maximize total profit of the business

  10. Unregulated monopoly maximize total profit of the business (6.2.1) Social benefit: Profit for business: Welfare lost:

  11. Regulated monopoly Probably by negotiation • The baseline is to allow them to earn some profit while to maximize social welfare • eg. Scheme of Control Agreement (管制計劃協議) applied in power generating companies in Hong Kong • One possible method: Ramsey-Boiteux pricing (5.5.1)

  12. Ramsey-Boiteux Pricing (5.5.1) Two ways of thinking: • Allow a fixed profit margin between revenue and cost Max s.t. • Weight supplier’s profit heavier then customer’s surplus

  13. Ramsey-Boiteux Pricing (5.5.1) By differentiation wrt p, we have If services are independent, we have ie. price markup over marginal cost is inversely proportional to the elasticity of demand

  14. How to Set a Price? B. What Competition Model the Business in • Monopoly  • Unregulated monopoly  • Regulated monopoly  • Oligopoly • Perfect Competition

  15. Oligopoly Game theory is wildly used to study interactions between a small number of competitive firms • Cournot game • Bertrand game • Stackelberg game

  16. Perfect Competition Some attributes of the perfect market • perfect competition - no individual can affect the market • Perfect information - everyone participant is fully informed • everyone has equal access to the market • everyone acts selfishly • homogeneous commodity

  17. Perfect Competition Some attributes of the perfect market • Strong network externalities effect Eg. Free SMS for intra-provider users • no transaction costs – no lock-in effect Eg. Bring phone number to other mobile service provider Eg. The pain to fill search for another provider

  18. How to Set a Price? B. What Competition Model the Business in • Monopoly  • Unregulated monopoly  • Regulated monopoly  • Oligopoly  • Perfect Competition 

  19. Today’s Agenda The QUESTION:How to set the price? • Basic requirements • What Competition Model the Business in • Common pricing methods in the internet • Ways to grasp the max profit from customers

  20. How to Set a Price? C. Common pricing methods in the internet • Dynamic pricing • Two part tariff (5.5.2) • Optional two-part tariff (5.5.3) • Flat-rate pricing (7.5) • Bargaining (7.2) • Shapley value (7.1.3) • Paris Metro pricing

  21. Dynamic Pricing Principle: to ask the customers using the service in the peak hours to pay more • Peak-load Pricing (5.4.4) Charge an extra premium in peak hours • Time-of-day pricing Divide time into different section, charge with different prices eg. Free night/weekend mobile phone minutes in US • Real-time pricing Charges varies depending on real-time traffic

  22. Peak-load Pricing (5.4.4) Principle: ask customers using the busiest timeslots to pay a premium of yt K: demand at the busiest timeslots Xt: demand timeslot t a: marginal cost To reach welfare maximization: utility price s.t. Xt <= K

  23. Two-part tariff (5.5.2) Principle: charge customers with a. fixed charge & b. usage charge eg. 荔園 (amuement park in HK) - pay a low entrance fee, and pay separately for each ride eg. pubs - pay fixed cover fee, and pay separately for each drink (if your main purpose to a pub is merely drinking :P )

  24. Two-part tariff (5.5.2) Advantage: providers could recover cost no matter no much a customer use the service Disadvantages: 1.social welfare decreases 2. some users with low usage will be kicked out Others: low usage customers would pay more relatively

  25. Two-part tariff (5.5.2) $ Observations: Demand changes depends on utility Social welfare decreases F = 900 Demand = u’(x) F = 300 MC x

  26. Optional two-part tariff (5.5.3) Principle: set up varies fixed charges and usage charges, customers picket charging scheme that fit most to their usage eg. Mobile plans (a partially correct example) • $98/1000 mins, $1.0/min onwards • $150/1200 mins, $0.5/min onwards Implementation: A set of K optional two-part tariffs, specified by pairs (ak, pk), where ak <= ak+1 , pk >= pk+1 Observation: Given a K-part optional tariff, we can always construct a K+1 part tariff that is not Pareto inferior (explain later)

  27. Optional two-part tariff (5.5.3) Advantages: • Users with different utility could choose among combinations Disadvantages: • Some users might take arbitrages (if plan set badly)

  28. Flat-rate pricing (7.5) Principle: all-you-can-eat for a fixed price eg. Countless examples… Advantages: • Easy to implement • Appealing to customers • Make the Internet ‘dumb-er’ Disadvantages: • Produce high social waste • Lost low-profile customers • Not subsidy-free

  29. Flat-rate pricing (7.5) marginal cost = 0 waste=

  30. How to Set a Price? C. Common pricing methods in the internet • Dynamic pricing  • Two part tariff (5.5.2)  • Optional two-part tariff  • Flat-rate pricing (7.5)  • Bargaining (7.2) • Shapley value (7.1.3) • Paris Metro pricing

  31. Bargaining (7.2) Table rule: • The bargain ends when both ‘players’ accept the price • Utility of both ‘players’ discounts by time Could talk about this at later presentations! Is >= ? Else propose …….

  32. Shapley value (7.1.3) Principle: a mechanism to distribute revenue/cost among several actors in the system Eg. No example…. Intuitive meaning: for each permutation of the actors, find the marginal utility gain for each additional player added into the system. The resultant value is then normalized

  33. Shapley value (7.1.3) Mission: AD 16.5% B A 33% D C 33% 16.5%

  34. Shapley value (7.1.3) Axioms: • Dummy if v(S U i) – v(S) = 0, then φi(v) = 0 • Symmetry if i, j symmetic, then φi(v) = φj(v) • Additively φi(v + w) = φi(v) + φi(w) • Efficiency There exists a unique value that satisfy the above four axioms, which is the Shapley value

  35. Shapley value (7.1.3) Advantages: • Fair (supposingly) Disadvantages: • Value must be calculated centrally • Impossible to implement in large scale

  36. How to Set a Price? C. Common pricing methods in the internet • Dynamic pricing  • Two part tariff (5.5.2)  • Optional two-part tariff  • Flat-rate pricing (7.5)  • Bargaining (7.2)  • Shapley value (7.1.3)  • Paris Metro pricing

  37. Paris Metro pricing Principle: by dividing the internet into different separate channels with different prices, channels with higher price would attract less traffic and hence provide better service Intuition: • first class in trains always have seats (more expensive) • if first class run out of seats, you simply take standard class.

  38. Paris Metro pricing Implementation: • Divide physical channel into several logical channels • Fixed capacity for each channel, all best effort, no QoS • Set different prices for each channel, flat-rate perhaps

  39. How to Set a Price? C. Common pricing methods in the internet • Dynamic pricing  • Two part tariff (5.5.2)  • Optional two-part tariff  • Flat-rate pricing (7.5)  • Bargaining (7.2)  • Shapley value (7.1.3)  • Paris Metro pricing 

  40. Today’s Agenda The QUESTION:How to set the price? • Basic requirements • What Competition Model the Business in • Common pricing methods in the internet • Ways to grasp the max profit from customers

  41. How to Set a Price? D. Ways to grasp the max profit from customers • Price discrimination (6.2.2) • Individual pricing • Versoning • Group pricing • Bundling (6.2.3) • Service differentiation (6.2.4) • Coffee in starbucks • Others • Taxations • Equilibrium Modeling

  42. Individual Pricing (6.2.2) Principle: charge each user individually such that the price of each user = utility of the user Eg. Coorperate bandwidth wholesale (if the provider is a monopoly) Properties: • Maximize welfare • No customer surplus

  43. Versoning (6.2.2) Principle: provider posts offers and allow customers to select their best plan eg. Communication: time-of-day, duration, location, distance (from the book) Advantage: • Welfare better than flat-pricing Disadvantages: • Welfare worse than individual pricing • Users might select the ‘wrong’ plan

  44. Individual Pricing (6.2.2) How provider could maximize total revenue by providing discounts User 1 might switch to the plan for user 2 to gain customers surplus B By having discount of B’, user 1 is motivated to use plan 1.

  45. Group Pricing Principle: divide customers into classes and provide different charges Eg. I. Adult / student / elderly tickets II. Coupon system Intuitive reasoning: To divide customers with different elasticity

  46. How to Set a Price? D. Ways to grasp the max profit from customers • Price discrimination (6.2.2) • Individual pricing  • Versoning  • Bundling (6.2.3) • Group pricing  • Service differentiation (6.2.4) • Coffee in starbucks • Others • Taxations • Equilibrium Modeling

  47. Service differentiation Principle: Add costless difference in service/product for differenciation Eg. Menu in starbucks: Latte: 20 / 23 / 26 Cappuccino: 25 / 28 / 31 Mocha: 30 / 33 / 36 Eg. Popcorns in cinemas: Small: $30 Medium: $35 Large: $40

  48. Today’s Agenda The QUESTION:How to set the price? • Basic requirements • What Competition Model the Business in • Common pricing methods in the internet • Ways to grasp the max profit from customers

  49. Backup Slides

  50. Ramsey-Boiteux Pricing (5.5.1) If services are dependent, we have The price might be lower than marginal cost when the services are complements to each others

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