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Internet Pricing Models

I. Economic and Behavioral Foundations of Pricing. II. Innovative Pricing Concepts and Tools. III. Internet Pricing Models. Internet Pricing Models. Outline. A taxonomy of Pricing Models Seller vs buyer posted pricing models.

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Internet Pricing Models

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  1. I. Economic and Behavioral • Foundations of Pricing • II. Innovative Pricing • Concepts and Tools • III. Internet Pricing • Models Internet Pricing Models

  2. Outline • A taxonomy of Pricing Models • Seller vs buyer posted pricing models

  3. Product categories: Airline tickets, hotels, car rentals, vacation packages, and cruises. Perishable inventories (e.g., yield management) Price fairness is less of an issue Marginal costs are close to zero Will grocery products work? http://www.priceline.com/

  4. Rules: Customer bids, waits up to 1 hour. If bid is accepted, ticket must be purchased. If not accepted, customer must wait 7 days to re-enter bid. Restrictions: Cannot specify time of flight, connection city or airline. Refund Policy: No Refunds/Exchanges. Hotels, Rental Cars: Yes Loyalty Miles or Points: No Rules: Customer can see fare and has 30 minutes to accept offer. Customers will be locked out for 72 hours if they reject offer. Restrictions: Cannot specify time of flight, connection city or airline. Refund Policy: No Refunds/Exchanges. Hotels, Rental Cars: Yes Loyalty Miles or Points: No http://www.priceline.com/ http://www.hotwire.com/index.jsp

  5. Rules: Customer gets fares, number of tickets available and how long offer is valid. Customer can purchase ticket then or be notified if price falls to desired rate. Restrictions: Can’t specify airline. Refund Policy: No Refunds/Exchanges Hotels, Rental Cars: Yes Loyalty Miles or Points: Available for some airlines. Rules: Will search fares globally. Customers will be able to purchase tickets at Qixo for 1% on top of price found at searched site. Restrictions: None. Refund/Policy: Depends on site policy. Hotels, Rental Cars: Yes Loyalty Miles or Points: Available for some airlines. http://www.qixo.com/flight.html

  6. Observations • Emergence and co-existence of new pricing mechanisms (e.g., www.priceline.com, www.ebay.com, www.landsend.com and etc.) • Unsubstantiated claims made by new pricing mechanism designers (e.g., “auction is the selling format of the future”, “priceline gives power back to the buyers”) • Shift in balance of power  Buyer plays a bigger role in price setting process • Menu costs are very low so dynamic price customization is now practical (with customer information) (e.g., www.techdata.com ) • Erosion of “ignorance premium”

  7. A Taxonomy of Pricing Models Price Setting Party Seller & Buyer Buyer Seller www.amazon.com www.priceline.com Static www.letsbuyit.com Price Over Time / Price Formation www.ebay.com www.landsend.com www.freemarkets.com Financial markets Dynamic

  8. Criteria to Evaluate Pricing Models • Social Welfare Metrics • Seller surplus • Buyer surplus • Inefficiency • Marketing Metrics • Average price • Sales volume • Price Posting Behavior • Seller posted price • Buyer posted price as a function of WTP

  9. WTP Buyer 1 40 Buyer 2 20 Buyer 3 15 Buyer 4 90 Buyer 5 60Buyer 6 50 Seller 1 c=0 Seller 2 c=0 A Simple Market

  10. Maximum Possible Surplus (MPS) WTP Buyer 1 40 Buyer 2 20 Buyer 3 15 Buyer 4 90 Buyer 5 60Buyer 6 50 Seller 1 c=0 Seller 2 c=0 MPS = 40 + 90 + 60 + 50 = 240

  11. An Example: Fixed Price Format WTP Buyer 1 40 Buyer 2 20 Buyer 3 15 Buyer 4 90 Buyer 5 60 Buyer 6 50 Price Seller 1 c=0 45 Seller 2 c=0 40 40 Seller surplus = 45 + 40 + 40 = 125 = 52.08% of MPS Buyer surplus = 45 + 20 + 10 = 75 = 31.25% of MPS Inefficiency = 40 = 16.67% of MPS Average Price = 41.67 Sales Volume = 3

  12. Experimental Test-Bedding • Develop a new price setting mechanism • Organize experimental/field markets with buyers and sellers using the new price mechanism and a benchmarked price mechanism • Provide sufficient monetary incentives to motivate buyers and sellers • Evaluate the price mechanisms based on performance criteria • Continue to fine-tune features of the new price setting mechanism to maximize a particular performance criterion

  13. Vernon Smith • Vernon Smith • 2002 Nobel Laureate in Economics • "for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms" http://xlab.berkeley.edu/

  14. An Application • Is priceline’s mechanism superior to the traditional retail price setting mechanism? • Does the party who sets the price gains a greater portion of the surplus? • How would the priceline’s mechanism’s perform if the seller is allowed to set a minimum acceptable price (MAP)?

  15. Three Internet Pricing Models • Sellers posting prices (e.g., www.amazon.com) • Buyers posting prices (e.g., www.priceline.com) • Sellers posting minimum acceptable prices (MAP) and buyers posting prices (a modified version of www.priceline.com)

  16. Experimental Design • Nine experimental sessions • Eight subjects per session; 2 sellers and 6 buyers • Standard experimental economics methodology (i.e., induced value, monetary incentives) • Seller’s earnings = sum of (price – cost) for each unit sold • Buyer’s earnings = WTP - price • Subjects made $20 on average, the actual payoffs ranged from $8 to $39 (the experiment lasted for 75 minutes)

  17. Design of Amazon Market • Determine the role of each subject • Determine each buyer's WTP for the product (1-100) • Each seller decides on a price • Determine each buyer's buying sequence • Determine whether there is a trade between each buyer and seller • According to the buying sequence, each buyer is sequentially asked to indicate whether she would buy from each of the sellers • Determine the earnings for everyone

  18. Design of Priceline Market • Determine the role of each subject • Determine each buyer's WTP for the product (1-100) • Each buyer decides on a price • Determine each buyer's buying sequence • Determine whether there is a trade between each buyer and seller • According to the buying sequence, sellers are asked whether they would sell a unit to each buyer • Determine the earnings for everyone

  19. Design of Priceline Market with MAP • Determine the role of each subject • Determine each buyer's WTP for the product (1-100) • Each seller decides on a minimal acceptable price (MAP) • Each buyer decides on a price • Determine each buyer’s buying sequence • Determine whether there is a trade between each buyer and seller • Buyer prices that are below all MAPs are rejected • According to the buying sequence, sellers are asked whether they would sell a unit to each buyer whose price is above their MAPs • Determine the earnings for everyone

  20. Results: Social Welfare Metrics

  21. Results: Marketing Metrics

  22. Amazon: Price Distribution

  23. Average Prices Over Time

  24. Seller Posted Price (Amazon) versus MAP (Priceline with MAP)

  25. Priceline: Posted Price versus WTP Posted Price = 5.62 + 0.41 x WTP (R2=0.73)

  26. Priceline with MAP: Posted Price versus WTP Posted Price = 4.25 + 0.39 x WTP (R2=0.71)

  27. Summary • Develop a new price setting mechanism • Organize experimental/field markets with buyers and sellers using the new price mechanism and a benchmarked price mechanism • Provide sufficient monetary incentives to motivate buyers and sellers • Evaluate the price mechanisms based on performance criteria • Continue to fine-tune features of the new price setting mechanism to maximize a particular performance criterion

  28. Punch-line • The power to set a static price (i.e., make a take-it-or-leave-it offer) allows a party to gain a higher surplus • In analyzing a price model: • Determine the criteria of performance • Engage in experimental test-bedding

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