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Unit 8.

Unit 8. Profit Maintenance/Enhancement. Investment Tip?. “The most important thing I look at in evaluating a company for investment purposes is whether or not they have a sustainable competitive advantage .” (Warren Buffett). Managing a Price Taking Firm.

stewart-velazquez
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Unit 8.

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  1. Unit 8. Profit Maintenance/Enhancement

  2. Investment Tip? • “The most important thing I look at in evaluating a company for investment purposes is whether or not they have a sustainable competitive advantage.” (Warren Buffett)

  3. Managing a Price Taking Firm • ‘Competitive’ firms have the biggest challenge of sustaining π’s. • Understand market forces to anticipate changes in input and output prices • Use cash market contracts, futures markets, etc. to establish favorable prices at times other than delivery • Costs must be minimized • Look into specialty products, niche markets, forming cooperatives,etc.

  4. Profit Enhancement/Maintenance Strategies (P setting firms mainly) • Create barriers to entry • Decrease P competition with rivals • Differentiate product to increase demand/decrease price elasticity • Decrease costs/increase productivity • Implement creative pricing policies

  5. Same Price or a Separate Menu? • Papa Dels is a popular pizzeria on the University of Illinois campus. The manager of this restaurant has been informed that the own price elasticity of demand for their pizza is -4 for lunch and -2 for dinner. The incremental cost of making and selling a large pizza is $6 for this firm, for both lunch and dinner. Would you recommend that Pap Dels have a separate menu for lunch and dinner? If yes, what prices do you suggest be charged?

  6. Marketing (Pricing) Internationally? • Kodak is currently selling its camera film in both the U.S. and Japan. The company’s research department has estimated the demand for Kodak film in each country as follows: U.S. => QUS = 15 – PUS Japan => QJ = 9 - .5PJ If MC = ATC = 3 in both countries, what pricing strategy would maximize Kodak’s profits in the U.S. and Japan combined?

  7. Coffee (P) Break? • Spooky Business sells its own brand of coffee on line. The company currently sets one price for each flavor or type sold. The marketing department has recently given management two alternative proposals to ‘perk’ up sales. One proposal is to simply lower price on each item. The second proposal is to give customers ‘quantity’ discounts (i.e. lower price on greater, specified quantities). Which option would you advise management implement?

  8. What Fee to Charge? • Rick and Joan Thompson recently moved from Iowa to Phoenix (AZ). They plan to run their own business there which is a health club called Sun Devil Spa and Fitness Club. While Rick and Joan are ‘fitness’ experts, they know very little about managing a business and, in particular, setting prices. They have noticed other health clubs have ‘members’ who are typically charged a membership fee. They have come to you for advice. Would you recommend they charge a ‘membership’ fee too or simply charge a fee ‘per visit’? If they decide to charge a ‘membership’ fee, what information would assist you in determining the ‘best’ fee to charge?

  9. Package (or Block) Pricing • Fruit of the Loom sells men’s tee shirts in packages (3 shirts per package). Management is wondering a) if the company would be better off selling the shirts individually and b) if not, is the company charging the ‘best’ price for its package? What recommendations do you have for management?

  10. Making ‘Bundles’? • Hewlett Packard sells both ‘printers’ and ‘print cartridges’ for microcomputers. Would you recommend to management that these products be priced and sold a) separately or b) together (as a ‘bundle’)? If HP prices these items separately, which strategy is likely to generate more profits: a) low price for the printers, high price for the cartridges or b) high price for the printers, low price for the cartridges?

  11. A Slam Dunk Deal? • Mark Cuban is the owner of the Dallas Mavericks, a professional NBA team (i.e. basketball). He is a very visible owner at games and is often seen cheering on his team as well as yelling at officials when he thinks they made a bad call. He has even been fined extensively by the NBA for his outspoken criticism of league referees. Cuban wants to win an NBA title in the ‘worst’ way. However, he is concerned that after he signs his players to ‘big’ contracts, they may not have the same incentive as he does to win an NBA title. What managerial ‘econ’ advice would you give Mr. Cuban on structuring player contracts for his team so as to provide more incentive for his players to try to win a championship?

  12. Reality Realty? • If you hire a real estate agent to sell your house, do they have the same economic incentive as you to maximize the selling price (i.e. get top dollar) for your house?

  13. Pricing Questions • Why: • Are buns sold in a package? • Is there an entrance fee but no charge for individual rides at some amusement parks? • Is the markup on coffee less than the markup on fresh flowers at a grocery store? • Are there senior-citizen and student discounts? • Does it cost more to do certain things at different times of the wk (e.g. fly, play golf, make phone calls, etc.) • Do travel agencies sell vacation ‘packages’?

  14. Creating barriers to entry • Advertise/differentiate • Proliferate new products (introduce first) • Maintain excess production capacity • Seek out sustainable niches • Guard trade secrets/plans • Obtain and/or extend patents • Entry limit pricing

  15. More Demand for Us, Less Demand for You? $ $ ATC D2 D1 D2 D1 Q Q Potential Entrant Existing Firm

  16. Entry Limit Pricing

  17. Decreasing competitive P rivalry • Match P • Random P • Non price competition • Customer service

  18. Creative Pricing Policies • Price discrimination • 2-part block (package) • Bundling • Q discounts • Multiple (joint) product

  19. Types of P Discrimination • First degree (= complete or perfect) • Selling each unit for a different price which = the maximum P any buyer is willing to pay (i.e. charge the maximum prices along a given D curve) • Second degree • Selling different quantity units for different prices to all buyers (i.e. quantity discounts) • Third degree • Selling all quantity units to different buyer groups at different prices (i.e. divide the market into different D segments and charge optimal prices accordingly)

  20. Robinson Patman Act (1936) • Makes it illegal for firms to price discriminate in ‘business’ markets (sales to other business firms) where the effect may be to injure competition. • The concern was over sellers giving ‘chains’ or large corporate buyers price discounts that would lower their costs and make it difficult for smaller firms to compete with them. • Does NOT disallow quantity discounts (if cost justified), cash payment discounts, and advance order/payment discounts if made available to all buyers.

  21. Third Degree Price Discrimination • The practice of charging different groups of consumers different prices for the same product • Examples include student discounts, senior citizen’s discounts, regional and international pricing

  22. Change in TR Due to Q (i.e. MR) NOTE: MR = 0 if E is unitary > 0 if E is elastic < 0 if E is inelastic

  23. Profit-Maximizing Prices •  P where MR = MC

  24. Profit-Maximizing ‘Markup’ Factors

  25. Assume: • Q = total demand for Kodak film • QUS = US demand = 15 – PUS  PUS = 15 – QUS  MRUS = 15 – 2QUS QJ = Japan demand = 18 – 2PJ  PJ = 9 - .5QJ  MRJ = 9 – QJ  QT = QUS + QJ = 33 – 3P (for P 9)  P = 11 – 1/3Q  MR = 11 – 2/3Q • MC = ATC = 3 in both the US & Japan

  26. Profit Max Example(with P Discrimination) • QJ to max J  MRJ = MC  9 – QJ = 3  QJ* = 6  PJ* = 6  max J = TRJ – TCJ = (6)(6) – (3)(6) = 36 – 18 = 18  max  = max US + max J = 36 + 18 = 54

  27. Profit Max Example(with P Discrimination) •  max  max US + max J • QUS to max US  MRUS = MC  15 – 2QUS = 3  QUS* = 6  PUS* = 9  max US = TRUS – TCUS = (9)(6) – (3)(6) = 54 – 18 = 36

  28. P Discrimination  Differential Markup Pricing • E0 in US at PUS = 9 • E0 in J at PJ = 6

  29. Π w/o Discriminating • NOTE: QU = 15 - PU = 15 – 7 = 8  U =(4)(8) = 32 QJ = 18 – 2PJ = 18 – 2(7) = 18 – 14 = 4  J = (4)(4) = 16 •  Max if PU = PJ  MRT = MC  11 – 2/3Qr = 3  2/3QT = 8  QT = 12  P = 11 – 1/3(QT) = 11 – 1/3(12) = 7  = (P-ATC)(QT) = (7-3)(12) = 48

  30. Charging Different PS to Different Customers (markets) P P PB PA MC MC DA DB Q Q MRB MRA Mkt A Mkt B

  31. Peak-Load Pricing • When demand during peak times is higher than the capacity of the firm, the firm should engage in peak-load pricing. • Charge a higher price (PH) during peak times (DH) • Charge a lower price (PL) during off-peak times (DL)

  32. Extracting Consumer Surplus: • Block Pricing: For items sold in a package (block), add units up to point where consumer willingness to pay = MC of adding last unit. Charge P = consumer surplus value at that point. • Two-part Pricing: For items sold where the seller can limit buyer access to the product, charge P = MC and also charge a ‘fee’ = to remaining consumer surplus. • Volume Discounts: Charge lower price for units purchased beyond given level.

  33. Block P Example • Typical consumer’s demand is P = 10 – 2Q • C(Q) = 2Q • Optimal number of units in a package? • Optimal package price?

  34. Costs and Profits with Block Pricing

  35. Results with Standard MR = MC Profit Max • P = 10 – 2Q •  MR = 10 – 4Q • TC = 2Q •  MC = 2 •  Max •  MR = MC •  10 – 4Q = 2 • Q = 2, P = 6 •  TR – TC = (6)(2) – (2)(2) = 12-4 = 8

  36. Optimal Quantity to Package: 4 Units

  37. Optimal Price for the Package: $24

  38. Costs and Profits with Two-Part Pricing Price Chargefee = CS 10 ½ (4) (10-2) = $16 8 6 Costs = $8 4 2 SetP = MC = $2 D 1 4 5 2 3 Quantity

  39. Commodity Bundling • The practice of bundling two or more products together and charging one price for the bundle. • Examples • Vacation packages • Computers and software • Film and developing

  40. A Kodak Bundle • Total market size is 4 million customers • Four types of consumers • 25% will use only Kodak film • 25% will use only Kodak developing • 25% will use only Kodak film and use only Kodak developing • 25% have no preference • Zero costs (for simplicity) • Maximum price each type of consumer will pay is as follows:

  41. Reservation Prices for Kodak Film and Developing by Type of Consumer

  42. Demand for Kodak Film

  43. Demand for Kodak Developing

  44. Revenue-Maximizing Film P?

  45. Revenue-Maximizing Developing P?

  46. Maximum TR Pricing Items Separately? • = Max Film TR + Max Developing TR • 16 + 9 • = 25

  47. Demand for Film & Developing ‘Bundle’

  48. Revenue-Maximizing ‘Bundle’ P? • Note: previous Max TR pricing items separately = 25.

  49. Bundles of Goods • Bundling often involves one ‘physical’ or ‘capital’ type good being sold with a related ‘services’ type good. Physical/capital good Razor Camera Computer Water softener Phone Copy machine Fertilizer Hotel room Service good Razor blades Film, film development Software, technical support Salt packets Calling plans Paper, cartridges, tech support Application, soil testing Transportation, meal

  50. Q Discount • Assume P = 100 - .1Q (Q = 00’s) • MC = ATC = 10 • What is firm π w/ • MR = MC production/pricing? • Charge P = 75 for Q up to 250, P = 55 for additional Q?

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