Title: Pricing and the Internet
1EC427The Internet for Business Economists (IfBE)
- Lecture 6
- Pricing and the Internet
The Internet for
Business Economists Guy Judge, September 2004
2Todays objectives
- to identify some of the issues raised in relation
to Pricing and the Internet - to focus specifically on questions relating to
dynamic pricing on the Internet - and
distinguishing it from differential pricing
(which is essentially a form of price
discrimination)
The Internet for
Business Economists Guy Judge, September 2004
3Reading and further references
- Some key references are given on slides at the
end of this presentation - For more details see the links6.html file -
available on the IfBE web site
The Internet for
Business Economists Guy Judge, September 2004
4 Preliminary Interactive Interchange Please
answer YES or NO to each of the following
- Do do you know what each of the following are?
- willingness to pay
- reservation price
- consumer surplus
- value-based pricing
- static, posted or menu-driven pricing
- reverse auctions
- pricebots
The Internet for
Business Economists Guy Judge, September 2004
5 Some issues concerning Pricing and the Internet
- Price competition on the Internet Frictionless
commerce? - have shopbots and shopping
comparison sites made online prices more
competitive? - Differential Pricing - how has the Internet
enabled sellers to fight back? Is it always bad
for consumers? - Dynamic pricing - what is it and how is it being
implemented?
The Internet for
Business Economists Guy Judge, September 2004
6 Price levels and price dispersion online and
offline (1)
- In the early years of e-commerce it was predicted
that the Internet would lead to a frictionless
economy - Lower search costs and better information would
increase competition and lead to lower prices and
greater price convergence see e.g. Bakos (1997) - There have been a huge number of empirical
studies, mainly on homogeneous products such as
books an CDs (see especially Brynjolfsson
Smith) but other studies have looked at cars,
consumer electronics, and also travel, life
insurance - A recent study of CDs and books in Italy by
Ancarani and Shankar (2004) provides a full
bibliography
The Internet for
Business Economists Guy Judge, September 2004
7 Price levels and price dispersion online and
offline (2)
- Ancarani and Shankar remind us that shopping
comparison sites provide information not only
about product prices but also on product
characteristics and independent product reviews
this can affect offline prices as well as online - Most studies have found lower price levels online
than offline, even when shipping and other costs
are included (e.g. Brynjolffson Smith) - Some studies distinguish three categories
pure-play Internet, bricks-and-mortar
(traditional shops) and bricks-and-clicks
(multichannel retailers) - But price dispersion remains as high online as
offline various explanations for this
The Internet for
Business Economists Guy Judge, September 2004
8 Price levels and price dispersion online and
offline (3)
- Just having a web presence doesnt mean that a
consumer will find your site. Haring has
introduced the notion of a virtual location.
Just as some physical stores are prominently
located on the high street or shopping mall, in
the virtual world some sites are highly visible
while others are more difficult to locate. With
the increasing importance of shopping search
tools (e.g. Froogle) what Baye et al. call
Information Gatekeepers it has become more
important for e-tailers to advertisein order to
establish brand awareness to foster consumer
loyalty and to appear high up a list of search
results - This may explain why a well known company like
Amazon has a greater volume of sales than some
less well known but cheaper rivals - But the issue of trust also comes into the
equation consumers wary of scams may not be
confident that less well known companies can be
trusted to deliver, or to replace faulty goods,
or to protect consumer confidentiality and
security. - All this tends to prevent the erosion of market
power and allow companies to practice price
discrimination
The Internet for
Business Economists Guy Judge, September 2004
9 Setting the scene 4 scenarios
- In a stable market for a uniform product - a
seller who can segment the market can charge
different consumers different prices
(third-degree price discrimination) - e.g.
computer software - In the market for a perishable (time-sensitive)
product the price can be varied over time to
ensure that all the product is sold e.g. fruit,
airline seats - In a market with unpredictable demand and supply
movements the price can be varied over time to
keep track of these movements and to ensure that
revenue is maximised - e.g. share prices - In the market for a unique or rarely traded
product the seller can use an auction to get the
best price e.g. antiques
The Internet for
Business Economists Guy Judge, September 2004
10 Differential pricing and dynamic pricing the
essential differences
- Differential pricing relates the price to the
customer (or group of customers) - - variations across customers
- Dynamic pricing relates the price to changing
market conditions (shifts in demand and supply
curves - or changing customer preferences) - - variations over time
- Both can be described as flexible pricing systems
and both can be implemented using web-based
software agents
The Internet for
Business Economists Guy Judge, September 2004
11 Dynamic pricing versus static pricing the
essential differences
- Static (posted, catalogue or menu pricing)
- The seller attempts to determine the best price
for the product before selling - the price
remains fixed (except in the face of severe
demand or supply shifts) - Dynamic pricing (responsive pricing)
- The seller constantly monitors supply and demand
conditions and regularly modifies the price to
respond to changing conditions - the aim is to
minimise disequilibrium transactions
The Internet for
Business Economists Guy Judge, September 2004
12 Differential pricing - segmenting the market
- segmenting the market by objective customer
characteristics - by age, demographic or other
factor (e.g. business/consumer) - involuntary
selection - segmenting the market via voluntary
self-selection - customer decides which version
is worth it - versioning - a form of customisation
especially relevant for online information
(digital) goods - the additional costs of
producing different versions can be very small
while the additional revenue extracted from
consumers can be large - by differentiating the products suppliers
decrease their substitutability
The Internet for
Business Economists Guy Judge, September 2004
13 Differential pricing - other tactics
- product bundling - e.g servicing or training
programmes - loyalty programs - to increase switching costs
The Internet for
Business Economists Guy Judge, September 2004
14 Differential Pricing is it always a bad thing
for consumers? Varians view.
- Varian (1996) explains that differential pricing
can sometimes be good for consumers, in that it
can lead to the supply of products that would
remain unprofitable and therefore unavailable if
the producer was forced to charge all consumers
the same price. - This is particularly relevant to goods with a
high fixed cost and low (perhaps close to zero)
marginal cost such as digital goods like online
journals.
The Internet for
Business Economists Guy Judge, September 2004
15 Differential Pricing is it always a bad thing
for consumers? Odlyzkos recent example
- Odlyzko has recently published a paper in the
journal Nature explaining why electronic
publishing means people will need to pay
different prices for online journals. - He provides a simple example to illustrate a
situation in which a journal publisher might be
unwilling to publish a journal unless it was able
to price discriminate among subscribers.
The Internet for
Business Economists Guy Judge, September 2004
16 The details of Odlyzkos example
- Suppose the publisher has two potential libraries
as subscribers. - Library A is willing to pay a maximum of 700 per
year, while library B is willing to pay up to
1000 annually. - However, suppose the publisher needs at least
1500 to cover costs (or even to make a small
profit and thus persuade him to enter the
market). - If the publisher is obliged to charge the same
price it will not be able to create the journal.
If the price does not exceed 700 both libraries
would be willing to subscribe, but at only 1400
the revenue would be insufficient to persuade the
publisher to publish. - If the price exceeds 700 library B would be
willing to subscribe but library A would not
the journal wouldnt be published. - But if the publisher was allowed to charge
library A 650 and library B 950, both libraries
would subscribe. Total revenue for the publisher
would be 1600 enough to make it profitable. - In this example price discrimination
(differential pricing) is essential to create new
economic activity
The Internet for
Business Economists Guy Judge, September 2004
17 Dynamic pricing - a definition
- A dynamic pricing model is defined as the buying
and selling of goods and services in free markets
where the prices fluctuate in response to demand
and supply and changing customer preferences - Srivastava (2001) - my underlining
- Dynamic pricing takes advantage of real-time
market and customer information to customise the
offer. Other related terms revenue or yield
optimization. An old idea in new clothes.
The Internet for
Business Economists Guy Judge, September 2004
18 Dynamic pricing - an old idea given a new boost
- In traditional markets the high transactions
costs associated with dynamic pricing mechanisms
have limited their adoption (except in specific
circumstances - e.g. shares and commodities) - But the Internet provides instant and cheap
communication and information updating - Hence the development of online auctions and
other dynamic pricing systems on the web
The Internet for
Business Economists Guy Judge, September 2004
19 Dynamic pricing with intelligent software (1)
- Early efforts were based around Excel
spreadsheets, dynamically linked to information
sources, that could be used as a decision support
tool - Now intelligent software is available
commercially that can track market conditions and
automatically change prices. Examples of
companies supplying this software are Talus (now
part of Manugistics), Azerity, Maxager and PROS
Revenue Management - Experiments are being conducted with intelligent
software agents (pricebots) - see Kephart et
al (2000) on the IBM Information Economics
project - could move beyond just pricing - humans
could delegate responsibility to agents who
negotiate with each other.
The Internet for
Business Economists Guy Judge, September 2004
20 Dynamic pricing with intelligent software
(2)problems
- todays dynamic pricing software is only as good
as the information fed into it - which is not
always current and even enthusiasts admit that it
can depend on sales force staff entering the data
and they ..do a pretty wimpy job, to be honest
(Fred Jones, whose company MicroTechnologies,
uses Azeritys ProChannel software agent) - hence the interest in developing pricebots that
autonomously collect and update information - but there are concerns about potential pitfalls -
their collective behavior may not closely
resemble that of humans (Kephart et al.)
The Internet for
Business Economists Guy Judge, September 2004
21 Dynamic pricing with intelligent software
(3)simulation experiments
- market simulators can be used to determine the
best agent strategies for each type of market
(see Morris 2001 who describes the Learning
Curve simulator) - Better than purely theoretical solutions that may
be difficult to apply - numerical results easier
to interpret. - Inputs market scenariobuyer bahaviour seller
strategies - Types of seller strategies explored by Learning
Curve - Derivative Following
- Myopically Optimal
- Dynamic Programming
- Reinforcement learning
The Internet for
Business Economists Guy Judge, September 2004
22 Dynamic pricing - did Amazon experiment?
- stories circulating on bulletin boards and mail
lists that Amazon was charging customers
different prices for the same product, perhaps
based on customer profiles (frequency of purchase
on Amazon, date of last purchase etc.) - ManagingChange.com carried out a survey (July
2001-June 2003) to test for links between prices
and these factors - asked for responses on 4
items (a book, a music CD, a video DVD and a PDA) - no evidence that price was linked to any of these
characteristics (or whether customer had browser
cookie enabled) but there were lots of price
fluctuations - perhaps sales promotions or
seasonal effects? - In any case would this really be dynamic
pricing or just differential pricing?
The Internet for
Business Economists Guy Judge, September 2004
23Types of dynamic pricing
- One buyer, one seller
- negotiation/haggling
- One buyer, many sellers
- Reverse auctions (e.g.B2B procurement and
sourcing) - One seller, many buyers
- Forward auctions (e.g. C2C via eBay, B2B for
disposing of old stock) - Many sellers, many buyers
- Aggregation systems
The Internet for
Business Economists Guy Judge, September 2004
24 Types of auction
- English auction - open cry - bids increase
- Dutch auction - opening price gradually
discounted - Vickrey auction - sealed bids - winner offers the
highest amount but pays 2nd highest amount - Used in disposing of excess inventories
- Used in valuing unique or rarely traded products
- Revenue Equivalence Theorem
- Reverse auctions for procurement - invitation to
bid to supply inputs - RFQ (Request For Quote
sales) - Online systems for C2C auctions - eBay
The Internet for
Business Economists Guy Judge, September 2004
25Request for Quote (RFQ) systems
- Buyer posts an RFQ for a product meeting certain
minimum requirements - Sellers respond with a single closed bid within
agreed time period - possible subsequent renegotiation
- example for B2C is Lycos Merchant Match
(Request-a-Quote) - they use their
request-response technology to search for
offers - they e-mail quotes to you within 24 hours
The Internet for
Business Economists Guy Judge, September 2004
26 eBay
- C2C auction system
- you place a bid for the item you want (maximum
amount) - eBay bids for you up to your limit
- reviews are available to help you rate sellers
- most sellers accept payment by PayPal
The Internet for
Business Economists Guy Judge, September 2004
27 Priceline.com
- Priceline.com is not a shopping service - it is a
bidding service. (Reverse auction) .Customers
are asked for their highest bid (maximum WTP) -
priceline searches for a suitable deal - airlines use it as an independent clearing house
to unload cheap last minute deals (they dont
like to advertise this) - also available are car
rentals, holidays and hotel rooms - Founded by the excellently named Jay Walker
- Walker calls it his buyer-driven commerce
business model - But customers have to be flexible - may have to
compromise on product specification
The Internet for
Business Economists Guy Judge, September 2004
28 Dynamic pricing - inhibiting factors
- Moral and ethical issues Customers may perceive
it to be unfair for firms to charge different
people different prices (although they have done
for many years - price discrimination and
discounting) - Unacceptable excessive price variations? - too
much variation in price may be counterproductive
- customers may not accept it - May cut across established customer relationships
- Set up costs - there may be a high set up cost in
terms of purchasing and customising the software
and integrating it into the business - will it be
worth it? - Not always appropriate to product and market -
for example where distribution cost is high
relative to other costs
The Internet for
Business Economists Guy Judge, September 2004
29Key references if you only read one, pick from
this list !
- Bradford et al (2001) Pricing, agents, perceived
value and the Internet - Odlyzko (2004) Why electronic publishing means
people pay different prices - Srivastava (2001) Dynamic Pricing Models
Opportunity for Action - Varian (1997) Versioning Information Goods
- Varian (1996) Differential Pricing and Efficiency
The Internet for
Business Economists Guy Judge, September 2004
30Thats all folks!
The Internet for
Business Economists Guy Judge, September 2004