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Pricing and the Internet

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Title: Pricing and the Internet


1
EC427The Internet for Business Economists (IfBE)
  • Lecture 6
  • Pricing and the Internet

The Internet for
Business Economists Guy Judge, September 2004
2
Todays 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
3
Reading 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
23
Types 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
25
Request 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
29
Key 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
30
Thats all folks!
  • Any questions?

The Internet for
Business Economists Guy Judge, September 2004
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