MECN 430

Homework 4 (Individual)

Winter 2020

1. Upon graduating from Kellogg, you end up working for Comcast. In many areas of the US,
Xfinity (Comcast’s cable internet service) is a monopolist for fast internet service and it is for
these markets that you are asked to reevaluate the product offerings and pricing strategy.
After extensive market research, it has determined that its customers fall into three
categories: Gamers, Streamers and Casual users. Gamers are willing to pay more for their
internet service than are Streamers and Casual users. The willingness to pay for a month’s
service with connections of different speeds for a typical Streamer, Gamer and Casual user is
shown in the table below:
Type 110Mbps 65Mbps 30Mbps
Gamer $90 $65 $35
Streamer $60 $55 $30
Casual user $35 $25 $20
Xfinity can offer any speed up to 110Mbps at a marginal cost of zero. You have reliably
estimated that there are 2 million Gamers, 4 million Streamers and 6 million Casual users in
the service area.
a. Currently, the provider offers two tiers of service: 65Mbps for $25 per month, and
110Mbps for $50 per month. How much profit is Comcast making on these offerings?
Assuming maximum surplus for the customers, we have that casual and streamers use
would consume the 65Mbps service and Gamers the 110Mbps services:
Π 0=$ 25∗( 6 M + 4 M ) + $ 50∗( 2 M )=$ 350 M
b. Can you improve on Comcast’s pricing strategy, given these two tiers of service offerings?
If we price the 65 Mbps at $55 and the 110 Mbps at $80 we have:
Π 1=$ 55∗( 4 M ) + $ 80∗( 2 M )=$ 380 M
c. Given these consumer preferences, what combination of tiers offered and prices earns the
provider the most profit? Explain.
If we assume that consumers will maximize surplus for them, the price difference
between each category its willingness to pay must be minimized and equal across
different product offerings so that customers that are best fitted for a more profitable
category won’t switch to less profitable ones.
For our case, the price of the first category has to be $20, otherwise we will not be able to
sell to casual users at that category and we don`t want to sell to casual users at other
categories since there are customers more profitable to reach.
If 30Mbps is priced $20, the benefit surplus for streamers and gamers are:
Streamers = 30−20=10
Gamers = 35−20=15

That locks the price of the second category to, at maximum, 10 less the willingness to pay
of streamers. Otherwise, streamers will chose the 30Mbps category.
P60 Mbps =55−10=45
That price locks the price of the last category to:
Gamers = 65−45=20 → P110 Mbps =90−20=70
For that scenario, the profits are:
Π 2=$ 70∗( 2 M ) + $ 45∗( 4 M ) + $ 20∗(6 M )=$ 440 M

d. Good news! Further research reveals that Gamers don’t view other internet service
providers as good alternatives even for slower speeds, due to the better reliability of
Xfinity; your research reveals that Gamers are actually willing to pay $60 for the 30Mbps
service, rather than the earlier estimate of $35. How would you revise Comcast’s pricing
strategy in light of this new information?
Yes, since its increasing wiliness to pay increase the benefit surplus to Gamers for the
30Mbps category, therefore they would all shift to the 30Mbps category, less profitable.
 The course of action would be to reduce 110Mbps price to $50 in order to maintain
gamers at the 110Mbps category. By doing this, we can terminate the offering of 60Mbps
since 110Mbps at $50 will be more appealing ( and more profitable ) to streamers.
Π 3=$ 50∗( 2 M + 4 M )+ $ 20∗( 6 M )=$ 420 M

2. Your success with Comcast has landed you a position with DirectTV, who have retained
you to consult on pricing for its satellite programming. Through extensive market
research, your team has identified two types of customers who subscribe to DirecTV;
there are approximately 1,000,000 of each type in DirecTV’s Chicago service area. The
values they place on different types of DirecTV -provided programming are as follows:
Network Television Sports and Special Interest
Type 1 $11 ?
Type 2 $8 $13

However, you’re uncertain about the value of Sports and Special Interest to Type 1
consumers. Part of your team has estimated this value to be $10; others believe that
estimate to be implausibly low, and have argued that it must be at least $15. The assistant
project manager of your team has just sent the group an email instructing your team to
spend another month gathering data to obtain a better estimate of that unknown value and
resolve the dispute, in order to provide DirecTV with clear recommendations. You can
assume a MC of 0 for both network television and sports & special interest.
a. What is the profit-maximizing price for network television (if sold separately)?
At $8, since:
Π a =$ 8∗( 2 M )=$ 160 M

b. Assume that the estimate of $10 is correct. What is the profit-maximizing price for
sports and special interest (if sold separately)?
At $10,
Π b =$ 10∗( 2 M ) =$ 200 M
3.
 a. Assume that the estimate of $10 is correct. What is the optimal price for the bundle
consisting of network television and sports & special interest? You can assume that if
a type is willing to pay $x for network television and $y for sports & special interest,
then it is willing to pay $x+$y for the bundle.
At $21 we should price the bundle, since it’s the sum of the willingness to pay for
both categories of both types of customers.
b. Now re-do b and c, assuming that your team’s other estimate of $15 is correct.
Π b =$ 13∗( 2 M ) =$ 260 M
Π c =$ 21∗ ( 2 M )=$ 420 M
We still should price at $21 the bundle since it’s the lower willingness to pay combined
for both categories within the types of customers. By doing this, we manage to target
both types of customers. Any value above that the increasing price will not offset the in
quantity by half. Any price below $21 will decrease profits.

c. Based on the above, would you recommend that DirecTV sell network television and
sports & special interest as a bundle? Can you offer them a useful pricing strategy
today, despite the disagreement within your team? Here you need to consider only
pure bundling (not mixed bundling).
They should offer a bundle at the price of $21. Its price, as showed above, should not
change despite the unclear wiliness to pay range of type 1 customers to our Sports
and Special Interest offering between 10-15.
If, however, we believe the willingness to pay for that customer segment is below 10,
we should adjust the price.

4. After graduating from Kellogg, you land a terrific job as a brand manager for General
Mills, where you have been given responsibility for its new Sriracha Frosted Flakes
cereal. Through extensive market research, you have identified two types of customer for
the new cereal. Type 1 individuals would pay at most $4 for the cereal, while Type 2
individuals value the cereal at $3. The two types also differ in the value of their time and
perspective on coupon use. For Type 1 individuals, the time, hassle and embarrassment of
using a coupon costs them the equivalent of $1.25, while for Type 2 individuals, finding
and using a coupon is costless. The marginal cost of a box of cereal is $2.50, and there
are roughly equal numbers of Type 1 and Type 2 individuals in the population.
 a. What price for the cereal do you recommend? Do you recommend that General Mills
offer a coupon? If so, how large a coupon do you recommend?
I would recommend to charge $4 for the cereal, with a $1 coupon discount to
maximize profits (2Q)
Π= ( 4−2.5 )∗Q+ ( 4−1−2.5 )∗Q=2 Q

b. Redo the previous question, but now assume that everyone has the same cost ($1.25)
in time and hassle of using a coupon.
If for everyone the cost is $1.25 to use a coupon, if we price the coupon by $1 and cereal
$4 as before the coupon will not bring additional Type 2 customers.
Π= ( 4−2.5 )∗Q+ ( 4−1−2.5 )∗0=1.5Q (1)
If we price the cereal $4, but use a $1.25 coupon discount, all customers will use the
coupon, so:
Π= ( 4−1.25−2.5 )∗2 Q=0.5 Q(2)
One other approach here would be to price the cereal at $3, with no coupons
Π= (3−2.5 )∗2Q=Q(3)
¿ ( 1 ) , ( 2 ) ∧(3) thebest approachis ¿ price at $ 4 with no coupon .

c. How do your answers to a and b depend on the assumption that there are roughly
equal numbers of Type 1 and Type 2 individuals in the population? Explain.
The profit equation depends on both Price and quantity, as below:
Π= ( p 1−2.5 )∗Q 1+ ( p 1−c 1−2.5 )∗Q 2
The type 1 and type 2 individuals’ quantity are expressed as Q1 and Q2. The concept
of use a coupon or not relies on if the potential gains of profitability by targeting
segment 2 with a coupon will offset the profit loss margin on type 1 customers that
could use the coupon. If there is no loss on offering a coupon (item a, 1$ coupon),
offering coupons will only bring benefits. Since there are equal number of
individuals, every $1 of profit from an additional customer from on segment has the
same “weight” as $1 of profit loss from the other one. If the quantities are
disproportional, for instance 1:9, type1:type2, we would change the recommendation
of item b to price it $3 rather than $4. Item a would still be the same answer, since
objectively by using a coupon at that scenario we are able to price the exact
willingness to pay for every type of customer.