Week 5: Pricing Issues

MECN 6200: Global Competition and Market Dominance
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Week 5: Pricing Issues

Week 5 Overview
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Week Five Overview Video Transcript
Week 5 Introduction
This week, you will accomplish four things:
1. You will learn how to set the optimal profit maximizing price.
2. You will understand other corporate pricing strategies.
3. You will review the methods of industry analysis.
4. You will learn about the role that innovation and destruction play in corporate life.
Nothing is more important to a company's success than where it sets its price level. Firms differ
in what their objectives are; some seeking to immediately maximize profits immediately, while
others may seek to gain a foothold in a new market. Each market structure faces different
pressures on price levels. We will also discuss the topic of transfer pricing. Then we will look at
industry analysis.
Week 5 Learning Objectives
After completing this week, you will be able to:
 Help your firm to establish the profit maximizing price.

 Decide whether another price level is more optimal.
 Use the Five Forces to evaluate your company's future in various ventures.
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Week 5 Learning Activities
Learning
Description Due Date Points
Activity
Readings  McGraw-Hill Custom Book, Content 10 Complete by

 Taylor Swift’s Ticket Strategy: Brilliant end of Day 7
Business or Slowing Demand? Rolling
Stone ~
 Wave of Megadeals Tests Antitrust Limits in
U.S. The Wall Street Journal
Self-Check Complete all self-check quizzes as they appear Complete by

~
Quizzes throughout the week's content. end of Day 7
Discussion 1 Taylor Swift's Ticket Strategy: Brilliant Business or Complete by 100

Slowing Demand? Rolling Stone end of Day 7
Discussion 2 Wave of Megadeals Tests Antitrust Limits in Complete by 100

U.S. The Wall Street Journal end of Day 7
Late Exam ProctorU is required to take this exam. Opens 100

beginning of
Complete your Late Exam. Day 1
Complete by
end of Day 7
Note: All discussions can be accessed in the Discussions area.
Week 5 Readings
 McGraw-Hill Custom Book, Content 10 (view Content Titles of weekly readings)

 Taylor Swift’s Ticket Strategy: Brilliant Business or Slowing Demand? Rolling Stone
 Wave of Megadeals Tests Antitrust Limits in U.S. The Wall Street Journal
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Lesson 1: Pricing (1 of 7)
Alternative Pricing Objectives
Companies seek to achieve different things with their pricing decisions. Among the major
objectives are these:
1. Profit maximization - to earn the most money now.

2. Market share maximization - to control the largest possible share of the market.
3. Limit entry - to keep new entrants out.
4. Control demand level - to limit demand when production is short of demand.
5. Helping related products - such as razors and blades.
6. Follow the leader - to avoid price wars.
Pricing (2 of 7)
Product Pricing
You will recall that earlier we saw how to find the profit maximizing price level. Let's review that
since it is so important.
Recall that:
MR = P ( 1 - 1/η ) and that to profit maximize we must set MR = MC so, MC = P ( 1 - 1/η )
Now suppose we know that MC = $2.00 and that η= 1.5.

To find the optimal price we put MC and η into the equation above.
$2.00 = P (1 - 1/1.5)
$2.00 = P (1 - 0.6666)
$2.00 = P (.333) so
P = $2 / 0.333 = $6.00
For this firm with these cost conditions and elasticities, charging a price of $6.00 would yield the
maximum profit possible.
Pricing (3 of 7)
Markup Pricing
Many firms do not use the optimal pricing rule (seen on the previous page); some are unaware
of it, some don't know their costs or elasticities, because they sell too many products/services to
be able to conduct all these analyses, and some experience market change so quickly that
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before they change price, facts will have changed again.
Many of these firms use markup pricing instead. Markup pricing basically adds a certain
percentage profit onto costs. A simple markup model looks like this:
Price = (1 + λ) "Cost" where λ is the markup.
The markup may be small or large depending on circumstances. Whatever the markup, it must
be sufficient to provide the firm with enough profits to allow it to continue operating.
Here is some food for thought:
What size markup would you expect the following firms to use?
 McDonald's
 Capital Grill
 Chipotle
Whose markup might be bigger?
Do markups ignore costs?
Are they better than profit maximization?
Jack Ryan Films
A bundle of four Jack Ryan films cost less than the four films purchased individually.
The Jack Ryan Collection - four films: $29.99

One film ...The Hunt for Red October: $14.99
 Question: Why is the bundle 50% less than the four films individually?
 Answer: There are cost savings in bundling, but the major reason is to induce purchase
by consumers who may not want all four films but who say “this is a bargain.”
Pricing (4 of 7)
Pricing Strategies for Substitutes and Complements Made by the Same Firm
Often firms sell more than one product. In some cases, those products may either be substitutes
(competing goods) or complements (goods that are used jointly). By carefully setting the price of
related goods in conjunction with each other, the firm may be able to improve its overall
profitability. Think in terms of a price gap: The price gap equals the difference between the
prices of two goods/services sold by the same firm. A small gap would mean that the two prices
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are relatively close, while a large price gap means that the prices are relatively distant.
Substitute and Complementary Goods Graphic Alternate Version
Pricing (5 of 7)
Existing Product Pricing Strategies
Probably the easiest category of goods/services to price are those that are well established with
known demand and supply characteristics. This section assumes that firms choose not to use
optimal pricing to find the maximum profits possible. The two primary choices with existing
products in that case are price positioning and value of attribute pricing.
Price positioning tries to achieve a certain balance in the marketplace. For example, it might set
price such that the firm is always a little less costly than the competition. Certain car brands, for
example, price relative to other brands. One example would be Hyundai pricing itself relative to
Toyota. Other existing products are priced in a manner such that the price never changes. For
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years certain chewing gum companies kept their price at $0.25 per pack. Such a strategy
makes it easy for customers to buy the product regularly without much thought.
The other approach used with existing products is to price a product according to its strengths
without regard for its costs. For example, Intel might price a certain chip at three times the price
of another chip just because it is "the fastest available." Or a TV manufacturer might price "the
largest TV" at a higher price not because it costs more to make, but because people will pay
that much.
Schering-Plough (Claritin)
Claritin is a popular antihistamine that is known to reduce allergy symptoms.
 Question: Why does Schering-Plough offer so many varieties of Claritin?

o Clue: It is off patent and the wholesale cost is about $0.01 to $0.06 USD.
Answer: Product proliferation squeezes out competitors whose products get lost on the shelf.
The following tale was on the internet in August 2018.
My favorite cereal went from 500g/box to 455g/box at the same price. Then months later the
store introduced a 500g/box called "Family Size" at a 15% higher price. Several months later
the 455g/box was discontinued.
 Question: Do most consumers see this? Does this upset consumers?

 Answer: Many consumers do not pay attention and miss how the manufacturer is raising
prices.
Pricing (6 of 7)
New Product Pricing Strategies
Pricing a new product is more difficult. Future demands are unknown as are the economies of
scale that might be available to reduce the cost of production. The number of future competitors
is also unclear.
Some companies try to price skim, which is a strategy to gain as much profit (by setting a very
high price), as soon as possible. For example, the first mobile phone, sold in 1984, cost $4,000
in 1984 dollars. This makes sense if other competitors are likely to jump into the market. It also
may be a long-term winning strategy if the firm's reputation grows and customers are later
willing to pay more for this company's products. Bose speakers may be an example of this. Over
time the firm can lower its price to try and remain competitive.
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Limit Pricing Graph Alternate Version
Other firms may price new products in

order to keep competitors out of their
market. This is called limit pricing. In a
perfectly-executed limit pricing strategy,
the price is set below the production cost
of all future competitors. In that case,
their entry into the market would result in
losses for the new competitors. The
objective is to remove the incentive for
entry. The graph to the right illustrates
limit pricing.
The existing firm's costs curve is lower

than the ATC of a possible new entrant
because it has a better technology, found
the best resources, etc. Price max in the
diagram is where a profit maximizing firm would set its price. Instead, the limit pricing firm sets
its price at Pricelimit in the diagram, which is below Price max and the ATC of the new entrant. At
Pricelimit the new entrant will lose money. The existing firm has a lower profit than it might
otherwise have but it keeps out a future competitor and may protect its future profits.
Pricing (7 of 7)
Monopoly Pricing Options
There may be strategies which improve the profitability of a monopolist beyond what can be
achieved from setting MR = MC. One example is to bundle products together and force
consumers to buy not just the products they want but also some of another product too. For
example, the syndication company that owns a popular TV show might demand that local
stations wanting the show also buy (at a much lower price) another program that they otherwise
would not want to buy.
Other monopolists use a two-part tariff which has a fixed charge and a usage charge. Many cell
phone companies use this practice. Consumers are asked to pay some dollars for just being on
the network and then a certain amount more for their usage of minutes. Amusement parks like
Disney World sometimes follow this plan too. Companies that implement these strategies raise
their profits otherwise they would resort to less complicated pricing schemes. One thing to
consider is how consumers evaluate such schemes when they seek to maximize their utility. It is
not easy to describe the unit price of cell phone calls when you must pay an upfront cost and a
units charge. Possibly, this is the intention of the monopolist.
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Cell Phones
 Question: Why do cell phone companies offer 2nd lines for less? What is the MC of
providing service? What is the constraint on providing service?
 Answer: As long as there is excess capacity on the network, the marginal cost is close to
zero.
Using Elasticity and Costs to Change Price
Starting Information
 Price = $9.00
 Quantity = 1,000
 TR = $9,000
 VariableC = $5.00/unit
 FixedC = $2,000
Contribution Margin = $9 - $5 = $4
Profit = $9,000 - $5,000 - $2,000 = $2,000
 Question: Should the firm cut its price by $1.00?
Revenue loss from existing units = $1,000
New Contribution Margin = $3
Breakeven Sales Analysis
% BE Sales Change to maintain profit = - (Price Change) / Contribution Margin + Price Change
= - (-$1.00) / $4 + (-$1) (Note: This is the give back divided by the new contribution margin)
= $1 / $3 = 33% (Note: This is the necessary sales change to maintain TR)
 Question: What elasticity ( ) is required to get back the lost $1?

 Answer:
o =% Quantity / % Price; which equals

o 33% / -1/9 or 33% / -11.1%
o Answer: -2.97
Does an η
of - 2.97 seem likely?
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Pricing (7 of 7) continued
Dynamic Pricing
Dynamic pricing was pioneered by airlines but is now used by car rental, hotel, and concert
venues.
Review the following articles:
 Taylor Swift's Ticket Strategy: Brilliant Business or Slowing Demand?

o Superstars like Swift are increasingly using “dynamic pricing” that shifts ticket
prices constantly like airline seats. But is it the future of the industry.
 Uber - What is Dynamic Pricing?
In the case of Taylor Swift, the model works by assuming a fixed supply.
Alternate Version of Chart
While demand is treated as an unknown. The model may start by assuming a high demand.
Yielding a price of $600 per ticket. If after some time, more tickets are sold than expected, a
higher demand is assumed. If fewer tickets are sold than expected, the dynamic price is
lowered.
Uber
Uber dynamic pricing is different since a higher fare can induce more supply from new drivers.
Demand on the other hand involves the same people who consider different price levels.
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Alternate Version of Chart
The creation of new drivers yields a new supply curve and a lower price, once those drivers
arrive on site.
Absolut Vodka (Pricing)
1.75L Bottle: $29.99

1.0L Bottle: $23.99
750ml Bottle: $19.99
 Question: What is Absolut's objective with their pricing?

 Answer: To sell larger bottles.
Dynamic Pricing is Similar to Time of Day Pricing
For example, the article "Why Not All Tolls Rise to Nearly $50, Washington state advised to lift
the $10 toll cap as congestion returns," discusses how the cost of express lanes (tolls) increase
based on the amount of traffic.
Source: The Wall Street Journal (2018)
Lesson 2: Price Discrimination

Despite the awful connotation, many firms engage in price discrimination. Some firms must
price discriminate to survive. This is true when no single price is sufficiently high to allow the
firm to cover all of its costs.
There are three types of price discrimination:
1. With first degree price discrimination, every buyer pays their maximum price. If you
remember the demand points from Lesson One of Week One, firms engaged in first
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degree price discrimination move down the demand curve seeking to uncover
and charge every customer up to their demand point. In a new car showroom, when the
salesperson asks you, "So you really like this car?" he/she is attempting to uncover your
demand point.
2. With second degree price discrimination, the discrimination is based on
time or urgency of consumption. For example, a first run movie might cost $15, a month
later it might cost $6 at a local theater, in one month it might be available on a premium
cable station, and in a year it is free on TV.
3. Third degree price discrimination charges different prices in different markets. For
example, a national movie chain might charge $15 to moviegoers in New York City but
only $12 in Dallas, Texas. The difference is not based on cost but on the firm's
perception of how much consumers are likely to pay.
Forms of First Degree Price Discrimination
There are four main strategies applied by firms to induce new customers, or generate higher
sales to existing customer, using price:
1. Trial offers
2. Coupons
3. Rebates
4. Free samples
Coupons Graph Alternate Version
The profit maximizing firm sets its price at Price max. It knows that some consumers are
purchasing the product/service of its competitor. Hoping to capture some of that demand the
firm offers a coupon which lowers the price on its product for some limited period of time. Look
at the graph above to answer the following questions.
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Self-Check Quiz: Forms of First Degree Price Discrimination Alternate Version
Second Degree Price Discrimination
In a second degree price discrimination regime there would be several prices that apply at
different points in time. In the graph below the firm has two prices. The higher price is charged
to consumers wanting to purchase the latest electronic good. The lower price is then instituted
several months later and charged to other consumers.
Second Degree Price Discrimination Graph Alternate Version
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Third Degree Price Discrimination
Third degree price discrimination is best used on markets/consumers that have decidedly
different price elasticities of demand. In the graph to the right there are two groups of
consumers. The one with red demand and MR curves has a higher initial demand point and a
steeper demand curve slope than the consumers seen on the green demand and MR curves.
The higher initial point means that the consumers in red have a greater appreciation for the
product. The steeper slope means that their demand is more inelastic. (They are unwilling or
reluctant to switch to another product if price is raised.)
Combining the two demand and MR curves yields the demand and MR curve for the entire
market. Notice that at first the combined demand and MR curves are just the red curve since no
one in the green market is willing to pay as much to get any goods. At lower prices consumers
in both markets buy the product.
Where the MC curve (in purple) intersects the combined MR curve it creates a reference point
that sets MR = MC. Bringing this reference point up to the two individual demand curves (green
and red) locates the optimal price for each market.
Third Degree Price Discrimination Graph Alternate Version
Self-Check Quiz: Third Degree Price Discrimination Alternate Version
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What Have the Airlines Taught Us About Pricing?
LESSON OBJECTIVE
Monitor Competitors' Prices Be positioned where you want
Don't Let Seats Go Empty Maximize revenues
Use 2nd Degree Price Discrimination Maximize revenues
Gain Revenue from Add-Ons Bags, preferred seats, food, etc.
Strategy May Lie Behind Pricing Decisions?
Ticket Price Boston to LA Traveling on 5/24/19
4/20/2019 5/17/2019
JetBlue $500 $1,100
United $1,000 $650
What do you think JetBlue and United are trying to do?

Be aware that JetBlue is the largest air carrier in Boston
Answer
Ticket Price Boston to LA Traveling on 5/24/19
4/20/2019 Remaining Seats 5/17/2019 Remaining Seats
JetBlue $500 130 $1,100 4
United $1,000 130 $650 28
On 4/20/19 United did not offer any free tickets for 12,500 mile flight.
On 5/17/19 United did offer free tickets for 12,500 miles each way.
Why did United do this?
Answer
Flight Cost
Emirates offered the following prices on 8/20/18 for travel in October - 12/18/18; prices are for
two passengers from JFK airport to Milan Italy. Same plane, same destination.
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Economy - $778
Business - $5,999
First Class - $9,999
 Question: Does this relate to costs or elasticities?

 Answer: While there is a slight difference in costs, most of this price differential reflects
elasticities.
Pricing Techniques
Some pricing techniques are explicitly designed to encourage consumers to buy more. One way
to do that is to provide a larger discount when the consumer spends more. Consider these
examples:
Creating New Customers or Higher Sales to Existing Customers Using Price
1. Trial offers - try for 30 days

2. Coupons - review First Degree Price Discrimination
3. Rebates - buy and get a refund
4. Free samples - take some home now
Saks Fifth Avenue
What is the pricing objective of this Saks Fifth Avenue ad?
Spend Some Get Some
$150 to $249 Instant $25 off your purchase
$1,000 or more Instant $400 off your purchase
Pricing Models (1 of 4)
The next few pages describe examples of pricing models for multiple products, along with some
food for thought.
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Pencils
Five pencils cost $2.89 at Amazon.
o Why can't you buy just one?

o How much do they cost to make?
o How much would you pay for just one?
Comcast Internet Only
 How much does it cost

Comcast to increase speed from
25 to 105?
 Why does the offer end in 12
months?
 Installation and a modem are not

mentioned in the advertisement.
Why not?
Aspen Ski Resort
What is the MC of one more skier? Why buy a multiple day package?
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Costco/BJs/Sam's Club
Entry is restricted to people who have paid a membership fee. Then individual goods are priced
with a 2% markup over costs.
 Is this profit maximizing? If it wasn't, they would revert to a simpler model of MR = MC

right?
 If their margin is 2%, why give back 2% with the Executive Membership?
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Netflix
Consumers can buy DVDs, streaming content, or both.
 What do most people buy?

 Which plan has higher costs to Netflix?
This table gives some financial data for Netflix's streaming services:
Netflix Financial Results - Total Streaming
Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 (Forecast)

Revenue $1.305B $1.4B $1.481B $1.581B $1.672B 1.813B
Contribution to Profits $178M $247M $248M $277M $270M $302M
Contribution to Margins 13.60% 17.70% 16.70% 17.50% 16.20% 16.70%
Total Memberships 57.39M 62.27M 65.55M 69.17M 74.76M 80.86M
Net Additions 4.33M 4.88M 3.28M 3.62M 5.59M 6.10M
This table provides company totals:
Netflix Financial Results - Total Including DVD Mail-In Subscriptions
Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 (Forecast)

Operating Income $65M $97M $75M $74M $60M $50M
Net Income $83M $24M $26M $29M $43M $11M
Earnings Per Share $0.19 $0.05 $0.06 $0.07 $0.10 $0.03
So does this imply that DVDs are unprofitable???
Graham Crackers
Some grocery stores carry only one brand; they don't even have store brands for sale.
 Why?
 How elastic do you think demand for graham crackers is?
 Could this be an example of limit pricing?
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Mobile Phones
Why do mobile phone companies offer second lines for less?
What is the MC of providing service?
What is the constraint on providing service?
Pricing by a Cost Dominant Firm in a Two Firm Industry
Now let's turn to the question of how a cost dominant firm in a two firm industry would develop
its optimal price.
Alternate Version of the Pricing by a Cost Dominant Firm Diagram
Pricing a cost dominate firm in an industry with TWO companies. For example: Uber vs.
Lyft
 Question: What are their objectives?

 Answer: They are seeking a common price with no competition between them.
Pricing Products Produced Simultaneously in Fixed Proportion
Suppose a company's production line simultaneously yields two products in fixed proportion, for
example:
 Electricity and steam
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 Ice milk and cream

 Wood chips and shoe trees
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Alternate Version of Pricing Products Produced Simultaneously in Fixed Proportion Diagrams
Pricing Multiple Products Produced on the Same Production

Line
Some companies are able to use platforms to turn out several products from the same
production line. This has the advantage of spreading fixed costs across products and allows
companies to offer numerous product variations that may appeal to different consumers. In
many cases, there are actually few cost differences between the various products. In the
example below, assume that there are no differences in costs between products. The firm
produces three types of TurboTax. Notice that in drawing the graph, the second and third
market demand curves are drawn above the point where the prior market demand curve has a
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MR = 0. This is done because the firm would never sell a product with a negative MR. Also, the
first product is the one with the highest initial demand point, likewise for the second product.
The optimal strategy is to produce until the MC of producing all three products equals the MR of
the last product. Logically, this should make sense to you because there are no production cost
differences between the products and by combining production the firm achieves economies of
scale. In order to maximize profits, the firm needs to have the same MR in all three markets. In
that case, MC = MR 1st market = MR 2nd market = MR 3rd market. Any deviation from this condition would
lower profits.
Pricing Multiple Products Produced on the Same Line at Very Similar Cost Graph Alternate
Version
Prices will not be equal in the three markets despite the fact that MR is equal in all three
markets. As seen in the graph below, prices are highest in the market with the highest initial
demand point and the least elastic demand.
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Pricing Multiple Products Produced on the Same Line with Constant Cost Graph Alternate
Version
The Dynamics of Pricing (1 of 5)
In reality, firms are keenly aware of their competitors. This is highlighted later in the lecture in
the section on Industry Analysis. This awareness affects their pricing strategies and how they
respond to tactics used by their competitors.
Firms soon learn the special characteristics of their own market. For example, in some markets
aggressive tactics are always matched by competitors leaving both firms worse off. In other
markets, aggressive tactics may yield higher sales and profits for the aggressor. Once firms
learn how their competitors are likely to respond to changes in the market, they often begin to
behave differently; they may even appear to be colluding to improve their own outlooks.
Price competition hurts firms. Unfortunately, for companies, collusion is illegal. Instead of
outright collusion, firms may engage in tacit cooperation in the hopes of achieving higher prices
and profits. As the number of firms in the industry grows it become more and more difficult for
firms to engage in tacit cooperation.
One strategy that companies follow to move competitors toward collusion is to adopt a tough
approach to competition. For example, announcing a "we are always 10% cheaper than they
are" policy may reduce future competition since other firms know that their price cuts will be
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more than matched. Highly concentrated industries are the easiest in which to engage in this
form of persuasion. Infrequent purchases made by a limited number of buyers may also
encourage collusion.
Some industries develop a price leader. When the price leader announces a price change all of
the other firms follow it. The price leader may encourage this role for them by announcing their
price changes in advance, which gives competitors time to adjust.
When firms don't compete on price they often compete on quality. Of course, quality is more
subjective than something as objective as price level. The internet may help consumers to learn
about quality.
Example: Staples Advertisement
Staples offers a guarantee that states "110% Lowest Price Guarantee - We'll beat our
competitors' prices."
 Question: Why has Staples offered this guarantee?

 Answer: This is a response to online sellers.
Choosing Quality Level
Quality choice is a strategic variable.
 Affects demand.
 What quality should the firm choose?
o Trade-off: equate marginal benefit (revenue) of increased quality with its marginal
cost.
Quality
Distinguish between:
 Experience goods
o Quality is difficult to observe before purchase (like wines, restaurants, surgeons).
o Objective signals aid in making a quality guess. Such signals may include
additional services, demonstrations, diplomas, recommendations, or
certifications.
 Search goods
o Quality easily observable before purchase.
o Quality delivering firms have an incentive to make their goods search goods.
 Brands aid this.
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 Being able to quantify a characteristic is important (e.g., 300 hp engine).
What must be true about quality products when store brands are priced at or above the level of
name brands? Consider this data presented in the Wall Street Journal:
Store Brands vs. Name Brands
ITEM STORE BRAND NAME BRAND
Sam's Club 200 Simply Right Premium: Luvs 204 Ultra Leakguard:
Diapers
$35.38 $33.97
Safeway 6 oz. Open Nature Strained Fage 6 oz. Total

Strawberry: Strawberry:
Greek Yogurt
$1.39 $1.00
Target's Archer Farms: Planters:

Roasted
Almonds
Price/oz.: $0.37 Price/oz.: $0.36
Source: Store Brands Step Up Their Game, and Prices. (2012, January 31). Wall Street Journal.
The dynamics of pricing decisions are influenced by a company's product's location along the
product lifestyle. The incentive to collude is greatest as the product ages.
Effect of Product Lifestyle on Pricing
New Growth Mature Declining
Number of
Few Growing Stable Falling
Competitors
Typical Customer Trendsetter Upper Middle Class Everyone Stragglers
Limit or Profit May require

Pricing Steady Falling
Maximizing discounting
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Minimum Advertised Price (MAP)
The basis of the MAP strategy is that the manufacturer provides marketing support to retailers
that price the product at or above a specified level; for example, Maui Jim sunglasses sell for
$159 everywhere. The firm may even choose to not sell to offending retailers.
In 2007 the Supreme Court reversed itself and ruled that MAP is not a federal antitrust violation,
and that the "rule of reason" should make that determination. Originally part of antitrust law; the
Supreme Court said that monopoly power is not illegal unless the power is used to restrain
trade. However, later the court said that certain agreements such as price fixing are still illegal
regardless of whether or not they restrain trade.
 How does this help the manufacturer?

 How does it help the retailer?
This table outlines the cost components of a $155 Polo Shirt:
Item Cost
Fabric $6.80
Fabric for placket and vent $0.99
4 buttons (includes 1 extra) $0.12
Thread $0.09
Labels $1.10
Hang Tag $0.40
Waste fabric $0.85
Labor $11.05
Packing Material $0.17
Ship Material to NY Plant then Shirts to Atlanta $5.00
Hand-Embroidered Linen Bag $3.00
Total $29.57
Wholesale Price $65.00

Source: Wall Street Journal, "Polo Puzzle: What Goes Into a $155 Price Tag?"
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Production Issues
Optimal Production with Two Production Sites
A firm with two plants may need less output than the combined total output of the two plants.
Rather than run the most efficient plant to its full capacity and then move the remaining
production to the other plant, it is better off to force the MC of each plant to be equal.
Output from the two plants is not equal; instead the MC of each plant is equal. In the diagram
below the output from plant 1, Q1, is larger than the output of plant 2, Q2. The sum of the two
outputs, Q1 + Q2, equals the total output of the firm.
Transfer Pricing Graph Alternate Version
Whether individual plants make money depends on their SR AVC. The sum of the profits of the
two plants equals the monopolist's total profit.
Industry Analysis
Every industry is different. Companies need to consider whom they compete with, how
competition is conducted, the industry's structure, and the degree to which companies are rivals
or cooperators.
A well-known method of industry analysis is referred to as Porter's Five Forces Analysis. Porter
presented these arguments in a March 1979 Harvard Business Review article, "How
Competitive Forces Shape Strategy", March - April 1979, pages 86-93. The Five Forces help to
understand the balance of power in a business situation. Are you in control or do your
competitors have all the power?
Porter assumes five important forces determine competitive power. These forces are the rivalry
27
between competitors (how many there are and how good their product is relative to yours), entry
(can new competitors easily enter your marketplace?), substitutes and complements (what are
the consumers other choices?), supplier power (can your suppliers raise prices to "steal away"
your profits?), and buyer power (can your buyers negotiate your price down?).
The Five Forces help a company to assess threats to profitability and opportunities in new
markets. They also help companies to develop strategies to overcome disadvantages identified
by the Five Forces. For example, if you have many rivals who have similar products to yours the
Five Forces analysis would suggest that you need to develop a plan that will tie your customers
more closely to you. These include ideas to make switching to competitors more expensive and
to make staying with your product/service less expensive than switching. It might also argue that
a company should change segments and sell in a less crowded environment.
Alternate Version of Five Forces Overview
End of Week 5
Week 5 Discussion 1
Week 5 Discussion 1
Value: 100 points
Due: Day 7
Each week, you must answer questions provided by the professor on an article from the Wall
Street Journal. You are expected to participate in this discussion each week.
Taylor Swift's Ticket Strategy: Brilliant Business or Slowing Demand? Rolling Stone
Questions:
1. As a consumer, are you disappointed that the artist is seeking to recapture the gains
going to ticket scalpers?
2. If you plan to attend a concert what strategies will you consider as to when to purchase
your tickets?
28
Week 5 Discussion 2
Week 5 Discussion 2
Value: 100 points
Due: Day 7
Each week, you must answer questions provided by the professor on an article from the Wall
Street Journal. You are expected to participate in this discussion each week.
Wave of Megadeals Tests Antitrust Limits in U.S. The Wall Street Journal
Questions:
1. Companies like Google, Apple and Facebook are facing intense antitrust scrutiny. Do
you feel that the lack of competition in their markets is harmful to you, those you know,
or society?
2. Should these companies be left alone?
Late Exam
ProctorU
The exam is password protected and can only be unlocked by ProctorU. Please be certain to
schedule your exam time at least 72 hours before taking the exam. You will need to know your
course's CRN number when registering in order to register for the correct section. The CRN
number can be found in the top left corner of Blackboard and is usually a 5-digit number
following the course code.
Also, it is crucial that you check all of the technical requirements for ProctorU prior to the time of
your exam and verify that your computer system meets ProctorU Technical Requirements. You
can do this by visiting ProctorU Technical Requirements and using the Test It Out tool. There is
also a 'Connect to a live person' option on the Technical Requirements page where you can
have further testing done on your system by a live ProctorU representative. This is required to
ensure you will be able to complete your exam without issue.
NOTE: You must log completely out of Blackboard before logging out of the ProctorU system.
Instructions
Please note that the exam will be released on Day 1 of Week 5.
This exam is a review of all the material covered since the Early Exam. It is worth 100 points, or
35% of your overall grade. There are a total of four sections, with essay questions (ranging from
4 to 27 points) and one fill-in multiple blanks question (24 points).
29
This examination is closed book and closed notes. It should not be taken in coordination with
any other student.
You have 2 hours to complete this exam. You are given one attempt.
Late Exam
Late Exam
Value: 100 points
Due Day 7
ProctorU
The exam is password protected and can only be unlocked by ProctorU. Please be certain to
schedule your exam time at least 72 hours before taking the exam. You will need to know your
course's CRN number when registering in order to register for the correct section. The CRN
number can be found in the top left corner of Blackboard and is usually a 5-digit number
following the course code.
Also, it is crucial that you check all of the technical requirements for ProctorU prior to the time of
your exam and verify that your computer system meets ProctorU Technical Requirements. You
can do this by visiting ProctorU Technical Requirements and using the Test It Out tool. There is
also a 'Connect to a live person' option on the Technical Requirements page where you can
have further testing done on your system by a live ProctorU representative. This is required to
ensure you will be able to complete your exam without issue.
NOTE: You must log completely out of Blackboard before logging out of the ProctorU system.
Instructions
This exam is a review of all the material covered since the Early Exam. It is worth 100 points, or
35% of your overall grade. There are a total of four sections.
This examination is closed book and closed notes. It should not be taken in coordination with
any other student.
You have 2 hours to complete this exam. You are given one attempt.
Course Evaluation
Please help us evaluate this course and improve the student learning experience by taking a
few minutes to complete this survey. This survey provides you with an opportunity to specifically
evaluate the course content and instruction.
30
This evaluation is completely confidential; your answers will be recorded electronically with no
connection to your identity. This survey lets you rate the course according to your perceptions.
We also encourage you to provide further feedback through the open-ended comment boxes.
You may provide as much or as little detail as you wish. The information you provide is critical,
and we examine it closely. We appreciate your thoughtful, constructive, and candid responses.
This survey should take only about 10-15 minutes to complete.
MECN 6200 FA2 2019
31

Week 5: Pricing Issues

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Week 5: Pricing Issues

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MECN 6200: Global Competition and Market Dominance

Note: This is the text-only version of this week’s lecture.

Week 5: Pricing Issues

Log in to the course to view video and alternative version.

Week Five Overview Video Transcript

This week, you will accomplish four things:

Week 5 Learning Objectives

After completing this week, you will be able to:

 Help your firm to establish the profit maximizing price.

Week 5 Learning Activities

Readings  McGraw-Hill Custom Book, Content 10 Complete by

Self-Check Complete all self-check quizzes as they appear Complete by

Discussion 1 Taylor Swift's Ticket Strategy: Brilliant Business or Complete by 100

Discussion 2 Wave of Megadeals Tests Antitrust Limits in Complete by 100

Late Exam ProctorU is required to take this exam. Opens 100

Note: All discussions can be accessed in the Discussions area.

 McGraw-Hill Custom Book, Content 10 (view Content Titles of weekly readings)

1. Profit maximization - to earn the most money now.

MR = P ( 1 - 1/η ) and that to profit maximize we must set MR = MC so, MC = P ( 1 - 1/η )

Now suppose we know that MC = $2.00 and that η= 1.5.

before they change price, facts will have changed again.

Price = (1 + λ) "Cost" where λ is the markup.

Here is some food for thought:

Whose markup might be bigger?

Do markups ignore costs?

Are they better than profit maximization?

Jack Ryan Films

The Jack Ryan Collection - four films: $29.99

Substitute and Complementary Goods Graphic Alternate Version

Existing Product Pricing Strategies

Claritin is a popular antihistamine that is known to reduce allergy symptoms.

 Question: Why does Schering-Plough offer so many varieties of Claritin?

The following tale was on the internet in August 2018.

 Question: Do most consumers see this? Does this upset consumers?

New Product Pricing Strategies

Limit Pricing Graph Alternate Version

Other firms may price new products in

The existing firm's costs curve is lower

Monopoly Pricing Options

Using Elasticity and Costs to Change Price

Profit = $9,000 - $5,000 - $2,000 = $2,000

 Question: Should the firm cut its price by $1.00?

Revenue loss from existing units = $1,000

New Contribution Margin = $3

Breakeven Sales Analysis

= $1 / $3 = 33% (Note: This is the necessary sales change to maintain TR)

 Question: What elasticity ( ) is required to get back the lost $1?

o =% Quantity / % Price; which equals

of - 2.97 seem likely?

Review the following articles:

 Taylor Swift's Ticket Strategy: Brilliant Business or Slowing Demand?

Alternate Version of Chart

Alternate Version of Chart

Absolut Vodka (Pricing)

1.75L Bottle: $29.99

 Question: What is Absolut's objective with their pricing?

Dynamic Pricing is Similar to Time of Day Pricing

Lesson 2: Price Discrimination

There are three types of price discrimination:

Forms of First Degree Price Discrimination

Coupons Graph Alternate Version

Self-Check Quiz: Forms of First Degree Price Discrimination Alternate Version