Practical Asset Pricing ECM 152

Class 3
Fabio Calonaci
Semester C, 2023

1. Define the compromise effect. Provide an example and discuss it. Solution:

• The compromise effect is a crucial behavioural impulse when designing prices

• Customers often choose the mid-priced option to protect themselves from mak-
ing a bad choice

• The implication here is that one can increase profits by adding a low-price or
high-price option in addition to an existing product

• Needs to be same brand

- Studies shows that if you add a premium brand as a decoy product it does
not have the shift consumers from low-price option to mid-price option

• Example: Nike has 3 level of shoes to incentive the middle level. Shell has 3
types of gasoline.

2. A company is considering launching a new smartphone model in the market. They

believe that the unique features of the phone will provide a perceived differentiation
value to customers. The company estimates that the annual revenue from the phone,
without the perceived differentiation value, will be $5 million. However, they antic-
ipate that if the phone has the perceived differentiation value, the annual revenue
will increase to $8 million. The additional cost associated with providing the per-
ceived differentiation value is estimated to be $1.5 million per year. Calculate the
economic value to the customer (EVC) based on the perceived differentiation value.
Solution:C

To calculate the economic value to the customer (EVC) based on the perceived dif-
ferentiation value, we need to consider the additional revenue and the additional cost
associated with the perceived differentiation value.
The additional revenue from the perceived differentiation value is given by:

• Additional Revenue = Revenue with Perceived Differentiation - Revenue without

Perceived Differentiation

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 Substituting the given values:
Additional Revenue = $8, 000, 000 − $5, 000, 000 = $3, 000, 000
The economic value to the customer (EVC) is the additional revenue minus the
additional cost:
EVC = Additional Revenue − Additional Cost
Substituting the given values:
EVC = $3, 000, 000 − $1, 500, 000 = $1, 500, 000
Therefore, the economic value to the customer (EVC) based on the perceived differ-
entiation value is $1,500,000.
3. Nespresso, has developed a new green coffee machine able to let the people save energy
and produce better coffee. Relative to buy a normal machine, an customer would
save $150 in electricity costs, $75 in government discount for buying green coffee
machine and $50 in water costs. What is the differentiation value of the company
ABC? Define.
Solution:C
Differentiation value = $150+$75+$50

Differentiation value = value of a products attribute difference between your offering

and the closest substitute (+ or -)
4. Using the setting of question 2. Find the ECV of the new coffee machine, knowing
the competitor price is $150 and the government taxes old coffee machines since not
green of $25.
Solution:D
ECV = ($275 + $25) + $150

The government taxes has to be seen as additional differentiation value since offered
to all the new green coffee machine.
5. Google has developed a very storage system. Google guarantees a crash occurance
of low than 5% a year for the first 5 years while its competitor Aruba of 11% over
the same period. Google has operating cost/hour of $55; the competitor is cheaper
and requires only $30 If the system crash this issue will cost your company $450,000.
You are planning to use this server for 2,500 hours a year. The competitor price is
$295,000. What is the EVC for StableServer?
A. $ 9750
B. $ 10300
C. $ 9500
D. $ 8000
Solution: C

Reference value = $295,000

Positive differentiation value = (0.11-0.05)*$450,000 = $27,000 (costs saved from

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 using Google servers)
Negative differentiation value = (55-30)*2,500*5 = $312,500 (added costs from using
Google servers)
EVC = $295,000 + $27,000 - $312,500 = $9,500

6. Ariston produces microwaves and has two lines of product on the market, Top Product
and Low Product . Top Product has a mark-up of 26% while Low Product of 14%.
The fix cost of the company faces every month to run its activity is $123000: 55%
for Top product and 45% for Low one. The variable costs for the 2 products are 45%
and 55% of the fix. What are the prices of the 2 products?
A. $ 84628.2 & $ 52200.0
B. $ 79012.8 & $ 49276.8
C. $ 79012.8 & $ 52200.0
D. $ 43878.3 & $ 28468.3
E. $ 73915.2 & $ 55800.0
Solution: E

P rice = (1 + % markup)(Unit Variable Cost + Average Fixed Cost)

P riceHigh = (1 + 0.26)((123000 ∗ 0.55) + (123000 ∗ 0.55 ∗ 0.45))

P riceLow = (1 + 0.14)((123000 ∗ 0.45) + (123000 ∗ 0.45 ∗ 0.55))

7. Explain how timing strategies can affect the customer evaluation. Discuss how reduce
the perceived pain of the payment
Solution:

• Getting the timing of pricing right can actually aid how much consumers enjoy
your good

• Basically, consumers prefer to avoid a payment that is timed when either they
are enjoying the good, or when they expect in particular to not enjoy the good

• Decouple the pain of paying from consumption for experience goods

- E.g. people are willing to pre-pay and pay a premium for things they enjoy
(such as vacations, phones etc.)

• Decouple the pain of paying from the pain of learning how to use a technology
good

- Customers are more likely to switch if they do not have to pay full price for
a technology service in the same month they learn how to use it
– Decouple pain of paying from possibility of bad experience of products

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