Fitness Club Sales Employee Incentive Plans - PowerPoint

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					          Unit 8.


Profit Maintenance/Enhancement
           Investment Tip?

 “The most important thing I look at in
 evaluating a company for investment
 purposes is whether or not they have a
 sustainable competitive advantage.”
 (Warren Buffett)
   Managing a Price Taking Firm
 „Competitive‟ firms have the biggest
  challenge of sustaining π’s.
 Understand market forces to anticipate
  changes in input and output prices
 Use cash market contracts, futures
  markets, etc. to establish favorable
  prices at times other than delivery
 Costs must be minimized
 Look into specialty products, niche
  markets, forming cooperatives,etc.
Profit Enhancement/Maintenance
Strategies (P setting firms mainly)

1. Create barriers to entry
2. Decrease P competition with rivals
3. Differentiate product to increase
   demand/decrease price elasticity
4. Decrease costs/increase productivity
5. Implement creative pricing policies
Same Price or a Separate Menu?
 Papa Dels is a popular pizzeria on the
  University of Illinois campus. The manager of
  this restaurant has been informed that the
  own price elasticity of demand for their pizza
  is -4 for lunch and -2 for dinner. The
  incremental cost of making and selling a large
  pizza is $6 for this firm, for both lunch and
  dinner. Would you recommend that Pap Dels
  have a separate menu for lunch and dinner?
  If yes, what prices do you suggest be
  charged?
Marketing (Pricing) Internationally?

 Kodak is currently selling its camera film in
  both the U.S. and Japan. The company‟s
  research department has estimated the
  demand for Kodak film in each country as
  follows:
       U.S. => QUS = 15 – PUS
       Japan => QJ = 9 - .5PJ
  If MC = ATC = 3 in both countries, what
  pricing strategy would maximize Kodak‟s
  profits in the U.S. and Japan combined?
Coffee (P) Break?
 Spooky Business sells its own brand of coffee
  on line. The company currently sets one
  price for each flavor or type sold. The
  marketing department has recently given
  management two alternative proposals to
  „perk‟ up sales. One proposal is to simply
  lower price on each item. The second
  proposal is to give customers „quantity‟
  discounts (i.e. lower price on greater,
  specified quantities). Which option would you
  advise management implement?
What Fee to Charge?
 Rick and Joan Thompson recently moved from Iowa
  to Phoenix (AZ). They plan to run their own business
  there which is a health club called Sun Devil Spa and
  Fitness Club. While Rick and Joan are „fitness‟
  experts, they know very little about managing a
  business and, in particular, setting prices. They have
  noticed other health clubs have „members‟ who are
  typically charged a membership fee. They have
  come to you for advice. Would you recommend they
  charge a „membership‟ fee too or simply charge a fee
  „per visit‟? If they decide to charge a „membership‟
  fee, what information would assist you in determining
  the „best‟ fee to charge?
Package (or Block) Pricing
 Fruit of the Loom sells men‟s tee shirts
 in packages (3 shirts per package).
 Management is wondering a) if the
 company would be better off selling the
 shirts individually and b) if not, is the
 company charging the „best‟ price for its
 package? What recommendations do
 you have for management?
Making „Bundles‟?
 Hewlett Packard sells both „printers‟ and „print
  cartridges‟ for microcomputers. Would you
  recommend to management that these
  products be priced and sold a) separately or
  b) together (as a „bundle‟)? If HP prices
  these items separately, which strategy is
  likely to generate more profits: a) low price
  for the printers, high price for the cartridges or
  b) high price for the printers, low price for the
  cartridges?
A Slam Dunk Deal?
 Mark Cuban is the owner of the Dallas Mavericks, a
  professional NBA team (i.e. basketball). He is a very
  visible owner at games and is often seen cheering on
  his team as well as yelling at officials when he thinks
  they made a bad call. He has even been fined
  extensively by the NBA for his outspoken criticism of
  league referees. Cuban wants to win an NBA title in
  the „worst‟ way. However, he is concerned that after
  he signs his players to „big‟ contracts, they may not
  have the same incentive as he does to win an NBA
  title. What managerial „econ‟ advice would you give
  Mr. Cuban on structuring player contracts for his
  team so as to provide more incentive for his players
  to try to win a championship?
           Reality Realty?
 If you hire a real estate agent to sell
  your house, do they have the same
  economic incentive as you to maximize
  the selling price (i.e. get top dollar) for
  your house?
Pricing Questions
 Why:
   Are buns sold in a package?
   Is there an entrance fee but no charge for
    individual rides at some amusement parks?
   Is the markup on coffee less than the markup on
    fresh flowers at a grocery store?
   Are there senior-citizen and student discounts?
   Does it cost more to do certain things at different
    times of the wk (e.g. fly, play golf, make phone
    calls, etc.)
   Do travel agencies sell vacation „packages‟?
 Creating barriers to entry
   Advertise/differentiate
   Proliferate new products (introduce first)
   Maintain excess production capacity
   Seek out sustainable niches
   Guard trade secrets/plans
   Obtain and/or extend patents
   Entry limit pricing
    More Demand for Us, Less
        Demand for You?
$                       $
                 ATC


                  D1                      D2
            D2                         D1
                   Q                      Q

    Potential Entrant       Existing Firm
Entry Limit Pricing
 Decreasing competitive P rivalry


   Match   P

   Random      P

   Non   price competition

   Customer    service
Creative Pricing Policies
   Price discrimination
   2-part block (package)
   Bundling
   Q discounts
   Multiple (joint) product
    Types of P Discrimination
 First degree (= complete or perfect)
    Selling each unit for a different price which = the
     maximum P any buyer is willing to pay (i.e. charge
     the maximum prices along a given D curve)
 Second degree
   Selling different quantity units for different prices
    to all buyers (i.e. quantity discounts)
 Third degree
    Selling all quantity units to different buyer groups
     at different prices (i.e. divide the market into
     different D segments and charge optimal prices
     accordingly)
Robinson Patman Act (1936)
 Makes it illegal for firms to price discriminate
  in „business‟ markets (sales to other business
  firms) where the effect may be to injure
  competition.
 The concern was over sellers giving „chains‟
  or large corporate buyers price discounts that
  would lower their costs and make it difficult
  for smaller firms to compete with them.
 Does NOT disallow quantity discounts (if cost
  justified), cash payment discounts, and
  advance order/payment discounts if made
  available to all buyers.
 Third Degree Price Discrimination

 The practice of charging different
 groups of consumers different prices for
 the same product

 Examples include student discounts,
 senior citizen‟s discounts, regional and
 international pricing
 Change in TR Due to Q (i.e.
            MR)
TR  PQ  QP 
                       NOTE:
      TR       P
          P     Q
      Q        Q     MR = 0 if E is
         P Q          unitary
MR  P        P
         Q P
                       > 0 if E is elastic
           1
MR  P[1  ]
           E           < 0 if E is inelastic
        E 1
MR  P[  ]
        E E
        E 1
MR  P[      ]
         E
    Profit-Maximizing Prices
  P where MR = MC
     E0  1
  P         MC
     E0 
      E0 
  P        MC
      E0  1
  E0 
  E  1  ' markup' factor applied to MC
  0 
Profit-Maximizing „Markup‟ Factors
         E0        E0 
                           
                    E 0  1

         -1.05         21
          -1.1         11
          -1.2          6
          -1.4        3.5
          -1.6       2.67
          -1.8       2.25
          -2.0          2
          -2.5       1.67
          -3.0        1.5
          -4.0       1.33
Assume:
 Q   =       total demand for Kodak film
 QUS =       US demand = 15 – PUS
             PUS = 15 – QUS
            MRUS = 15 – 2QUS
  QJ =       Japan demand = 18 – 2PJ
            PJ = 9 - .5QJ
            MRJ = 9 – QJ
   QT =     QUS + QJ
             = 33 – 3P (for P 9)
   P = 11 – 1/3Q
   MR = 11 – 2/3Q
 MC = ATC = 3 in both the US & Japan
          Profit Max Example
           (with P Discrimination)

 QJ to max J  MRJ = MC
  9 – QJ = 3
  QJ* = 6
  PJ* = 6
  max J = TRJ – TCJ
    = (6)(6) – (3)(6) = 36 – 18 = 18
  max  = max US + max J
    = 36 + 18 = 54
          Profit Max Example
           (with P Discrimination)

  max  max US + max J
 QUS to max US  MRUS = MC
    15 – 2QUS = 3
    QUS* = 6
    PUS* = 9
    max US = TRUS – TCUS
     = (9)(6) – (3)(6) = 54 – 18 = 36
P Discrimination  Differential
        Markup Pricing
 E0 in US at PUS = 9
    Q P       9
       ( 1)  150
                    .
    P Q       6
       E0     150
                 .     15
                         .
                          3 markup
      E0  1 150  1 .5
               .

 E0 in J at PJ = 6
    Q P          6
         ( 2)   2
    P Q          6
       E0      2
                    2 markup
     E 0  1 2  1
          Π w/o Discriminating
                              NOTE:
  Max if PU = PJ
                               QU = 15 - PU
   MRT = MC
   11 – 2/3Qr = 3             = 15 – 7
                               = 8  U =(4)(8) = 32
   2/3QT = 8
   QT = 12
                               QJ = 18 – 2PJ
   P       = 11 – 1/3(QT)
                                  = 18 – 2(7)
            = 11 – 1/3(12)
                                  = 18 – 14
            =7
                                  =4
   =       (P-ATC)(QT)
     =      (7-3)(12)         J = (4)(4) = 16
     =      48
Charging Different PS to Different
     Customers (markets)
  P                       P




                      PB

 PA



                MC                    MC

                 DA                   DB

                      Q       MRB          Q
          MRA

      Mkt A                   Mkt B
Peak-Load Pricing

 When demand during
  peak times is higher
  than the capacity of the
  firm, the firm should
  engage in peak-load
  pricing.
 Charge a higher price
  (PH) during peak times
  (DH)
 Charge a lower price
  (PL) during off-peak
  times (DL)
Extracting Consumer Surplus:
1.   Block Pricing: For items sold in a package
     (block), add units up to point where
     consumer willingness to pay = MC of
     adding last unit. Charge P = consumer
     surplus value at that point.
2.   Two-part Pricing: For items sold where the
     seller can limit buyer access to the product,
     charge P = MC and also charge a „fee‟ = to
     remaining consumer surplus.
3.   Volume Discounts: Charge lower price for
     units purchased beyond given level.
Block P Example

 Typical consumer‟s demand is P = 10 –
  2Q
 C(Q) = 2Q
 Optimal number of units in a package?
 Optimal package price?
Costs and Profits with Block Pricing

  Results with Standard MR =
        MC Profit Max
 P = 10 – 2Q
  MR = 10 – 4Q


 TC = 2Q
  MC = 2


  Max
  MR = MC
  10 – 4Q = 2
 Q = 2, P = 6
  TR – TC = (6)(2) – (2)(2) = 12-4 = 8
    Optimal Quantity to Package: 4 Units


Optimal Price for the Package: $24


Costs and Profits with Two-Part
           Pricing
 Price
                       Charge fee = CS
   10
                       ½ (4) (10-2) = $16
    8
    6
                       Costs = $8
     4
     2                          Set P = MC = $2
                         D

         1   2 3   4     5     Quantity
      Commodity Bundling
 The practice of bundling two or more
  products together and charging one
  price for the bundle.
 Examples
   Vacation packages
   Computers and software
   Film and developing
A Kodak Bundle

 Total market size is 4 million customers
 Four types of consumers
    25% will use only Kodak film
    25% will use only Kodak developing
    25% will use only Kodak film and use only Kodak
     developing
    25% have no preference
 Zero costs (for simplicity)
 Maximum price each type of consumer will
  pay is as follows:
Reservation Prices for Kodak Film and
  Developing by Type of Consumer


    Type       Film    Developing
      F         $8         $3
     FD         $8         $4
      D         $4         $6
      N         $3         $2
    Demand for Kodak Film

    Demand for Kodak Developing


Revenue-Maximizing Film P?
    P      Buyers         TR
     8   F, FD         8 x 2 = 16

     4   F, FD, D      4 x 3 = 12

     3   F, FD, D, N   3 x 4 = 12
Revenue-Maximizing Developing P?
    P       Buyers      TR
     6   D             6x1=6

     4   D, FD         4x2=8

     3   D, FD, F      3x3=9

     2   D, FD, F, N   2x4=8
 Maximum TR Pricing Items
       Separately?

 = Max Film TR + Max Developing
 TR

 16 + 9


 = 25
    Demand for Film & Developing
             „Bundle‟

Revenue-Maximizing „Bundle‟ P?


          P         Buyers       TR
         12    FD            12 x 1 = 12
         11    FD, F         11 x 2 = 22
         10    FD, F, D      10 x 3 = 30
          5    FD, F, D, N   5 x 4 = 20

 Note: previous Max TR pricing items
    separately = 25.
          Bundles of Goods
 Bundling often involves one „physical‟ or
 „capital‟ type good being sold with a
 related „services‟ type good.
 Physical/capital good   Service good
 Razor                   Razor blades
 Camera                  Film, film development
 Computer                Software, technical support
 Water softener          Salt packets
 Phone                   Calling plans
 Copy machine            Paper, cartridges, tech support
 Fertilizer              Application, soil testing
 Hotel room              Transportation, meal
Q Discount
    Assume P = 100 - .1Q (Q = 00‟s)
        MC = ATC = 10


    What is firm π w/
    1) MR = MC production/pricing?
    2) Charge P = 75 for Q up to 250, P = 55 for
       additional Q?
      P


                          No Q Discount π
    120

    100

     80                         Std MR=MC pricing π
                                Π = (P-ATC)Q
     60                             = (55-10) 450
                                    = 20,250
     40
                                               P=100-.1Q
     20
     10                            MC=ATC
                                                      Q (00)
MR = 100 - .2Q            450   MR           1000
   => MR = MC
   => 100 - .2Q = 10
   => .2Q = 90
   => Q = 450 => P = 55
  P


                 Q Discount π
120

100
                       Π = (75-10)(250)
 80                      + (55-10)(200)
      75
 60                      = 16,250 + 9,000
      55                 = 25,250
 40
                                   P=100-.1Q
 20
 10                      MC=ATC
                                          Q (00)
           250   450   MR         1000
Cross-Subsidies
 Prices charged for one product are
  subsidized by the sale of another product.
 May be profitable when there are significant
  demand complementarities effects.
 Examples
   Browser and server software
   Drinks and meals at restaurants
   => TR = PXQX + PYQY
     Economic „Incentive‟ Questions
1.    Suppose a business firm manager hires a
      tax return preparer, a lawyer, a contractor,
      and an employee. What do they have in
      common from the business firm manager‟s
      perspective?
2.    Do employees have an incentive to „shirk‟
      their duties and, if so, how do personnel
      managers attempt to reduce „shirking‟ by
      employees?
3.    What do most home insurance, car
      insurance, and medical insurance policies
      have in common and why?
Principal-Agent Problem
 Problem  agent has incentive to
 pursue their own goals which hinders
 principal‟s ability to achieve their goals.
 Principal = individual   Agent = individual
 who employs or           employed to
 supervises others        assist a principal
 (agents)
 • stockholders           • management
 • management             • employees
 • business owner         • sub contractor
 • defendant              • lawyer
 • team owner             • team player
   Principal-Agent Solutions
 Supervision of Agent
   Time clock
   Spot check
 Internal Incentives
    Profit sharing (e.g. bonus)
    Revenue sharing (e.g. tips, commissions)
    Piece rate pay
 External Incentives
   Reputation concerns
   Takeover threat
Economic Problems Caused by
Asymmetric Information:
1.   Adverse selection  one party can benefit at the
     expense of another because they have more
     information about an unobserved characteristic.
       Examples:
       Potential employee‟s work ethic
       Health status of an insurance customer
       Driving tendencies of insurance customer
       Product quality
2.   Moral hazard  one party can benefit at the
     expense of another because they have more
     information about unobserved actions
     Solution = contracts to make incentives more
     compatible
               Types of Contracts
1.   Fixed fee
     a. To agent (e.g. person hired)
     b. To principal (e.g. land or property owner)
2.   Hire
     a. wage or salary
     b. piece rate
3.   Contingent
     a. revenue sharing
     b. profit sharing
     c. some outcome (e.g. no wrong doing by policy holder, outcome of
     the trial)

Conclusions:
1.   Contracts provide economic incentives to both parties; best contracts
     provide compatible incentives
2.   Need to examine incentives provided and likely consequences of
     contract terms
3.   Contracts that usually provide the most compatible economic
     incentive to agents are 1b and 3b above

				
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