Pricing Processes for Small Businesses

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					           [Pricing Electronic Services]
           Lecture 1

           [Judith Molka-Danielsen]

     Dell’s Front
  Online Orders





           •   Participants in the market
           •   Pricing Forces
           •   Model of consumers
           •   Model of products
           •   Pricing on the Web
               – effect of market forces on pricing
               – pricing models

           Who participates in determining price?

           • Porter Forces (power of players)
                          New Entrants

       Suppliers                                 Buyers
                          Intensity of Rivalry

           Participants               Suppliers
           Who participates in determining price?
           Supplier Oriented Electronic Marketplace
           • B2B: Dell, Intel, Cisco, IBM – 90% of their sales to
             business buyers.
           • They need different services for business buyers
             (repeat buyers, order large quantities).
           • End customer buyers or small businesses must
             search and compare suppliers and products,
             searching at e-stores or e-malls to find the best
           • Buyer owned shopping carts with stored buyer
             preference and can be integrated with business
             buyers order system.
           • Computer reseller Ingram Micro (
             has proprietary auction sites for regular buyers to
             get surplus discounts.
           Example of Supplier-Oriented Market Place

           Participants                   Buyers
           Who participates in determining price?
           Buyers Oriented Electronic Marketplace
           • B2B: Boeing Inc. is a powerful buyer. They purchases
             thousands of items on the Internet.
           • These strong buyers prefer to open electronic markets on
             their own servers or to use electronic intermediary services.
           • They can invite potential suppliers to bid on announced RFQs
             (Request for Quotations).
           • Software agents can be used to participate in automatic
             bidding processes online.
           • As an intermediary, Boeing’s PART links airlines with 300 key
             suppliers of Boeing’s maintenance parts.
           • General Electric TPN Post has its own auction bidding site to
             other buyers so they can post their own RFQs.

           Example of Buyer Oriented Marketplace

           Example: GE’s use of an Electronic Intermediary Service.

           Example of Benefits for an Intermediary Electronic
           Marketplace Service

           Factors for determining/setting price:
           • Price directly effects the firms revenue.
           • Businesses try to maximize the firms surplus while
             consumers try to maximize their consumer surplus.
           • Businesses would like to set price (need power).
           • Consumers try to buy a product when prices are low.

                                                  p'                        loss


              price   PS


                                      q                           q'          q                           q    q"
                           demanded                    supply restriction                  price restriction

           Other Factors for setting price:
           • Businesses (decision makers) can set
             prices with other goals than profit
             maximization in mind. They might try to
                 gain larger market share
                 cooperate with competitors
                 focus on improving brand recognition over
                  short term profits
                 set low prices on new products to penetrate
                  the market before competitors
                 use discounts, rebates, and price bundling

           Other Factors for setting price:
           • Customers (decision makers) can make
             purchase decisions with other goals than
             price in mind. Their decisions are based on:
                 product and information availability
                 the cost of searching for the product
                 the power of the buyer (small customers
                  have little power to set prices).

           Pricing Forces:
           • Customers have tools to help them reduce search
             costs, give customers more information and give
             them choice (power) to shop around.
                  search engines (Yahoo!, Excite, Lycos)
                  site services (opinions of experts and peers)
                  chat rooms, bulletin boards
                  intelligent agents (to compare products)

           • Businesses respond to increased customer power
             by innovation of products. This can lead to
             imitations, oversupply, and more customer choice,
             and also to the cycle of price competition speeding
           Model of Customers
           • Model 1. All customers are not equal. (80-20 Rule,
             80% of your revenues comes from 20% of your
             customers.) Low value customers take longer to
             repay investments.
           • Example: Frequent Flyer programs. C group is less loyal, do
             not use service often, buy on price. B group still price
             sensitive. A group have high value to the firm, use service
             often, loyal customers (not shop around on price). A+
             customers are highest value to firm and are given special

               High customer value           5%       A+

                                            15%        A

                                           30%             B

               Low                             50%             C

           Model of Products
           • Axis: Exchange between participants. At one
             extreme it is voluntary (trading stocks on the
             exchange, fair and mutual benefits) and at the
             other it is forced (at least one party does not want
             the trade, theft).
           • A market is efficient if price is the only information
             needed to make the exchange. Maximum market
             efficiency (100%) is where the trading maximizes
             the gains of buyers and sellers (refer: 1st welfare
           • Between extremes is the range of marketing

           Model of Products
           • Between extremes is the range of marketing

             Market forces
                                  theft by force
                                  theft by fraud
                                                      Range of
                                  products and        marketing

                                  trades on a stock
             Corporate strategy

           Range of market effectiveness
           • Seduction can imply that consumers resist at first,
             but then may enjoy the product after marketers
             have enticed them to switch to it.

           • Products and services can be in large variety, with
             differentiated characteristics and quality. Products
             that are easily substituted are commodities. But
             these also can be differentiated by brand name,
             packaging, and attached services.

           • Marketing works best in the Range of marketing
             effectiveness. Parties are not equal in power.
             There can be information asymmetries. Marketers
             make promises to encourage the exchange.
           Combining the models
           • Goal of the business should be to move
             customers up the pyramid in Model 1 and to
             move products and services into the zone of
             seduction in Model 2 (where prices are high).

           • Competitive forces in the market (product
             competition and increased customer power) will
             tend to
                  force the customer into lower value groups
                   (they can switch) in Model 1,
                  moves products and services to
                   commodities (technology advances makes
                   it simple and easy to reproduce products,
                   prices go down as with cheap PCs).
           Web Market Forces: that help the customer

           • Technology enables customer search. Searching
             costs in time and money can be reduced. Tools are:
             search engine, directories, comparison sites,
             intelligent agents
           • Customers make prices. Usually customers take
             prices. On-line auctions allow customers to choose
             their price. allows customers to say the
             price they want to pay, and comes back if they can
             find an item that matches the customers bid. Then
    receives the difference in the
             customers bid and the item-price for the product or
             service that they found.

           Web Market Forces: that help the customer
           • Transaction costs are reduced. costs of conducting a
             transaction in the market. These costs can be included in
             the firms price of a product or service. Types
               – Search costs - finding buyers and sellers. Search
                 engines help to reduce search costs.
               – Information costs - learning about products. Web
                 catalogs, chat rooms, bboards, inform about products.
               – Bargaining costs - transact, communicate, negotiate
                 the sale. On-line bidding systems can negotiate price,
                 and reduce time needed to reach agreement.
               – Decision costs - deciding between supplier, product.
                 Comparison sites help.
               – Policing costs - monitoring the transaction against
                 cheating. On-line banking allows customers to check
                 balance. Electronic receipts.
               – Enforcement costs -enforcing contractual rights. Legal
                 proceedings and reimbursements. Chat lines can
                 publicize brand reputations.
           Web Market Forces: That help the business
           • They want to differentiate products and move
             customers up the pyramid.
           • Differentiated prices, all the time. Mass
             customization is possible. Businesses can make
             products that are customized and cheap,
             automated and personal. But because they can
             make the product different for every customer,
             they can also charge different prices to every
             customer. (My Yahoo!, Pointcast news)
           • Use technology to de-menu pricing. It use to take
             a long time to change a product's shelf price. The
             price change had to filter down from supplier,
             distributor, retailer, to salesperson. Changes at
             each stage had implementation costs. With
             extranets this can be done with little costs and little
7/8/2011     time.
           Web Market Forces: That help the business
           • Creating customer switching barriers. Sellers can
             collect very detailed data on customers. They can
             make their products match the buyer very closely,
             personally. If the business can bring the customer
             exactly what they want, the customer will not want
             to switch on price alone, (because it costs the
             customer to search and learn about another
           • Customers might be willing to pay more. They may
             expect to pay less on-line, but they can save in
             transactions costs (including time) and so they
             might pay more.
           Web Market Forces: That help the business

           • Differentiate by staging experiences.
             Differentiation before was by enhancing quality,
             adding features, and building brand identification,
             and on customer service. When products are
             more alike, they must be made to appear
             different. The Web allows for many different stage
             experiences. (personal experiences, esthetic
             differences, entertainment differences,
             educational differences, etc.)

           Web Market Forces: That help the business
           • Total purchase cost. Purchase price of an item is
             only one part of the total cost. Other costs:
             searching, shipping, holding. Reducing the other
             costs will reduce the total cost of the product.
               T= total costs = P + O
               P= purchase price
               O= other costs (include opportunity costs that is time and
                money that could have been spent on something else).
               w= Web (web product)
               s= store (traditional product)
               Consumers will purchase on the Web when: Tw<Ts
               Consumers will pay (d)= Pw - Ps where (d)<Os - Ow
           • Firms should reduce customers Os, to raise Pw
             just below where Tw=Ts. If sellers can reduce
             Total Costs they can raise their web prices (Pw)
             over their store prices (Ps).
           Web Market Forces: That help the business
           • Establish electronic exchanges. Barter or trade
             goods when prices are low.
           • Maximize revenue not price. Airlines perform yield
             management. They have complex pricing
             schemes that are hard for customers to compare.
             Web sites can sell tickets on slow-to-fill flights or
             ready-to-leave flights. If the flights are not filled
             that is missed revenue. Customers can also have
             options (rights but not obligations) to sell tickets at
             the last minute.

           Web Market Forces: That help the business
           • Reduce buyer's risk. Customers may be willing to pay
             a higher price if they can lower their risk in the
             transaction. Consider a used car dealer. The dealer
             (is an intermediary) can buy cars at physical auctions
             or at On-line auto auctions. With on-line auctions, the
             dealers can have virtual lots of cars. The dealer sells
             the car to an end customer before they buy it. The
             dealer avoids risk.

           A Summary of Web Market Forces
           • Bargaining power of buyers and suppliers differs.
           • Web empowers traditionally weak buyers to search
             and collect information used in decision making.

           • Marketing effectiveness based on different products
             and services also differ.
           • Businesses have motivation to differentiate on price.
           • Web empowers businesses to create diverse pricing


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