The promise and peril of dynamic targeted pricing

Dynamic pricing is widely adopted in many industries, such as travel and insurance. These industries are also gaining extensive capabilities in identifying and segmenting customers, partly fueled by the increasing availability of data. It is natural to ask whether firms should take advantage of such developments by charging different prices to different customer segments. If so, under what conditions? We seek answers to these highly managerially relevant questions.We consider a market with two customer segments served by a monopolist. The monopolist can choose among a set of pricing strategies to exploit consumers’ inter-temporal preferences and/or inter-segment variations. At one end of the spectrum, the firm can charge a constant price to all customers, which is called static pricing. At the other end of the spectrum, the firm can charge different prices to different customer segments and vary these prices over time, which is referred to as dynamic targeted pricing. We systematically compare these alternative pricing strategies. We show that dynamic pricing without targeting can be more effective than static targeted pricing when customers are not very forward looking, which corroborates the findings in the empirical literature. Interestingly, we find that the monopolist can be worse off when she adopts targeting in addition to dynamic pricing. We conduct laboratory experiments to test several key model predictions. The studies show that individuals behave in a manner consistent with the predictions of our model.     

Monopoly Prices versus Ramsey-Boiteux Prices: Are they “Similar”, and: Does it Matter?

Ramsey-Boiteux prices and monopoly prices are frequently regarded as being similar. This might suggest that sometimes monopoly pricing is close to the Ramsey-Boiteux second best and welfare superior to imperfectly regulated prices. This paper tries to specify what is meant by “being similar”. Both sets of prices are similar in a theoretical sense but differ not only with respect to price levels but can even lead to different price orders. The paper discusses the impact of competition and stresses the difference between market and residual demand, which are important for the Ramsey-Boiteux and the monopoly problem, respectively. JEL classification  L33, L50, L94     

我国成品油价格形成机制评析

现阶段我国采取国际三地原油价格加权基础上追加相应成本和利润的办法来确定国内成品油价格。此种定价机制曾起到一定的积极作用,但没有涉及价格机制的核心问题。随着近几年特别是2005年以来国际市场油价的频繁波动,现行成品油价格机制逐渐暴露出矛盾和问题,主要包括成品油价格变动滞后、国内油价长期低于国际油价和国内石油企业之间不平等竞争。改革我国现行成品油定价机制,必须充分发挥价格机制和供求机制,破除垄断和过度行政干预,建立风险分摊和转嫁机制,并完善政府的经济职能。     

Economic Benefits of Renting Software

In this article, we analyze the economics of a monopoly firm selling and renting a packaged software product by employing an intertemporal monopoly pricing game to model the firm's pricing strategy. The game models the software product as two versions; the first version is available in the first period and the second, a revised version, is available in the second period. The second version benefits from consumer reports of bugs and requests for additional features. This is modeled using delayed network externalities that take effect only in the second period. We observe that the introduction of the rental product in the first period leads to an increase in profits. We also find that the firm's profits are monotonically increasing with the intensity of the network effect. As the intensity of the network effect becomes stronger, the firm chooses to reduce its prices in the first period to expand the size of its network and later increases prices in the second period. Because many of the customers who choose to rent in the first period subsequently make a purchase in the second period, the firm is able to capture the benefits of network externalities in the first period without reducing sales in the second period. For high levels of network intensity, consumer surplus and social welfare are also higher.     

Complementary Goods: Prices and Consumer Welfare Under Duopoly and Monopoly

We examine prices, profits, and consumer surplus for differentiated complementary goods under duopoly and a multi‐product monopoly. We find that little can be said about the relative magnitudes of prices of the components of a system of complementary goods under the alternative market structures. Although demand complementarity can lead to lower prices for either the primary or the secondary good under monopoly, both prices are not necessarily lower. The results unique to this paper are that, when two complementary goods form a system, the system price is unambiguously lower and consumer surplus and profits are higher under a multi‐product monopoly.     

Industry associations and non-competitive behaviour in Australian wool marketing: Evidence from the Melbourne Woolbrokers' Association, 1890–1939

From the 1890s the sale of Australian wool was organised through a series of regionally based associations of wool selling brokers and wool buyers. They engaged in cartel-type behaviour by price fixing and exclusive dealing. We ask the question whether the wool selling brokers exploited their monopoly power to thefull in setting fees and charges paid by the growers and buyers. Association records provide data on the pricing structure and rationale for changes. We surmise that the existence of the cartel lifted prices above competitive levels. However, the pricing behaviour was moderated to a strong form of limit pricing.     

Information content of cross‐sectional option prices: A comparison of alternative currency option pricing models on the Japanese yen

This article implements a currency option pricing model for the general case of stochastic volatility, stochastic interest rates, and jumps in an attempt to reconcile levels of risk‐neutral skewness and kurtosis with observed option prices on the Japanese yen and to analyze the information content of the cross section of option prices by investigating the hedging and pricing performance of various currency option pricing models. The study makes use of both a method of moments and a more traditional generalized‐least‐squares (GLS) estimation technique, taking advantage of the fact that methods of moments do not specifically require the use of cross‐sectional option prices, whereas GLS does. Results centered around the Asia economic crisis of 1997 and 1998 indicate that the cross section of option prices surprisingly does not appear to contain superior information as the two estimation techniques yield relatively similar results once idiosyncratic differences between them are acknowledged. Extensions of the G. Bakshi, C. Cao, and Z. Chen (1997) results to currencies are also provided. © 2006Wiley Periodicals, Inc. Jrl Fut Mark 26:33–59, 2006     

Pricing practices: A critical review of their effects on consumer perceptions and behaviour

With the present challenge to compete on price or product assortment, retailers and manufacturers are increasingly focusing on state-of-the-art pricing strategies which have their roots in behavioural economics and psychology. The current review is an empirical investigation on the relative effectiveness of various pricing practices on consumer perceptions and behaviour. Six pricing strategies were reviewed; drip pricing, reference pricing, the use of the word ‘free’, bait pricing, bundling and time-limited offers. The review shows that the former three have received a significant amount of attention and have a robust impact on consumer perceptions and behaviour. There is less research on the latter three; however, the available evidence does suggest that they, too, may be capable of influencing consumers’ choices. Finally, it is also clear that the effects of pricing practices can be moderated by a variety of factors. Overall, the current review indicates that sellers are able to influence perceptions and purchase decisions of consumers based on the manner in which prices are displayed. The implications of these findings for retailers, policy makers and researchers are discussed.     

On The Reference Point Effect of Reserve and Buy It Now Prices

In recent years, a trend in retail pricing has been to give consumers greater autonomy in setting their own prices, be it through auctions or other forms of participative pricing. Such consumer pricing autonomy often requires the seller to set limits in the form of price floors and price ceilings. Price floors and ceilings in our auction settings are referred to as reserve prices (RP) and Buy It Now (BIN) prices, respectively. We examine the effect of RP and BIN presence and magnitude on the number of bidders and ending price. Using auctions, we uncover consumers’ willingness to pay (WTP) through bids. WTP is malleable through reference cues. Our focus is on two such cues: BINs and RPs. Results of two field studies, augmented with a laboratory study, show that both BINs and RPs result in lower bidder entry, but have an overall positive effect on ending price. Furthermore, results show that RP is more effective than a comparable BIN magnitude and that these two pricing cues are substitutes. The study design allows the authors to rule out alternative explanations. Open RP and BIN's effect on ending price is due to a reference point effect rather than a price truncation effect. Thus, retailers can increase WTP through changing these reference cues and exploit a richer choice set over which to shape a malleable WTP. The quantification of the interaction between RP and BIN gives managers the ability to jointly take advantage of both RP and BIN.     

Fee or free? How much to add on for an add-on

Sellers often provide complimentary “no extra charge” add-ons (e.g., free Internet connection) to consumers who buy their primary products (e.g., a hotel stay), but recently add-ons that used to be free are offered for a fee. The conventional wisdom is that unadvertised add-ons for high fees help competitors increase profits that are competed away by advertising low prices for the basic products. This theory cannot explain why complimentary add-ons are still offered by some sellers. We show that providing complimentary add-ons can be profitable for sellers with monopoly power under certain demand conditions. If these demand conditions are not met, it is optimal to charge a supplementary fee for the add-on. We also show how pricing policy can be designed to selectively target or deter different consumer segments from purchasing the add-on to boost sellers’ profits, providing a strategic role for selling add-ons at either below-cost or at exorbitantly high prices. Yet such behavior may have repercussions for economic welfare when it results in socially inefficient giveaways when consumers would be better served with a lower price on the basic product without the add-on or, with the other extreme, when it results in excessively high prices for an add-on that restricts sales and leads to its under-provision from a societal perspective. The paper also provides managerial insights on the design and use of add-ons.     

Value-based pricing in competitive situations with the help of multi-product price response maps

This article introduces multi-product price response maps for various value pricing applications in competitive situations. The maps are based on the direct elicitation of individual willingness to pay (WTP) as a range for competing products; they reveal an individual's or market's choice probability for a focal product, at its own and competing products' prices. Transforming the price response into profit, revenue, or unit sold maps supports optimal pricing decisions. The maps are also useful for optimizing profit differences from the closest competitor and for portfolio pricing. Managers can use a consumer indecisiveness map, gained from the WTP range data, to devise complementary marketing measures at prices where consumer uncertainty is high. The illustration of this approach uses two empirical examples, featuring two or more competing consumer goods, and demonstrates the predictive and external validity of these proposed maps.     

Duopolists’ Retail Pricing Behavior in Multiple Markets

The law of one price asserts that, with costless trade, prices for identical goods in different countries should be equal after accounting for the exchange rate. The empirical literature suggests that exchange rate pass-through to prices is low and that the law of one price fails; instead, firms are more likely to price to market. This study adds to the literature by examining the pricing strategy of comic book firms within the context of the competition’s pricing behavior in a duopoly industry. Comic books, uniquely, display their retail prices in multiple countries on their cover giving us detailed information about the pricing behavior of each individual firm and their competition which allows us to test a pricing-to-market model. We find that an empirical model of an imperfectly applied law of one price outperforms a simple competitive, pricing-to-market model of pricing. Retail exchange rate pass-through rates between Canada and the United States average 76.8 %. This high exchange rate pass-through rate for comic books exists despite the existence of sticky prices and convenience pricing.     

Optimal pricing in social networks considering reference price effect

We study the optimal monopoly pricing strategies in a social network, in which consumers experience a network effect that is dependent on their neighbors' consumptions and a reference price which is the average price received by their neighbors. We establish a two-stage game model for any social network. Utilizing the backward induction, we derive the equilibrium price by maximizing the monopolist's profit. In addition, we apply this model to the two most commonly used network structures: the star network and the bipartite network. We find that both the network effect and the reference price effect play a critical role in deciding pricing strategies in social networks. Moreover, our numerical results demonstrate that whether to implement discriminatory pricing depends critically on the network structure. This work provides monopoly firms a useful guideline for optimal pricing decisions in social network marketing.     

Barriers to implementing value-based pricing in industrial markets: A micro-foundations perspective

Value-based pricing has the potential to improve differentiation, profitability, and value creation for industrial firms and their customers. However, while most of the pricing research considers the ways organizations set or get value-based prices, only few studies consider how individual managers influence the pricing process and what prevents them from setting and getting value-based prices. This is of critical concern, since it is not just organizations, but individuals within organizations who make pricing decisions—and their decision-making is influenced by institutional pressures such as socially prescribed norms, rationalized meanings, and beliefs about profitable approaches to pricing. This study addresses this gap in the current knowledge by adopting a micro-foundations perspective to pricing, and focusing on the barriers that individual managers encounter when implementing value-based pricing. Drawing on a single case study in a global industrial firm, and from interviews with 24 managers, this study identifies 11 individually, organizationally, and externally induced barriers to value-based pricing. The study also sheds light on the potential sensegiving strategies for overcoming these barriers.     

The impact of household level heterogeneity in reference price effects on optimal retailer pricing policies

The field of marketing has witnessed substantial improvement in modeling household level heterogeneity. However, relatively little has been written about how modeling household heterogeneity translates into better marketing decisions. In this paper, we study the impact of household level heterogeneity in reference price effects on a retailer's pricing policy. Reference prices are certain anchors or standards that households use to compare the observed purchase price of a product against. If the observed price is greater than the reference price it is perceived as a “loss” and if it is smaller than the reference price it is perceived as a “gain”. In order to study the impact of heterogeneity in reference price effects on retail pricing, we test a nested logit model under two alternative reference price (memory and stimulus based) and heterogeneity (finite mixture and hierarchical Bayes) specifications. In the empirical analysis, we find that households are quite heterogeneous in terms of their gain and loss effects. For some households a gain has higher impact than a corresponding loss, while the opposite is true for others. Using individual level estimates we then develop a normative pricing policy for a retailer maximizing category profit. Our results indicate that the optimal pricing policy derived from the heterogeneous case is qualitatively different, and more profitable, than the case when heterogeneity is ignored. We show that for an important marketing problem pertaining to a retailer, the optimal pricing decisions for various brands in a category are inextricably related to household heterogeneity in reference effects and brand preference.     

Cable Television Rate Deregulation

In the 1984 Cable Communications Policy Act, cable television operators were effectively freed from rate regulation, and subsequently enjoyed monopoly franchise protection with free market pricing. In 1992, however, reregulation of basic cable service rates was established in the Cable Consumer Protection and Competition Act. The argument for reimposing regulation was that a substantial increase in basic cable rates had occurred post–deregulation. Yet the efficacy of rate controls upon an industry which has substantial freedom to adjust product quality is theoretically ambiguous. This study examines simple price, quality, and output evidence to determine how rate deregulation impacted consumers. It finds support for the view that rate controls did not lower quality–adjusted prices and are best explained as tools for influencing rent distribution across interest groups     

The promoter's role in ticket pricing: Implications of real options for optimal posted prices and rationing

We consider the problem of pricing event tickets for initial sale when demand is uncertain. It is a standard industry practice for a performer to contract with a promoter who underwrites the event and offers the tickets for sale at a posted price that is sticky in that it is either fixed or costly to adjust once sales begin. Promoters, therefore, bear price risk, and we show that bearing the risk associated with posting a sticky offer price amounts to writing a put option on the ticket revenue. Further, we show that optimal posted-offer prices can be expected to result in rationing (surpluses) if price uncertainty and price elasticity of demand are material (immaterial), even when the demand forecast is accurate. Our results have implications for a more general set of pricing problems in which items are offered for sale at sticky posted prices.     

Viability and Equilibrium in Securities Markets with Frictions

In this paper we study some foundational issues in the theory of asset pricing with market frictions. We model market frictions by letting the set of marketed contingent claims (the opportunity set) be a convex set, and the pricing rule at which these claims are available be convex. This is the reduced form of multiperiod securities price models incorporating a large class of market frictions. It is said to be viable as a model of economic equilibrium if there exist price-taking maximizing agents who are happy with their initial endowment, given the opportunity set, and hence for whom supply equals demand. This is equivalent to the existence of a positive lineaar pricing rule on the entirespace of contingent claims—an underlying frictionless linear pricing rule—that lies below the convex pricing rule on the set of marketed claims. This is also equivalent to the absence of asymptotic free lunches—a generalization of opportunities of arbitrage. When a market for a nonmarketed contingent claim opens, a bid-ask price pair for this claim is said to be consistent if it is a bid-ask price pair in at least a viable economy with this extended opportunity set. If the set of marketed contingent claims is a convex cone and the pricing rule is convex and sublinear, we show that the set of consistent prices of a claim is a closed interval and is equal (up to its boundary) to the set of its prices for all the underlying frictionless pricing rules. We also show that there exists a unique extended consistent sublinear pricing rule—the supremum of the underlying frictionless linear pricing rules—for which the original equilibrium does not collapse when a new market opens, regardless of preferences and endowments. If the opportunity set is the reduced form of a multiperiod securities market model, we study the closedness of the interval of prices of a contingent claim for the underlying frictionless pricing rules.     

Increasing Price Transparency: Implications of Consumer Price Posting for Consumers' Haggling Behavior and a Seller's Pricing Strategies

In an attempt to gain a better position in haggling, consumers often seek a seller's pricing information (e.g., whether the posted price is negotiable, the discount and transaction prices) before going to that seller. Although traditionally difficult to obtain, such information is becoming increasingly available due to consumer price posting (CPP), whereby consumers post and share their purchase price information on the Internet. In this analytical study, we consider a market in which a seller, who chooses between a fixed price policy and a haggling policy, serves two types of consumers who differ in their willingness to pay and haggling costs. We explore how CPP can affect consumers' behavior and the seller's pricing strategies (i.e., pricing policy and the associated prices). In the absence of CPP, our model features a two-sided uncertainty: the seller does not know individual consumer's type and thus may find it optimal to use a haggling policy to price discriminate consumers, whereas consumers do not readily observe the seller's cost type and pricing policy, and thus are uncertain whether their haggling will be fruitful. In the presence of CPP, consumers' uncertainty about the seller's pricing policy is resolved. Because CPP can improve price transparency, inhibit consumers' acceptance of a posted price and spur price haggling, it seems apparent that it should benefit consumers and hurt the seller. However, our analysis shows that CPP can lead to fewer purchases, higher prices and even a greater seller profit. It further shows that although CPP surely increases information accessibility, it can also reduce the amount of information available to consumers. These results are in sharp contrast to the conventional wisdom in the literature.     

Are Derivative Warrants Overpriced?

This study investigates the pricing efficiency of Hang Seng Index (HSI) derivative warrants in Hong Kong. Different from similar research, the study examines the pricing efficiency of index warrants by comparing their implied volatilities (IV) with realized volatility (RV). Although prior studies find that warrants are more expensive than the corresponding options, they are not necessarily overpriced in the conventional sense—that is, relative to the RV. This approach allows the study to test the pricing efficiency of warrants via a test of their information content. Moreover, unlike studies that focus on data at market close, the study uses a large sample of highly synchronous intraday, firm, bid–ask quote data to avoid possible distortions arising from intraday variations in liquidity and pricing in the instruments. The data also helps eliminate the potential nonsynchronous price problem that may affect the test results. Consistent with the results from previous studies, we find that warrants are often more expensive than options. This result is attributed to the inability of non‐issuers to sell short, and the high participation rate of unsophisticated investors in the warrants market. However, regression analysis shows that IVs from ATM and OTM warrants provide unbiased volatility forecasts, and that IVs from ATM options do not subsume the information content of ATM warrants. ATM warrant prices are in line with the RV and are efficiently priced. Simulation results show that writing warrants is more profitable than writing options, and that the overpricing is directly related to the volatility premium.