Sample Exam Questions I. Economic and Behavioral Foundations of Pricing II. Innovative Pricing Concepts and Tools III. Internet Pricing Models April 27, 2005 Teck-Hua Ho 1 Example 1: EVC High-tech Manufacturing has developed a new type of seat belts that is easier to install and more comfortable to wear than the seat belts currently in use. The cost of a standard seat belt to automobile manufacturers is $5.00. The labor cost to install one belt is $3.00. The new belts take 10% less time to install with a resulting labor cost of $2.70 per belt. A marketing research study suggests that car buyers are willing to pay $50 more for a car equipped with the new and more comfortable belts. (A typical car requires five seat belts.) What is the EVC (per car) of the new seat belts to auto manufacturers? April 27, 2005 Teck-Hua Ho 2 Example 1: EVC Reference Value = $5 x 5 = $25 Differentiation Value = $0.3 x 5 + $50 = $51.50 EVC = $76.50 April 27, 2005 Teck-Hua Ho 3 Example 2: Ho’s Diagram Burger King has decided to cut the price for its Original DOUBLE WHOPPER Sandwich from $2.49 to $1.99. The unit variable cost is $0.99. What is the minimal % increase in sales necessary for a profitable price cut? = - ($1.99 – $2.49) / ($1.99 – $0.99) = 50% What is the minimal price elasticity needed for this to be a profitable price cut? = 50 % / ( 0.5 / 2.49) x 100%) = 2.5 April 27, 2005 Teck-Hua Ho 4 Example 3: Customer versus Product Margin (Loss Leader) As a pricing analyst for Ho grocery chain, you are asked to prepare the analysis of a proposal to price frozen chicken low in order to attract shoppers to the Ho store. The current price for chicken is $1.09 per pound. The proposal is to set a promotional price of $0.69 per pound. The wholesale cost of the chicken, prepackaged and ready for sale, is $0.59 per pound. By tracking past changes in sales of chicken with changes in sales of other grocery products, you discover that each one pound change in the sales of chicken is associated with the following changes in the sales of other products: Product Dollar Change Contribution Margin Fruits & Vegetables $0.80 50% Packaged Groceries $1.00 20% Frozen Foods $0.50 40% Other Meat including Chicken Parts ($0.25) 40% Assume the above sales relationship holds, by how much must chicken sales increase (in percentage terms) to make this price promotion profitable? = - (0.69 – 1.09) / (0.10 + 0.40 + 0.20 + 0.20 – 0.10) = 0.4 / 0.8 = 50% April 27, 2005 Teck-Hua Ho 5 Example 4: Customize, Customize, Customize Answer the following questions, clearly stating the price customization variable used in each case. Each example should be chosen so that the customization variable involved is different from the other examples. Pick any bookstore and describe a price customization strategy that it adopts. Pick any restaurant and describe a price customization strategy that it adopts. Pick any hotel and describe a price customization strategy that it adopts. April 27, 2005 Teck-Hua Ho 6 Example 5: Explain the differences if any between the following pairs of pricing policies: “Buy One Get One Free” and “50% off”. “An in-store price drop of $5 to $20” and “a coupon of $5” on a product that is regularly priced at $25. April 27, 2005 Teck-Hua Ho 7 Example 5: Reference Price Explain the differences if any between the following pairs of pricing policies: “Buy One Get One Free” and “50% off”. “An in-store price drop of $5 to $20” and “a coupon of $5” on a product that is regularly priced at $25. April 27, 2005 Teck-Hua Ho 8 Example 6: Revenue Model Design Visit www.bizrate.com and describe its revenue model. What are its revenue levers? Give a specific suggestion to improve the model. Other interesting websites include: www.shopping.com http://personals.yahoo.com/ http://www.cafepress.com/cp/info/ http://www.ubid.com/ April 27, 2005 Teck-Hua Ho 9 BizRate’s Revenue Model in 2003 Revenue = “research” revenue + “e-commerce” revenue + “advertising” revenue NR Re venue Research i i 1 NC Click Fee j 1 j NC 5% Price j 1 j NA Banner Fee j 1 j Re searchi $ 20 K to $250 K (Proportio nal to Extent of Analysis) Click Fee j $0.4 $2.0 (depending on vendor) Banner Fee depends on site traffic where April 27, 2005 NR is the number of retailers NC is the number of “clicks” NA is the number of banner ads Teck-Hua Ho 10 Example 7: Conjoint Analysis Sears Tires is interested in measuring consumers’ tradeoffs among the following attributes of a tire: Brand (Sears, Goodyear, Goodrich), Miles (30K, 40K, and 50K), Price ($50, $60, $70), and Sidewall (White and Black). A conjoint experiment that involves a group of 50 customers from a targeted segment was conducted. Respondents rated a set of 18 product profiles on a 10-point scale and their ratings were used to construct the segment’s utility equation. Below is the regression output with the appropriately defined dummy variables: April 27, 2005 Teck-Hua Ho 11 Data Rating Sears 5.2 7.3 5.7 4.8 7.2 9.3 0.8 3.2 6.4 2.2 8.1 8.3 6.3 7.4 7.3 2.2 4.3 5.7 April 27, 2005 Goodyear 1 1 1 0 0 0 0 0 0 1 1 1 0 0 0 0 0 0 Mile40 0 0 0 1 1 1 0 0 0 0 0 0 1 1 1 0 0 0 Mile50 0 1 0 0 1 0 0 1 0 0 1 0 0 1 0 0 1 0 Price50 0 0 1 0 0 1 0 0 1 0 0 1 0 0 1 0 0 1 Price60 1 0 0 0 0 1 0 1 0 0 1 0 1 0 0 0 0 1 White 0 1 0 1 0 0 0 0 1 0 0 1 0 1 0 1 0 0 1 1 0 0 1 1 1 0 1 0 1 1 1 0 1 1 1 0 Teck-Hua Ho 12 Example 7: Regression Output SUMMARY OUTPUT Regression Statistics Multiple R 0.985140055 R Square 0.970500928 Adjusted R Square 0.949851577 Standard Error 0.527494076 Observations 18 ANOVA df Regression Residual Total Intercept Sears Goodyear Miles=40K Miles=50K Price=$50 Price=$60 Sidewall=White April 27, 2005 7 10 17 SS 91.5425 2.7825 94.325 Coefficients Standard Error -0.18333 0.37299 2.36667 0.30455 3.28333 0.30455 2.66667 0.30455 3.53333 0.30455 1.71667 0.30455 1.48333 0.30455 1.22500 0.26375 MS F Significance F 13.0775 46.99910153 7.38702E-07 0.27825 t Stat -0.49152 7.77106 10.78097 8.75612 11.60186 5.63675 4.87059 4.64460 P-value Lower 95% Upper 95% 0.633669705 -1.014417322 0.647751 1.51708E-05 1.688089432 3.045244 7.94605E-07 2.604756098 3.961911 5.29382E-06 1.988089432 3.345244 4.00975E-07 2.854756098 4.211911 0.000216381 1.038089432 2.395244 0.000651034 0.804756098 2.161911 0.000915546 0.637334876 1.812665 Teck-Hua Ho 13 Utility Equation U 0.18 2.37 Sears 3.28 Goodyear [Brand] April 27, 2005 2.67 40 K 3.53 50 K [Miles] 1.72 $50 1.48 $60 [Price] 1.23 White [Color] Teck-Hua Ho 14 Example 7 Which brand has the highest brand equity? If the products available in the market are (Sears, 30K, $50, Black), (Goodyear, 40K, $70, White), and (Goodrich, 30K, $50, Black), which brand is likely to have the highest market share? If the market share of a product in the marketplace is predicted by the following equation (typically we estimate this relationship using historical data): Market Share of Product i Ui U j j where Ui is the utility of product i and the denominator is the sum of the utilities of all products available in the marketplace. Compute the market share for Sears. April 27, 2005 Teck-Hua Ho 15 Example 7 Sears is considering three price options for a new and improved product: (Sears, 40K, $50, White), (Sears, 40K, $60, White) or (Sears, 40K, $70, White). Assume Sears replaces the old product with the new one. If the marginal cost is $25 and the total market size is 2 million units per year, which price option should Sears adopt in order to maximize its annual profits? How would the above answer change if Goodyear drops its price to $60 while Goodrich keeps its price unchanged? April 27, 2005 Teck-Hua Ho 16 Utility Computation Parameter Intercept Sears Goodyear Miles=40K Miles=50K Price=$50 Price=$60 Sidewall=White April 27, 2005 Brand Miles Price Color Product 1 Sears 30,000 $50 Black Utility 1 1 0 0 0 1 0 0 3.90 Value -0.18 2.37 3.28 2.67 3.53 1.72 1.48 1.23 Product 2 Product 3 Option 1 Option 2 Option 3 Goodyear Goodrich Sears Sears Sears 40,000 30,000 40,000 40,000 40,000 $70 $50 $50 $60 $70 White Black White White White 1 0 1 1 0 0 0 1 6.99 1 0 0 0 0 1 0 0 1.53 1 1 0 1 0 1 0 1 7.79 1 1 0 1 0 0 1 1 7.56 1 1 0 1 0 0 0 1 6.08 Teck-Hua Ho 17 Market Share Computation Parameter Intercept Sears Goodyear Miles=40K Miles=50K Price=$50 Price=$60 Sidewall=White April 27, 2005 Brand Miles Price Color Product 1 Sears 30,000 $50 Black Utility 1 1 0 0 0 1 0 0 3.90 1 0 1 1 0 0 0 1 6.99 1 0 0 0 0 1 0 0 1.53 MS 31.39% 56.27% 12.34% Value -0.18 2.37 3.28 2.67 3.53 1.72 1.48 1.23 Product 2 Product 3 Option 1 Option 2 Option 3 Goodyear Goodrich Sears Sears Sears 40,000 30,000 40,000 40,000 40,000 $70 $50 $50 $60 $70 White Black White White White 1 1 0 1 0 1 0 1 7.79 1 1 0 1 0 0 1 1 7.56 1 1 0 1 0 0 0 1 6.08 47.75% 46.99% 41.61% Teck-Hua Ho 18