Basic Pricing Principle

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Basic Pricing Principle the Internet

• Refer to Ch5-7 of Pricing Communication networks

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Todays Agenda

• The QUESTION How to set the price?
• Basic requirements
• What Competition Model the Business in
• Common pricing methods in the internet
• Ways to grasp the max profit from customers

3
How to Set a Price?

• A. Basic requirements (in normal cases)
• the price lt utility of customers
• the price is sustainable (7.1.2)
• There is no way that the potential entrant can
  post price that less than the incumbents for
  some service and the serve all of part of the
  demand without incurring loss

4
Welfare Maximization (5.4)

• The ideal case welfare maximization (5.4)
• Aim to max total welfare of both customers and
  providers

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Welfare Maximization (5.4)

• The ideal case welfare maximization (5.4)
• Lagrange multiplier

Optimal price
Marginal cost pricing
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Todays Agenda

• The QUESTION How to set the price?
• Basic requirements
• What Competition Model the Business in
• Common pricing methods in the internet
• Ways to grasp the max profit from customers

7
How to Set a Price?

• B. What Competition Model the Business in
• Monopoly
• Unregulated monopoly
• Regulated monopoly
• Oligopoly
• Perfect Competition

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Unregulated monopoly

• Basic criteria
• maximize total profit of the business (6.2.1)
• differentiate r.w.t. pi, we have
• compared to the welfare maximization curve
  (5.5.1)
• (will mention in Ramsey pricing)

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Unregulated monopoly

• Basic criteria maximize total profit of the
  business

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Unregulated monopoly

• maximize total profit of the business (6.2.1)

Social benefit
Profit for business
Welfare lost
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Regulated monopoly

• Probably by negotiation
• The baseline is to allow them to earn some profit
  while to maximize social welfare
• eg. Scheme of Control Agreement (??????) applied
  in power generating companies in Hong Kong
• One possible method
• Ramsey-Boiteux pricing (5.5.1)

12
Ramsey-Boiteux Pricing (5.5.1)

• Two ways of thinking
• Allow a fixed profit margin between revenue and
  cost
• Max
• s.t.
• Weight suppliers profit heavier then customers
  surplus

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Ramsey-Boiteux Pricing (5.5.1)

• By differentiation wrt p, we have
• If services are independent, we have
• ie. price markup over marginal cost is inversely
  proportional to the elasticity of demand

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How to Set a Price?

• B. What Competition Model the Business in
• Monopoly ?
• Unregulated monopoly ?
• Regulated monopoly ?
• Oligopoly
• Perfect Competition

15
Oligopoly

• Game theory is wildly used to study interactions
  between a small number of competitive firms
• Cournot game
• Bertrand game
• Stackelberg game

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Perfect Competition

• Some attributes of the perfect market
• perfect competition - no individual can affect
  the market
• Perfect information - everyone participant is
  fully informed
• everyone has equal access to the market
• everyone acts selfishly
• homogeneous commodity

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Perfect Competition

• Some attributes of the perfect market
• Strong network externalities effect
• Eg. Free SMS for intra-provider users
• no transaction costs no lock-in effect
• Eg. Bring phone number to other mobile service
  provider
• Eg. The pain to fill search for another provider

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How to Set a Price?

• B. What Competition Model the Business in
• Monopoly ?
• Unregulated monopoly ?
• Regulated monopoly ?
• Oligopoly ?
• Perfect Competition ?

19
Todays Agenda

• The QUESTION How to set the price?
• Basic requirements
• What Competition Model the Business in
• Common pricing methods in the internet
• Ways to grasp the max profit from customers

20
How to Set a Price?

• C. Common pricing methods in the internet
• Dynamic pricing
• Two part tariff (5.5.2)
• Optional two-part tariff (5.5.3)
• Flat-rate pricing (7.5)
• Bargaining (7.2)
• Shapley value (7.1.3)
• Paris Metro pricing

21
Dynamic Pricing

• Principle to ask the customers using the service
  in the peak hours to pay more
• Peak-load Pricing (5.4.4)
• Charge an extra premium in peak hours
• Time-of-day pricing
• Divide time into different section, charge with
  different prices
• eg. Free night/weekend mobile phone minutes in US
• Real-time pricing
• Charges varies depending on real-time traffic

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Peak-load Pricing (5.4.4)

• Principle ask customers using the busiest
  timeslots to pay a premium of yt
• K demand at the busiest timeslots
• Xt demand timeslot t
• a marginal cost

To reach welfare maximization
utility
price
s.t. Xt lt K
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Two-part tariff (5.5.2)

• Principle charge customers with
• a. fixed charge
• b. usage charge
• eg. ?? (amuement park in HK) - pay a low
  entrance fee, and pay separately for each ride
• eg. pubs - pay fixed cover fee, and pay
  separately for each drink (if your main purpose
  to a pub is merely drinking P )

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Two-part tariff (5.5.2)

• Advantage
• providers could recover cost no matter no much a
  customer use the service
• Disadvantages
• 1. social welfare decreases
• 2. some users with low usage will be kicked out
• Others
• low usage customers would pay more relatively

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Two-part tariff (5.5.2)

• Observations
• Demand changes depends on utility
• Social welfare decreases

F 900
Demand u(x)
F 300
MC
x
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Optional two-part tariff (5.5.3)

• Principle set up varies fixed charges and usage
  charges, customers picket charging scheme that
  fit most to their usage
• eg. Mobile plans (a partially correct example)
• 98/1000 mins, 1.0/min onwards
• 150/1200 mins, 0.5/min onwards
• Implementation
• A set of K optional two-part tariffs, specified
  by pairs (ak, pk), where ak lt ak1 , pk gt pk1
• Observation
• Given a K-part optional tariff, we can always
  construct a K1 part tariff that is not Pareto
  inferior (explain later)

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Optional two-part tariff (5.5.3)

• Advantages
• Users with different utility could choose among
  combinations
• Disadvantages
• Some users might take arbitrages (if plan set
  badly)

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Flat-rate pricing (7.5)

• Principle all-you-can-eat for a fixed price
• eg. Countless examples
• Advantages
• Easy to implement
• Appealing to customers
• Make the Internet dumb-er
• Disadvantages
• Produce high social waste
• Lost low-profile customers
• Not subsidy-free

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Flat-rate pricing (7.5)

• marginal cost 0
• waste

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How to Set a Price?

• C. Common pricing methods in the internet
• Dynamic pricing ?
• Two part tariff (5.5.2) ?
• Optional two-part tariff ?
• Flat-rate pricing (7.5) ?
• Bargaining (7.2)
• Shapley value (7.1.3)
• Paris Metro pricing

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Bargaining (7.2)

• Table rule
• The bargain ends when both players accept the
  price
• Utility of both players discounts by time
• Could talk about this at later presentations!

Is gt ? Else propose
.
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Shapley value (7.1.3)

• Principle
• a mechanism to distribute revenue/cost among
  several actors in the system
• Eg. No example.
• Intuitive meaning
• for each permutation of the actors, find the
  marginal utility gain for each additional player
  added into the system. The resultant value is
  then normalized

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Shapley value (7.1.3)
Mission A?D
Permutation A B C D
A B C D 0 0 0 2
A B D C 0 0 1 1
A C B D 0 0 0 2
A C D B 0 1 0 1
A D C B 0 1 1 0
A D B C 0 1 1 0
B A C D 0 0 0 2
B A D C 0 0 1 1
B C A D 0 0 0 2
B C D A 2 0 0 0
B D A C 1 0 1 0
B D C A 2 0 0 0
C A B D 0 0 0 2










16.5
B
A
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D
C
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16.5
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Shapley value (7.1.3)

• Axioms
• Dummy if v(S U i) v(S) 0, then
• fi(v) 0
• Symmetry if i, j symmetic, then
• fi(v) fj(v)
• Additively fi(v w) fi(v) fi(w)
• Efficiency
• There exists a unique value that satisfy the
  above four axioms, which is the Shapley value

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Shapley value (7.1.3)

• Advantages
• Fair (supposingly)
• Disadvantages
• Value must be calculated centrally
• Impossible to implement in large scale

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How to Set a Price?

• C. Common pricing methods in the internet
• Dynamic pricing ?
• Two part tariff (5.5.2) ?
• Optional two-part tariff ?
• Flat-rate pricing (7.5) ?
• Bargaining (7.2) ?
• Shapley value (7.1.3) ?
• Paris Metro pricing

37
Paris Metro pricing

• Principle
• by dividing the internet into different separate
  channels with different prices, channels with
  higher price would attract less traffic and hence
  provide better service
• Intuition
• first class in trains always have seats (more
  expensive)
• if first class run out of seats, you simply take
  standard class.

38
Paris Metro pricing

• Implementation
• Divide physical channel into several logical
  channels
• Fixed capacity for each channel, all best effort,
  no QoS
• Set different prices for each channel, flat-rate
  perhaps

39
How to Set a Price?

• C. Common pricing methods in the internet
• Dynamic pricing ?
• Two part tariff (5.5.2) ?
• Optional two-part tariff ?
• Flat-rate pricing (7.5) ?
• Bargaining (7.2) ?
• Shapley value (7.1.3) ?
• Paris Metro pricing ?

40
Todays Agenda

• The QUESTION How to set the price?
• Basic requirements
• What Competition Model the Business in
• Common pricing methods in the internet
• Ways to grasp the max profit from customers

41
How to Set a Price?

• D. Ways to grasp the max profit from customers
• Price discrimination (6.2.2)
• Individual pricing
• Versoning
• Group pricing
• Bundling (6.2.3)
• Service differentiation (6.2.4)
• Coffee in starbucks
• Others
• Taxations
• Equilibrium Modeling

42
Individual Pricing (6.2.2)

• Principle
• charge each user individually such that
• the price of each user utility of the user
• Eg. Coorperate bandwidth wholesale (if the
  provider is a monopoly)
• Properties
• Maximize welfare
• No customer surplus

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Versoning (6.2.2)

• Principle provider posts offers and allow
  customers to select their best plan
• eg. Communication time-of-day, duration,
  location, distance (from the book)
• Advantage
• Welfare better than flat-pricing
• Disadvantages
• Welfare worse than individual pricing
• Users might select the wrong plan

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Individual Pricing (6.2.2)
How provider could maximize total revenue by
providing discounts
User 1 might switch to the plan for user 2 to
gain customers surplus B
By having discount of B, user 1 is motivated to
use plan 1.
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Group Pricing

• Principle
• divide customers into classes and provide
  different charges
• Eg. I. Adult / student / elderly tickets
• II. Coupon system
• Intuitive reasoning
• To divide customers with different elasticity

46
How to Set a Price?

• D. Ways to grasp the max profit from customers
• Price discrimination (6.2.2)
• Individual pricing ?
• Versoning ?
• Bundling (6.2.3)
• Group pricing ?
• Service differentiation (6.2.4)
• Coffee in starbucks
• Others
• Taxations
• Equilibrium Modeling

47
Service differentiation

• Principle
• Add costless difference in service/product for
  differenciation
• Eg. Menu in starbucks
• Latte 20 / 23 / 26
• Cappuccino 25 / 28 / 31
• Mocha 30 / 33 / 36
• Eg. Popcorns in cinemas
• Small 30
• Medium 35
• Large 40

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Todays Agenda

• The QUESTION How to set the price?
• Basic requirements
• What Competition Model the Business in
• Common pricing methods in the internet
• Ways to grasp the max profit from customers

49
Backup Slides
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Ramsey-Boiteux Pricing (5.5.1)

• If services are dependent, we have
• The price might be lower than marginal cost when
  the services are complements to each others