Pricing Differentiated Products

1. Pricing Differentiated Products

2. Radical view • Corporate managers are not people • Corporate managers try to exploit consumers  Products are differentiated as a strategy to create pricing power by finding “hidden” niches where the firm can operate as a monopolist. True or false? Markets and Prices in Agribusiness

3. Does this type of strategy imply monopoly pricing? Remember monopoly pricing? Can you label these curves? Why can a monopolist “set” prices? Why does a monopolist set prices like this? Markets and Prices in Agribusiness

4. monopoly pricing of one product P*= P(cost drivers, demand drivers, attributes) P MC P* Demand AR MR Y Markets and Prices in Agribusiness

5. Alternative view • Firms have to compete to fulfill consumer demands. • One way they compete is by offering a wide variety of products targeted at specific market segments. • Firms can set prices but generally those prices are forced toward average cost by competitor entry…. • iPhone quickly faced “near equivalent” substitutes • Gatorade …. Markets and Prices in Agribusiness

6. Estimating margins between differentiated goods Are these margins the result of arbitrage?

7. Arbitrage in horizontal markets • Think of each point in a product space as a different “location” • Prices of products at different points in product space are “linked” through arbitrage…… • Product space arbitrage is different from other forms of arbitrage …..how? Markets and Prices in Agribusiness

8. Product space arbitrage • Producers can move products from one location in product space to another…. • Tomato soup can be changed • in composition (add peppers) • In packaging…quick snack, microwavable • In quantity….package volume  Price of each product along a grocery shelf is related to near equivalent product prices…. Markets and Prices in Agribusiness

9. Product space arbitrage • Consumers play a role as well • Consumers typically purchase only one product type…but which one? F • Through “shopping” they compare their WTP with prices and buy the product that delivers best packgage of attributes and has WTP > Price Markets and Prices in Agribusiness

10. Implications • Consumers & producers are doing the arbitrage! • By sorting themselves into respective markets • By switching products • Implications for prices define Pb price of a national brand Pg as price of a near equivalent, e.g. private label Then, we are free to write Pb = Pg + Pb – Pg or equivalently, Pb = Pg + ΔPgb = price + brand margin But, what is this margin? How is it determined? How could we explain its magnitude? Markets and Prices in Agribusiness

11. Analyzing Data • Suppose we have a set of data for a specific yogurt product that indicates price, and whether it has a store branding • Suppose we collect the price and attributes from 100 different stores, i= 1,….100 • We could use simple computation to calculate the average margin between brand and the private label Pbi = Pgi+ ΔPgbi The margin will vary across stores. Markets and Prices in Agribusiness

12. Looking for average relationships We could look for average difference based on all stores Pb = Pg+ ΔPgb where Pb =∑ i=1,100Pbi /100 But, this might not tell us very much!~ Markets and Prices in Agribusiness

13. Using data to analyze prices • Suppose we would like to know • How the margin created by branding varies by • Type of brand (store vs. national) • Store characteristics • By day-of-week • Across different yogurt products (e.g. organic, natural, …) Let’s start just by looking at branding. Suppose we also collect type of branding. To describe it, define two “binary” variables di = 1 if store brand = 0 if not Note: If di = 0 then the product is “national brand” ! Markets and Prices in Agribusiness

14. Using regression We defined Pbi = Pgi + ΔPgi Now, take the average (use an underscore to indicate average) Pb = Pg+ ΔPg and we can say… Pbi = Pb + error ΔPg= ΔPgi - error so, by substitution Pbi = Pg+ ΔPgi + error (branded price=ave generic price + margin + error = B0 + B1* di + ei < we can think of this as a “model” where di =1 if product is store branded B1 di = ΔPgi B1 is a number, if we knew its value we could calc ΔPgi B0 = Pg B0 is a number, if we knew its value we could calc Pg ei is random error think of it as what we can not explain…. Markets and Prices in Agribusiness

15. Interpreting our model Pbi =B0 + B1* di + ei where di =1 if product is store branded So, the challenge is use data to develop estimates of B’s. Regression is the best approach. Markets and Prices in Agribusiness

16. How to do it……. • Enter data into a spread sheet with column headings Price Type (d=1 if store branded) • Use EXCEL to get estimates for the B’s • Graph Price vs. type and use Fit a trend line… • Use EXCEL regression • Price is Y • Type is X Markets and Prices in Agribusiness

17. Interpreting results • Regression produces estimates of B0 , and B1, let’s call the estimates b0 and b1 In general, b0≠ B0 b1≠ B1 ! Because they are estimates! • The estimated model is : P bi = b0 + b1* di + ui recall, ui is not that same as ei since we are using estimates of B0 and B1. We call ui the residual. Markets and Prices in Agribusiness

18. Using results Suppose our results indicated….. For the yogurt example, b0 = .63 b1 = .17 then, estimated average price pbi pbi = .63 + .17* di So at store i, average generic price = $.63 average branded price = $.80 Markets and Prices in Agribusiness

19. Now, let’s consider multiple attibutes Let’s change our notation slightly! suppose i indicates the specific product vanilla yogurt, 3 oz recyclable bag, organic,etc Suppose we collect price and attributes for 100 yogurt products Markets and Prices in Agribusiness

20. General case: Multiple attributes Suppose we want to consider how price varies over four attributes: a1 = volume of yogurt a2 = whether fruit is on the bottom (=1 if yes, = 0 if no) a3 = whether yogurt is low fat (=1 if yes, = 0 if no) a4 = whether yogurt is nationally branded (=1 if yes, = 0 if no) Markets and Prices in Agribusiness

21. Thinking about how to measure price Given we have an interest in how price varies with volume of the package, we need to adjust all prices to a common volume! • Suppose we decide to use unit price: $ / lb Markets and Prices in Agribusiness

22. What is the market price for lowfat? To find the market price or value for any attribute, we could use regression to estimate: Pi = B0 + B1* a1i + B2* a2i+ B3* a3i+ B4* a4i + ei Estimated model would be pi = b0 + b1* a1i + b2* a2i+ b3* a3i+ b4* a4i + ui Taking average, we have Ave pi = b0 + b1* a1i + b2* a2i+ b3* a3i+ b4* a4i Markets and Prices in Agribusiness

23. Interpreting results a1 = volume of yogurt a2 = whether fruit is on the bottom (=1 if yes, = 0 if no) a3 = whether yogurt is low fat (=1 if yes, = 0 if no) a4 = whether yogurt is nationally branded (=1 if yes, = 0 if no) Suppose for the yogurt case, we found: pi = 1.60 - .15* a1i + .03* a2i+ .005* a3i+ .02* a4i + error = ave price not low fat, no fruit, generic - .15 on ave per oz over 16 oz + .03 on ave if fruit on bottom + .005 on ave if low fat + .02 if branded + error • Particular price = average +adjustments for attributes + error Estimated regression coefficients can be interpreted as the estimated average price of the attribute! Markets and Prices in Agribusiness

24. Valuing attributes a1 = volume of yogurt a2 = whether fruit is on the bottom (=1 if yes, = 0 if no) a3 = whether yogurt is low fat (=1 if yes, = 0 if no) a4 = whether yogurt is nationally branded (=1 if yes, = 0 if no) Ave pi = 1.60 - .15* a1i + .03* a2i+ .005* a3i+ .02* a4i package volume: -$.15 /oz. For each oz. above the average package volume (6 oz.) fruit on the bottom: +$.03 if yes low fat: +$.005 if yes branded: + $.62 if yes So, the above regression says…. Ave Price of nationally branded yogurt = 1.60+.62= 2.22/lb Ave price of nationally branded, low fat yogurt = 1.60 + .62 + .005 = 2.225/lb Markets and Prices in Agribusiness

25. Discussion • Why are prices of attributes for yogurt so low? • What are the implications of the results for branding for advertising? • Can we trust regression estimates? Markets and Prices in Agribusiness

26. Examples from readings • Pricing wine • Prices of Louisana farm land • Regional rural land prices in Louisiana • Pricing art Markets and Prices in Agribusiness

27. Markets and Prices in Agribusiness

28. Model results 10s of $/acre Markets and Prices in Agribusiness

29. Markets and Prices in Agribusiness

30. Pricing art – the extreme case…. Markets and Prices in Agribusiness

31. Data Markets and Prices in Agribusiness

32. Markets and Prices in Agribusiness

33. Others are easily retrieved from google search Specification and estimation of hedonic housing price models "Spatial hedonic models of airport noise, proximity, and housing prices," Working Papers 2006-026, Federal Reserve Bank of St. Louis. [Downloadable!] ...ideas.repec.org/a/eee/regeco/v22y1992i3p453-474.html - 16k - Markets and Prices in Agribusiness