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Memo 7 from Time Warner (Most Relevant Chapters 10, and 13)
Pricing Manager, District 6SW
Vice President, Marketing
Strategic Pricing Decision
Our only competitor in District 6SW currently provides bundled services at $84.95. We are currently charging a 10 percent premium over their price, but there are unsustainable rumors that they are contemplating a 10 percent price increase. We don’t know their cost structure, so we don’t know whether their potential price increase is driven by cost increases or merely a strategic move on their part.
Historically when we both charge the same price, our market share is about 65 percent. When we charge a 10 percent premium over their price, our market share declines to about 60 percent. It appears that in those instances where they have charged a 10 percent premium over our price, our market share is about 70 percent.
Please provide a recommendation regarding whether we should maintain our current price or reduce our price to $84.95. Please factor into your recommendation that we pay programming fees to providers that amount to $32.50 for each subscriber. In addition, maintenance, service and billing costs are about $7.60 per subscriber. At present, there are about 110,000 households in the relevant area.
ANALYSIS AND EXPLANATION
After reviewing the above memo, my recommendation for the pricing manager would be to work with the simultaneous-move game and sequential-move game.
– Game in which each player makes decisions without knowledge of the other players’ decisions.
- Game in which one player makes a move after observing the other player’s move.
Pricing Manager – Horizontal
Competitor – Vertical
Pricing Manager Charges 10% Higher
Competitor Charges 10% Higher
Pricing Manager Charges 10% Higher
This table shows that the Pricing Manager has the dominant strategy in all three categories. Whether the competition has a price of 10% less of the pricing manager, they both charge the same price, or the competitor charges 10% more than the competition the pricing manager will always have a higher market share.
- A strategy that results in the highest payoff to a player regardless of the opponent’s actions.
The best option for our market would be to maintain the same price as our competitors and gain 65% of the market share.
Charging the same price = $84.95
Charging 10% increase on premium = $84.95 x 10% = $93.45
If there are 110,000 people in the market, the break up of market share goes as follows:
110,000 x 60% = 66,000
110,000 x 65% = 71,500
110,000 x 70% = 77,000
If we maintain our price of $84.95 we will gain 65% of the market share:
$84.95 x 71,500 = $6,073,925
If we charge 10% premium over their price our price will be $93.45 and our market share will decline to 60%:
$93.45 x 66,000 = $6,167,700
Lastly, if the competition charges 10% premium over our price the price will stay at $84.95 but our market share will increase to 70%:
$84.95 x 77,000 = $6,541,150
The above information shows that charging a price of $84.95 and gaining 65% market share gives us the best outcome of $6,073,925. Here our company spends the least amount of total money possible after figuring out the correct outcome.
Real Life Examples
A classic example of dominant strategies or the prisoner’s dilemma is from drug testing student athletes. If you take into consideration two athletes that both have to decide if they want to take the performance enhancement drug (steroids). We must look at both Athlete #1 and Athlete #2’s situations.
Athlete #1 has two options:
If athlete #2 doesn’t take any drugs, it would be beneficial for athlete #1 to take the drugs to have a better chance of winning.
If athlete #2 does take the drugs, it would be beneficial for athlete #1 to take the drugs as well so they have an equal chance of winning.
Athlete #2 has the exact same two options.
The outcome of this example will always be that both the athletes will end up taking the drug because they feel either choice will give them an advantage.
Multiple Choice Questions:
Sequential-Move game is
Game in which each player makes decisions without knowledge of the other players’ decisions.
Game in which one player makes a move after observing the other players’ move.
Game in which both players move at the same time.
None of the above.
In the prisoners’ dilemma athlete drug testing example, what was the outcome of the two athletes?
Only athlete #1 will take the drug.
Only athlete #2 will take the drug.
Both athletes will automatically take the drug.
Neither athlete will take the drug.
Which market share was the best option for the pricing manager?
None of the above
If a player has a strategy that results in the highest payoff to a player regardless of the opponent’s action they have a _
a. Secure Strategy
b. Nash Equilibrium
d. None of the above
True of False:
The competitor came out on top of the market share in regards to the pricing manager in the Memo #7.
Multiple Choice Answers
1. B, By definition Sequential-move game is a game in which one player makes a move after observing the other player's move.
2. C, The outcome of this example will always be that both the athletes will end up taking the drug because they feel either choice will give them an advantage. If one of the athlete's doesn't take the drug, it would be beneficial for the other athlete to take the drug to have a better chance of winning. Also, if the first athlete takes the drug, it would be smart for the second athlete to take the drug to have a chance to compete.
3. A, 65% because at this percentage we gain 110,000 x 65% = 71,500 people from the market share. If we maintain our price of $84.95 we will gain 65% of the market share:
$84.95 x 71,500 = $6,073,925
This amount ($6,073,925) is the less of the three choices meaning our company will save the most amount of money with 65%.
4. C, Dominant strategy by definition is a strategy that results in the highest payoff to a player regardless of the opponent's action.
pricing manager came out on top of the market share because when they charged the same price of $84.95 the pricing manager had a market share of 65% of the households which is greater than their competitors 35%.
Baye, Michael. Managerial Economics and Business Strategy__. 6. New York: McGraw-Hill/Irwin, 2009.
Einy, E., Haimanko, O., Orzach, R., & Sela, A. (2002). Dominant strategies, superior information, and winner's curse in second-price auctions.
International Journal of Game Theory
Gilber, D. R. (1996). THE PRISONER'S DILEMMA AND THE PRISONERS OF THE PRISONER'S DILEMMA.
Business Ethics Quarterly
Schneier, B. (2006, August 10).
Drugs: Sports' Prisoner's Dilemma
. Retrieved November 30, 2008, from Wired:
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