Create and answer a case study similar to Memo 14 from Time Warner (Most Relevant Chapter 11)- that uses regression analysis to estimate demand functions and then shows how to price to increase profits.
Nathaniel Wenning MEMO 14 Time Warner A La Carte Pricing MBA651 Fall 2011 Nathan Wenning
Time Warner has been getting increased requests for a la carte pricing for its cable channels. Subscribers don't like paying for channels they don't watch or find objectionable. In Memo 14, Time Warner's Vice President of Marketing has proposed offering two small programming packages to its subscribers of its basic package. This will be a test in Regions 1 and 2. The first package that will be offered is a sports package that will offer such channels as NBA TV and the Soccer Channel. The second package that will be offered is a music package that will include such channels as MTV and GAC (Great American Country). (Baye)
The chart below shows data gathered by Time Warner's marketing department that shows anticipated sales at various price points. It is worth noting that the Income less incremental cost assumes sports and music are charged the same price and sums their profits for a given region.
REGION 1
REGION 2
Price
Cost of Sports
Cost of Music
Number of Sports Subscribers
Number of Music Subscribers
Income less Incremental Costs
Number of Sports Subscribers
Number of Music Subscribers
Income less Incremental Costs
$1.40
$1.45
$1.20
4,859
6,565
$1,070.05
6,780
4,386
$538.20
$1.60
$1.45
$1.20
5,631
7,920
$4,012.65
8,401
4,950
$3,240.15
$1.80
$1.45
$1.20
4,499
6,554
$5,507.05
7,119
3,862
$4,808.85
$2.00
$1.45
$1.20
2,703
4,065
$4,738.65
4,509
2,272
$4,297.55
$2.20
$1.45
$1.20
3,169
4,904
$7,280.75
5,545
2,614
$6,772.75
$2.40
$1.45
$1.20
2,100
3,335
$5,997.00
3,837
1,702
$5,687.55
$2.60
$1.45
$1.20
1,976
3,216
$6,774.80
3,759
1,576
$6,529.25
$2.80
$1.45
$1.20
1,767
2,940
$7,089.45
3,488
1,389
$6,931.20
$3.00
$1.45
$1.20
1,390
2,361
$6,404.30
2,841
1,078
$6,343.95
$3.20
$1.45
$1.20
1,342
2,324
$6,996.50
2,832
1,027
$7,010.00
$3.40
$1.45
$1.20
1,041
1,836
$6,069.15
2,265
787
$6,148.15
$3.60
$1.45
$1.20
1,074
1,927
$6,933.90
2,404
803
$7,095.80
$3.80
$1.45
$1.20
740
1,349
$5,246.40
1,701
547
$5,419.55
$4.00
$1.45
$1.20
860
1,593
$6,653.40
2,030
630
$6,940.50
$4.20
$1.45
$1.20
425
798
$3,562.75
1,027
308
$3,748.25
$4.40
$1.45
$1.20
350
667
$3,166.90
866
251
$3,357.90
$4.60
$1.45
$1.20
316
611
$3,072.80
801
225
$3,288.15
$4.80
$1.45
$1.20
359
702
$3,729.85
928
253
$4,019.60
$5.00
$1.45
$1.20
313
620
$3,467.15
826
219
$3,764.50
In order to estimate the linear demand function, the assumption on the type of market must be made. It is evident that there are several service providers and the industry is not a monopoly. On the other hand, perfect competition happens when there are many firms producing the same products, firms can enter easily, and buyers are well informed. Because this the industry has extremely high starting costs which creates a barrier to entry, we will assume the industry is an monopolistic competition. This is because there are relatively few firms making similar yet differentiated products. Based on this assumption, we will determine the profit maximizing strategy based upon the data provided.
The above charts are broken down by subscription between music and sports along with region. Being able to charge different prices based upon region is a form of third degree price discrimination. Assuming a linear demand curve, the marginal revenue can be determined by taking the equation and doubling the slope. At that point, MR can be equated to the marginal cost to determine the profit maximizing quantity. The final step is to plug the calculated quantity into the original demand function to determine the equilibrium price.
|| || Demand
MR
MC
Region 1 Music
P= -.0005Q + 4.54
MR = -.0010Q + 4.54
$1.20
Region 2 Music
P= -.0007Q + 4.25
MR= -.0014Q + 4.25
$1.20
Region 1 Sports
P= -.0006Q + 4.35
MR= -.0012Q + 4.35
$1.45
Region 2 Sports
P= -.0005Q + 4.69
MR= -.0010Q + 4.69
$1.45
|| || Price
Quantity
Region 1 Music
$2.87
3340
Region 2 Music
$2.72
2180
Region 1 Sports
$2.90
2420
Region 2 Sports
$3.07
3240
Journal Summary
I In a more general discussion, there are several theories on the market efficiency of a la carte and bundle pricing. This topic has become more popular in recent years because as of October 2003, a study by the US General Accounting Office (GAO) found that cable television rates had increased 40% over the previous 5 years while the inflation increased 12%. (Rennhoff and Serfes)
On one hand, bundling is considered a form of price discrimination which allows firms to design a product line to extract the maximum consumer surplus. (Crawford) Crawford used a dataset from the cable markets in 1996 to show that adding general interest networks has little effect discriminatory effect; however, adding special-interest cable networks to a bundle increased profits and decreased consumer welfare by an average of 4%.
In another study of the effects of regulating a la carte pricing, the Federal Communications Commission reported little benefit to consumers with a la carte regulation (2004); however, they reversed many of the initial report findings in 2006, reporting many substantial consumer benefits. (Rennhoff and Serfes) They made assumptions that the cable market had marginal costs were zero and that consumers have free disposal. Their findings were consistent to the Law of Large Numbers. As the bundle increases, consumers converge to a single willingness to pay. As a monopoly sets the price to this it maximizes the profit by eliminating consumer surplus and deadweight loss. (Rennhoff and Serfes) With this being said, there consumers should prefer to have a la carte pricing.
On the other hand, there is some literature that suggests a la carte pricing would ultimately eliminate consumer choices and have no effect of price. In the example of park fees, imagine if residents had to pay $100 to maintain all 20 parks regardless of their use. The 100,000 residents became upset that because they didn’t visit all the park and still have to pay to maintain all of them ($10million in to cover $10million expense). The parks department decides to sell passes per park ($20); however after year the average family only purchased 2 passes and revenues dropped by 60%. At this point, the parks would ultimately raise their prices to $100 for only one park permit per person. (Rognlie) The above example assumes that the parks are not overcrowded, similar to the low marginal cost of cable service. The point made by this MIT PhD student is that a la carte pricing will lead to less selection for a given price or poor selection at a slightly reduced price. Therefore, if the cable company offers channels on an a la carte basis, the fewer subscribers should cause prices to skyrocket and less requested channels to disappear. Although there are several complex situations and various assumptions that must be made, there is no clear answer that a la carte pricing is good or bad for an economy. In general, providing more choices to consumers should increase the total surplus. However, it has become more clear that any attempt to provide more plans and options by a cable company will more likely create imperfect information and confused consumers.
Works Cited
Baye, Michael R. Managerial Economics and usiness Strategy (6e). New York: McGraw-Hill Irwin, 2009.
Crawford, Gregory S. "The Discriminatory incentives to bundle in the cable television industry." Quant Market Econ (2008): 41-78.
Rennhoff, Adam D and Konstantinos Serfes. "The Role of Upstream-Downstream Competition on Bundling Decisions." Journal of Economics & Management Strategy (Summer 2009): Volume 18, Number 2, 47-88.
1) Which of the following is best describes the cable television industry? A) Perfect Competition B) Oligopoly C) Monopoly D) Duopoly Perfect competition has many firms producing the same products, firms can enter easily, and buyers are well informed. A monopoly has 1 firm and barriers to entry. Oligopoly has few firms that produce differentiated or homogeneous and the firm’s decisions impact one another, where a duopoly is the same but with only two firms. Therefore oligopoly is the most relevant choice. Also, because there are large barriers to entry, monopolistic competition is also not the best option.
2) In a monopolistic competition, MR is equal to which of the following in the short run? A) The demand curve with 2x the slope B) Same as demand C) The demand with ½ the slope D) None of the above
monopoly_MR.jpg
Monopolistic competition behaves like a monopoly in the short run.
3)In a monopolistic firm, if the marginal cost is $5 and the demand function is P=-2.5Q + 20, what is the equilibrium quantity? A) 6 B) 10 C) 3 D) None of the above Operating where MR=MC, $5 = -2.5*2Q+20, -5Q = -15, Q=3
4) What is 3rd degree price discrimination? A) Discriminating based on groups B) Discriminating based on personal value C) Discriminating based on volume
5) Which of the following is not an example of 3rd degree price discrimination? A) Regional Pricing B) Car Dealerships C) Student Discounts Regional pricing and student discounts both discriminate against groups of people. Car dealerships can discriminate against each person that
NFL NETWORK A PRISONER’S DILEMMA 11/21/2011
There are two conditions that need to be considered. The first is that cable customers will purchase cable from the company with the NFL network. In this case, the NFL network will have the same number of customers regardless of who they have a contract with. On the other hand, if customers are loyal to their service provider than the NFL network has to worry about who they sign with in order to get the most viewers and most income from their advertising. In this case, the NFL network may pay for a larger network to insure more viewers.
The author describes the relationship between these groups a prisoners dilemma because in the contract negotiations there is a mutually beneficial decision and a decision in which they both lose. From my understanding a prisoners dilemma does not arise unless both parties are trying to benefit over the other and choose an option that is worse than them working together. For this reason, I do not believe cable television has a prisoners dilemma.
1st degree price discrimination is pricing that charges everyone what they are willing to pay. Is a la carte pricing a form of price discrimination? The consumer below purchased an all you can eat sushi meal, but only ate the raw meat in the sushi. Because he was eating a la carte and skipping the rice, the owner charged him a la carte prices plus a $1 cup of green tee
The person sued for discrimination against his diabetes, but in an economic form of discrimination, this person was charged more because of his unique preference.
Air lines have continued to cut all their extras to the point where the next step may be to rent a seat cushion for your flight. Peanuts, drinks, bags, and priority seating are all purchased by a la carte pricing.
This has caused more ambiguity between competitors. Does Delta charge $25 a bag or $50? It is reasonable to assume that some airlines hope for imperfect information. New rules state that full prices need to be displayed upfront and airlines must state that prices may increase for baggage or other fees.
The upside of this is consumers are more likely to pay what they are willing to for services. If I could save $5 and not have 5 tiny pretzels, I would.
A LA CARTE FOOD 10/31/11
This article discusses why a standard three course meal is much less expensive than a more typical a la carte meal. Although several reasons were given, a few reason why this was cheaper included: cost savings are no substitutions allows the kitchen to prepare limited items most efficiently, purchasing in bulk cuts down marginal costs, portions are often smaller, and meals are usually offered during not peak hours.
If a package has enough variety to entice a large group of customers, the restaurant can justify a package. However, it is often the case that customers have a wide preference for one of the set items (such as a side item). Offering a set menu with a couple of al la carte options is known as mixed bundling. This practice is common in the cable TV market which offers base packages and then an additional sports or movie package.
MORE CHOICE IS LESS CHOICE 10/24/11 This article explores the example of 20 large parks in a city that aren’t overcrowded. Residents are upset that because they don’t visit all the park and still have to pay to maintain all of them ($100). The parks department decides to sell passes per park ($20), however year two the prices had to be increased to $100. When the passes were sold, the average family purchased to passes taking the average revenue from $100/family to $40/family. Therefore, if the cable company offers channels on an a la carte basis, the fewer subscibers should cause prices to skyrocket. The author of the article points out that a lacarte could shake up monopolies and eliminate the least popular programing. However, in a market with zero marginal cost for additional programing, the most likely result would be less choice. http://makeanysense.blogspot.com/2010/07/more-choice-is-less-choice-strange.html
Nathaniel Wenning
MEMO 14 Time Warner A La Carte Pricing
MBA651 Fall 2011
Nathan Wenning
Time Warner has been getting increased requests for a la carte pricing for its cable channels. Subscribers don't like paying for channels they don't watch or find objectionable. In Memo 14, Time Warner's Vice President of Marketing has proposed offering two small programming packages to its subscribers of its basic package. This will be a test in Regions 1 and 2. The first package that will be offered is a sports package that will offer such channels as NBA TV and the Soccer Channel. The second package that will be offered is a music package that will include such channels as MTV and GAC (Great American Country). (Baye)
The chart below shows data gathered by Time Warner's marketing department that shows anticipated sales at various price points. It is worth noting that the Income less incremental cost assumes sports and music are charged the same price and sums their profits for a given region.
In order to estimate the linear demand function, the assumption on the type of market must be made. It is evident that there are several service providers and the industry is not a monopoly. On the other hand, perfect competition happens when there are many firms producing the same products, firms can enter easily, and buyers are well informed. Because this the industry has extremely high starting costs which creates a barrier to entry, we will assume the industry is an monopolistic competition. This is because there are relatively few firms making similar yet differentiated products. Based on this assumption, we will determine the profit maximizing strategy based upon the data provided.
The above charts are broken down by subscription between music and sports along with region. Being able to charge different prices based upon region is a form of third degree price discrimination. Assuming a linear demand curve, the marginal revenue can be determined by taking the equation and doubling the slope. At that point, MR can be equated to the marginal cost to determine the profit maximizing quantity. The final step is to plug the calculated quantity into the original demand function to determine the equilibrium price.
|| || Demand
|| || Price
Journal Summary
I
In a more general discussion, there are several theories on the market efficiency of a la carte and bundle pricing. This topic has become more popular in recent years because as of October 2003, a study by the US General Accounting Office (GAO) found that cable television rates had increased 40% over the previous 5 years while the inflation increased 12%. (Rennhoff and Serfes)
On one hand, bundling is considered a form of price discrimination which allows firms to design a product line to extract the maximum consumer surplus. (Crawford) Crawford used a dataset from the cable markets in 1996 to show that adding general interest networks has little effect discriminatory effect; however, adding special-interest cable networks to a bundle increased profits and decreased consumer welfare by an average of 4%.
In another study of the effects of regulating a la carte pricing, the Federal Communications Commission reported little benefit to consumers with a la carte regulation (2004); however, they reversed many of the initial report findings in 2006, reporting many substantial consumer benefits. (Rennhoff and Serfes) They made assumptions that the cable market had marginal costs were zero and that consumers have free disposal. Their findings were consistent to the Law of Large Numbers. As the bundle increases, consumers converge to a single willingness to pay. As a monopoly sets the price to this it maximizes the profit by eliminating consumer surplus and deadweight loss. (Rennhoff and Serfes) With this being said, there consumers should prefer to have a la carte pricing.
On the other hand, there is some literature that suggests a la carte pricing would ultimately eliminate consumer choices and have no effect of price. In the example of park fees, imagine if residents had to pay $100 to maintain all 20 parks regardless of their use. The 100,000 residents became upset that because they didn’t visit all the park and still have to pay to maintain all of them ($10million in to cover $10million expense). The parks department decides to sell passes per park ($20); however after year the average family only purchased 2 passes and revenues dropped by 60%. At this point, the parks would ultimately raise their prices to $100 for only one park permit per person. (Rognlie) The above example assumes that the parks are not overcrowded, similar to the low marginal cost of cable service. The point made by this MIT PhD student is that a la carte pricing will lead to less selection for a given price or poor selection at a slightly reduced price. Therefore, if the cable company offers channels on an a la carte basis, the fewer subscribers should cause prices to skyrocket and less requested channels to disappear.
Although there are several complex situations and various assumptions that must be made, there is no clear answer that a la carte pricing is good or bad for an economy. In general, providing more choices to consumers should increase the total surplus. However, it has become more clear that any attempt to provide more plans and options by a cable company will more likely create imperfect information and confused consumers.
Works Cited
Baye, Michael R. Managerial Economics and usiness Strategy (6e). New York: McGraw-Hill Irwin, 2009.
Crawford, Gregory S. "The Discriminatory incentives to bundle in the cable television industry." Quant Market Econ (2008): 41-78.
Rennhoff, Adam D and Konstantinos Serfes. "The Role of Upstream-Downstream Competition on Bundling Decisions." Journal of Economics & Management Strategy (Summer 2009): Volume 18, Number 2, 47-88.
Rognlie, Matt. Does that make any sense. 18 July 2010. 20 11 2011 <http://makeanysense.blogspot.com/2010/07/more-choice-is-less-choice-strange.html>.
1) Which of the following is best describes the cable television industry?
A) Perfect Competition
B) Oligopoly
C) Monopoly
D) Duopoly
Perfect competition has many firms producing the same products, firms can enter easily, and buyers are well informed. A monopoly has 1 firm and barriers to entry. Oligopoly has few firms that produce differentiated or homogeneous and the firm’s decisions impact one another, where a duopoly is the same but with only two firms. Therefore oligopoly is the most relevant choice. Also, because there are large barriers to entry, monopolistic competition is also not the best option.
2) In a monopolistic competition, MR is equal to which of the following in the short run?
A) The demand curve with 2x the slope
B) Same as demand
C) The demand with ½ the slope
D) None of the above
3)In a monopolistic firm, if the marginal cost is $5 and the demand function is P=-2.5Q + 20, what is the equilibrium quantity?
A) 6
B) 10
C) 3
D) None of the above
Operating where MR=MC, $5 = -2.5*2Q+20, -5Q = -15, Q=3
4) What is 3rd degree price discrimination?
A) Discriminating based on groups
B) Discriminating based on personal value
C) Discriminating based on volume
5) Which of the following is not an example of 3rd degree price discrimination?
A) Regional Pricing
B) Car Dealerships
C) Student Discounts
Regional pricing and student discounts both discriminate against groups of people. Car dealerships can discriminate against each person that
NFL NETWORK A PRISONER’S DILEMMA 11/21/2011
There are two conditions that need to be considered. The first is that cable customers will purchase cable from the company with the NFL network. In this case, the NFL network will have the same number of customers regardless of who they have a contract with. On the other hand, if customers are loyal to their service provider than the NFL network has to worry about who they sign with in order to get the most viewers and most income from their advertising. In this case, the NFL network may pay for a larger network to insure more viewers.
The author describes the relationship between these groups a prisoners dilemma because in the contract negotiations there is a mutually beneficial decision and a decision in which they both lose. From my understanding a prisoners dilemma does not arise unless both parties are trying to benefit over the other and choose an option that is worse than them working together. For this reason, I do not believe cable television has a prisoners dilemma.
http://theincidentaleconomist.com/wordpress/economics-of-cable-tv/
DISCRIMINATION 11/14/2011
1st degree price discrimination is pricing that charges everyone what they are willing to pay. Is a la carte pricing a form of price discrimination? The consumer below purchased an all you can eat sushi meal, but only ate the raw meat in the sushi. Because he was eating a la carte and skipping the rice, the owner charged him a la carte prices plus a $1 cup of green tee
The person sued for discrimination against his diabetes, but in an economic form of discrimination, this person was charged more because of his unique preference.
http://articles.latimes.com/2011/feb/17/business/la-fi-lazarus-20110218
PRICE AMBIGUITY 11/7/11
Air lines have continued to cut all their extras to the point where the next step may be to rent a seat cushion for your flight. Peanuts, drinks, bags, and priority seating are all purchased by a la carte pricing.
This has caused more ambiguity between competitors. Does Delta charge $25 a bag or $50? It is reasonable to assume that some airlines hope for imperfect information. New rules state that full prices need to be displayed upfront and airlines must state that prices may increase for baggage or other fees.
The upside of this is consumers are more likely to pay what they are willing to for services. If I could save $5 and not have 5 tiny pretzels, I would.
A LA CARTE FOOD 10/31/11
This article discusses why a standard three course meal is much less expensive than a more typical a la carte meal. Although several reasons were given, a few reason why this was cheaper included: cost savings are no substitutions allows the kitchen to prepare limited items most efficiently, purchasing in bulk cuts down marginal costs, portions are often smaller, and meals are usually offered during not peak hours.
If a package has enough variety to entice a large group of customers, the restaurant can justify a package. However, it is often the case that customers have a wide preference for one of the set items (such as a side item). Offering a set menu with a couple of al la carte options is known as mixed bundling. This practice is common in the cable TV market which offers base packages and then an additional sports or movie package.
http://livingeconomics.org/article.asp?docId=158
MORE CHOICE IS LESS CHOICE 10/24/11
This article explores the example of 20 large parks in a city that aren’t overcrowded. Residents are upset that because they don’t visit all the park and still have to pay to maintain all of them ($100). The parks department decides to sell passes per park ($20), however year two the prices had to be increased to $100. When the passes were sold, the average family purchased to passes taking the average revenue from $100/family to $40/family.
Therefore, if the cable company offers channels on an a la carte basis, the fewer subscibers should cause prices to skyrocket. The author of the article points out that a lacarte could shake up monopolies and eliminate the least popular programing. However, in a market with zero marginal cost for additional programing, the most likely result would be less choice.
http://makeanysense.blogspot.com/2010/07/more-choice-is-less-choice-strange.html