Ecommerce 6

7/31/2019 Ecommerce 6

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Clicks and Mortar

Efficiency and the Internet


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Price Discrimination

Uniform versus non-uniform pricing Possibility of arbitrage Uniform pricing

Uniform pricing is linear pricing

Tariff T(q)=pq Distribution of surplus and efficiency

Types of price discrimination

First degree

Seller extracts full surplus

Second degree Partial discrimination based on buyer self-selection into pricing

category

Third degree

Discrimination based on signal correlated with preference


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First degree discrimination

Charge each customer her maximum willingness to pay

Extracts total social surplus from the market

Resulting allocation is efficient:

Let p(q) be the inverse demand function. Then the monopolist receives

p(q) for the qth unit sold. This the monopolists marginal revenue. Profit

maximization requires that the monopolist produce and sell to the point

where MR=MC. But this is the same condition that determines the

competitive equilibrium allocation which is efficient.

Implementation in monopoly market by two-part tariff

Let Sc be the competitive consumer surplus

dqpqpScq

o

c

c


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Graphically:


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Suppose there are n buyers each of whom has the

same demand schedule.

The monopolist offers a two-part tariff of the form

The profit per unit sold is then

where C(q) is the monopolists marginal cost

if

if

00

0

q

qn

Sqp

qTcc

qCn

Sqpq c

c


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Total profit is obtained by integrating the marginal

profit with respect to q:

But this is just the total surplus in the market.

It is straightforward to show that the profit the monopolist

obtains exceed what she would have gotten at the uniform

monopoly price. Difficulties with implementing first-degree

discrimination

Lack of knowledge about demand

Heterogeneity of demand

qCSqp ccc


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Second-degree price discrimination

Applicable when buyers are heterogeneous and seller has limited

information about preferences

Uses a menu of non-linear tariffs to allow buyers to self-select into

a pricing scheme (personalized pricing)

Two-part tariff is a simple example of non-linear pricing scheme

Digital goods implementation in the form of versioning


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Tie-in Sales

Bundling of complementary goods or services leads naturally to a

two-tier pricing system

Cameras and film Amusement parks and rides

Online news subscriptions and access to archived material

Information tracking and analysis capabilities of the web

Flip side of targeted advertising

Track buyer preferences

Conduct price sensitivity experiments

Structure pricing tariffs according to data collected

Dark Side: Privacy Issues


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Third-degree price discrimination

Monopolist is able to segment the market using external signals

about buyer types

Signals: Age

Sex

Occupation

Location (or referring site)

New vs. repeat purchases The monopolist then sets a uniform price in each market segment

to maximize profits from each segment.


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Model

N market segments

pi = price in segment i, qi = quantity sold in segment i

Di(pi) = segmented demand function q = i Di(pi)

Assuming a uniform cost function across segments, the monopolists

profit maximization is then to choose prices for each market segment

to solve the problem

i

ii

i

iiippp

pDCpDpN,...,1

max


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The first-order conditions for this problem can be manipulated into

the form

The optimal pricing rule then is for the monopolist to set the markup

over marginal cost (as a percentage of the price) equal to the inverse

of the elasticity of demand.

ii

iiii

ii

i

pD

pDp

p

qCp

where

1


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Some implications of the markup rule

Market segments with higher demand elasticity will receive a lower

price

Greater price sensitivity market segments get lower prices

Conversely, segments which are less price sensitive will pay higher

prices

Welfare analysis for simple cases shows that the overall effects of

market segmentation are ambiguous. Depending on how price sensitive

different segments are relative to each other, overall consumer surplusmay be larger or smaller with discrimination than without


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Privacy Issues

Sensitivity of personal information

Medical information and insurance

Access to credit

Protection from job actions

Exposure to spam

Exposure to price discrimination

Information value-added Customization of products

Targeting of useful information about products

Simplification of transactions


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The myth of anonymity


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Internet communications

Complexity of communication protocols requires tracking

information

Packet switching Message fragmented into uniform size packets

Headers encode information about packet destination using the internet

protocol (IP) address of the recipient

Packets routed through network under control of network transmission

control protocol (TCP)

TCP checks for errors in packets and will request retransmission ofbad packetspackets can be traced

Message reconstructed as packets reach destination

Cookies

Internet communication is anything but anonymous


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Protecting content while revealing identity

Encryption

Secure communications

Online payment systems Digital signatures

Trust relationships

Legal protections

Privacy guarantees and the First Amendment (freedom of speech) and

Fourth Amendment (freedom from unlawful searches)

Legal restrictions on distribution of personal information disclosed intransactions

Truth in advertising enforcement of pledges to protect customer

privacy by firms


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Market mechanisms for privacy protection

Service for information arrangements

Email

Search

Online file storage

Data analysis engines

Trust relationships

Trusted independent intermediary verifies content and claims

Provision for legal intervention by violators

Better business bureau model


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Intermediation

Economic role of intermediaries

Transactional efficiencies

Lower costs in inventory holding, product delivery, insurance,

financing, accounting Inventory and demand issues

The internet as an information aggregator and transactional role for

intermediaries in markets for digital goods

Intermediaries as Experts

Repeat purchases Incentive to acquire knowledge about product

Intermediary as Long-term Player

Ongoing benefit to credibility


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Intermediation

Intermediaries as information sources

Long-term, multi-product intermediaries and reputational

spillovers

Intermediary has incentive to ensure high quality in any given productto avoid lost sales in other, unrelated products

Intermediary role provides a punishment mechanism in the form of

exclusion of a sellers product if quality lags

Intermediate production activities

Combining of separate products in retail bundles

Particularly germane in the information industry

News and entertainment content providers combine, package and

distribute work of individual authors

CNN, Napster


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Auctions and Contracts

Market Efficiency and Competition

Contracts versus Auctions

Auctions are competitive but costly to hold when all parties tothe transaction must be present in the same place and time to

participate

Contracts are negotiated bilaterally

Less information about costs

Less competitive pricing (Ford-Autolite example) Less flexibility if terms change

Lower cost since contract governs relationship for an extended

period of time


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Auction Types Direct vs. Reverse

English vs. Dutch

Sealed bid vs. open outcry Vickerys Theorem

If buyers have the same information about an object being sold, arerisk-neutral, and have independent valuations of the object, thenany of the above auction formats will achieve maximum revenue

for the seller. Key points:

Uncertainty about value

Independence of valuations


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Common value auctions

Most common type of auction

Valuations are unknown but closely (or perfectly) correlated

Example: Offshore oil tracts

Example: Procurement contracts for manufactured intermediate

products

The Winners Curse

Experiment: Auctioning off a jar of money Format

Sealed Bid

First price (i.e. highest price wins)


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Information and the Winners Curse

Distribution of guesses

Mean guess as best estimate of actual value


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Since the winning bid must be higher than the mean (unless all

bids are at the mean), if the mean is an accurate estimate of the true

value, then the winning bid necessarily overstates the value of the

object at auction, and the winner ends up paying too much for the

object.

Optimal bid when faced with the winners curse?

Shave bids below what you believe the true value to be

Reduces revenue to the seller


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Reducing the risk of the Winners curse

Second-price auction

Highest bid wins, but pays second highest price

Eliminates incentive to shave bids

Open outcry auctions

Allows sharing of information among bidders as to the best guess of

the true value of the object

Multi-object auctions

Discriminatory vs. Uniform

Potential inefficiencies in sequential auctions


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Example: 2 units to be auctioned

Buyer 1 values one unit at 10 and 2 at 20

Buyer 2 values one unit at 9 and 2 at 10

Simultaneous auction of both units

Buyer 1 wins with a bid of 10

Sequential auction: Backward induction

Suppose Buyer 1 wins in round 1

To win round 2, Buyer 1 must bid at least 9

Moving back to round 1, since Buyer 2 values one unit at 9, for Buyer

1 to win round 1, she must bid at least 9.

Buyer 1s profit from this is 20-9-9=2.


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Now, suppose Buyer 1 loses in first round.

Buyer 1 can win in round 2 with a bid of 1, yielding a profit of 10-

1=9. Hence, Buyer 1 is better of losing in round 1.

Knowing this, Buyer 2 can win round 1 with a bid of 2. To see why,

we note the following:

Buyer 1 can get a profit of 9 by losing round1 and winning round 2.

Hence, her maximum round 1 bid, if she wins, must yield profit at least

equal to what she gets if she loses, i.e. 9.

Letting this bid be x, we need 20-9-x=9 or x=2 and buyer 2 can win in

round 1 with a bid of 2

Revenue from the sequential auction is then 2+1=3 so the sequential

auction is clearly inefficient.

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Ecommerce 6