Price and Pricing

One of the most enjoyable aspect of my job is tweaking the scheduling strategy. The impact on the channel’s performance is direct and scheduling is more of a science backed by in-depth analysis of data. Eventually, a pattern will emerge and the gaps are as glaring as daylight. Another aspect of why this is so fascinating is because the scheduling landscape moves all the time because the competition is not dumb. They react accordingly, whether by accident or by design, and therefore it is necessary to be vigilant on the changing landscape and put in counter strategies. It is really like playing chess and when the numbers show positive results, it is very satisfying, just like winning a good game of weiqi.

As people who knows me knows, I am quite interested in economics and pricing does interest me too. In the course of my work, I have heard detailed analysis on pricing strategies employed, or should be employed and both of these arguments aims at the same aspect of our organisation.

One argument is such that when the ratings of a particular programme is consistently very high, one should raise the price of advertising slots to maximise advertising revenue. For timeslots or programmes that is not popular, the price should be reduced or bundled and sold as a package together with the high ratings programme. This, to many people, is actually common sense but common sense is actually a rare commodity. The real question here is this: what is the maximum price can one put in relation to the ratings numbers? Say, in the standard price list, a 30 seconds spot costs RM4,000 no matter where the spot is placed in the channel. Now, say the 7am slot has a low ratings number of X and the 9pm slot has a high ratings number of Y. Is it possible from here to construct a mathematical equation to shows the path to the optimum pricing for advertising for both these slots?

The other argument has to do with perception instead on real ratings numbers. Now, this is a lot more tricky but I can assure you that it is founded on precise mathematics as well. The key here is really competitive advantage. To what extent can a company differentiate its products based on its competitive advantages from what is available in the market will determine how much extra money they can charge. Differentiation has a lot to do with elasticity, the more differentiated, or perceived to be differentiated, the less elastic will be the price. As Bruce Greenwald and Judd Kahn said in their book “Competition Demystified”, there is really actually one aspect of Porter’s Five Forces that stands heads and shoulders above the other Forces and that is The Barriers To Entry.

Barriers to Entry, according to the authors, is really determined by three kinds of genuine competitive advantages. These are: Supply advantages, Demand advantages and Economies of Scale. As for my current company, although some people said that it is protected by the Government via licenses etc. looking at its history, it is exactly these three factors that see it win the competition. It has superior product supply – often exclusivity deals, a captive demand customer based on formed habits and stickinessof the programmes and the general economies of scale of its customer base and thus reducing its average cost per customer.

All the above needs further qualifications and needs to be guarded against. For example, in terms of supply, the exclusive content can easily be taken away by a player who has better connections with the supplier and/or and offer a significantly higher price. What is there to stop this from happening? In terms of demand, viewing habits can be changed via a superior product and marketing.

Ok, back to the question of pricing. If the company has differentiated its products effectively via the competitive advantages gained, the company should be able to charge a higher price compared to other players in the market. For example, say there is one channel that has its audience spend 40% of their TV viewing time on and the company decides to now start charging the customers after a period of free viewing. How much can it charge? There is a math in this and the correct number can be computed.

One fascinating way to compute the number is via equations using Game Theory. A simple example, here’s an abstract representation of Bargaining Problems:

[v1(z) + t] + [v2(z) – t] = v1(z) + v2(z),

where v1(z) is player 1’s benefit of z in monetary terms, t is the amount of money to be transfered between players 1 and 2.

The surplus in the bargain is represented by the following:

v1(z) + v2(z) – d1 – d2,

where d1 and d2 is the outcome for both players 1 and 2 if no agreement is made.

The above are the abstract and here is the standard bargaining solution. The standard bargaining solution is a mathematical representation of efficiency and proportional division (based on each player’s bargaining power). Each player is assumed to obtain his default payoff plus his share of the surplus. The mathematical equation is this:

d1 + n1(v* – d1 – d2) = v1(z*) + t,

where n1 is player 1’s relative barganing power, v* is the maximum joint value by determining the value z* that maximises v1(z)+ v2(z)

With the above equation, solve for t to find the optimum amount of money to transfer between the players.

Still with me? hmmmm…..I am not sure if I am still with myself. But if you put some effort and follow the equations carefully, it is really common sense.

Let’s try to put this into the pricing problems that we have and see if we can find the answer.

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Filed under Business, Economics, Game Theory

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