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# Product Line Design and Price Customization

Part 1:
Decision Process and Optimization Methodology
XMBA 206.1
Summer 2008

Ganesh Iyer

Examples of Versioning

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## Statistical Software Packages http://www.systat.com/store/

Microsoft Office:
Product Line (Versioning) in Action

Office 2000
Developer

Office 2000

Office 2000
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Office 2000
Professional

Office 2000
Standard
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\$399
Color
\$399
\$449

Palm Vx
\$299

Palm IIIxe
\$179

Palm m100
\$129
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## If CSC offers only one version of Modeler, which version should it

offer? At what price?

Should the firm offer more than one version of Modeler? If so, which
versions should it offer? At what prices?

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## Product Line Pricing:

Optimization Methodology and Decision Process

(Decision Tree)

## Two Step Decision Process = Backwards Induction

Stage 1
Product Choice
Backwards
Induction

Stage 2
Pricing and Targeting

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Decision Process
Stage 2: Pricing and Targeting for a given product

## Suppose CSC introduces student version, what is the optimal price?

Relevant Costs
What are the relevant costs at this stage of decision making?
segment development cost
variable cost (per unit)
Is product completion cost a relevant cost at this stage?

unit contribution-margin vs. volume (# segments served).
choose the price which gives the maximum total contribution.
Total Contribution = Unit Price Volume - Segment Dev. Cost(s).

Can the optimal price of CSC be different from \$ 50, \$ 100, \$ 150, \$ 175 or \$ 200?

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Student version

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## Single-version Case: Fixed Cost Trap

Key Learning: Look out for Fixed Cost traps in decision making.
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## Derive the Total Contribution if CSC instead offered commercial or

industrial version
Backwards induction Management has already figured out its optimal
pricing policies in these contingencies.

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## Step 2: Product Choice

Net contribution analysis

## Choose the version which gives the maximum Net Contribution

What becomes relevant at this stage?

## Product Development cost

Student = 100,000
Commercial = 200,000
Industrial = 500,000

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## Optimal Single product design means 3 interrelated decisions

Product = Industrial
Price = \$ 600.
Targeting = 3 high-end segments viz. Large Corp., Labs and
Consultants segments.

## This is where pricing, product design and segmentation come

together.

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Recaptwo-stage process.

Stage 1
Product Choice
Backwards
Induction

Stage 2
Pricing and Targeting

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Single-version Case

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Product Line

## In the single-version case CSC ignores the largest segment = students

= 500,000. Why?
Negative price effect (reduction in unit contribution) outweighed the positive
volume effect (demand expansion).

## Is there some other way to include the Students segment?

Offer 2 versions with Students segment buying one version and other

## Two possible options: (1) Industrial + Commercial versions or

Industrial + Student versions.

## Consider Industrial and Student version why?

In the single-version case, if CSC were to introduce Commercial version,
it would have ignored the students segment.

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Catch em young

## Pricing to lock consumers in youth

Apple
Gaming
WSJ student edition
Pharmaceutical firms and medical interns.

Loyalty through consumer investments in learning

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## How will you price the student version?

Price_Student = \$50.

Can you charge \$ 600 for the Industrial version as in the single
product case?
What are the considerations?

## Considerations that are different in the pricing of 2 products compared

to one product?
No purchase of high quality product does not mean zero purchase.

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## Pricing the Industrial Version

Key Principle: Self-Selection/Cannibalization
Maximum Price for
Industrial version

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version

Surplus from
Student

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## CSC introduced two versions

Industrial at \$1950
Student at \$50

## This allowed Cambridge to increase profit from

\$14,305,000 to \$20,580,000 (plus \$6,275,000).

future potential as they move to commercial and
industrial employment.

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## Product Line Design

Part 2:
Strategic and Managerial Considerations

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## There are economic benefits to a product line pricing strategy

using several products, but these benefits must be weighed
against the costs
1. Management complexity and coordination.
2. Potential consumer confusion = Diverse product line means less
focused positioning

## There are questions that cannot be answered by numbers

alone What do the people in the firm really want?
1. How does your sales force react to selling too many versions?

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## Design to accentuate the needs of different groups of

customers. Emphasizing customer differences allows you to
extract, through the product line versions, a higher fraction of
the total value you create.

## Features to emphasize differences:

Speed of Operation Mathematical software
Support -- Software with & w/o documentation. Minitab
Capability -- 7 versions of Kurzweils voice recognition software
differentiated on range & type of vocabulary

## Need not be physical features

Time (Delay): PAWW Financial Network -- \$50/month for real-time
quote & \$8.95/month for 20-minute delayed quote

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## Identify the best features to distinguish the different versions of

the product/service

## Need to determine which features will be highly valuable to some

customers but of little value to others.

## Goal: Create the right # of versions -- targeted at the right

customer segments by setting the right prices.

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## Preventing Cannibalization: Disabling Attributes

Intel sells 486DX chip for \$1000.

## Intel disables the math coprocessor of the DX chip and makes

the SX chip (thus incurring a cost of \$50).

## So Intel sells a damaged product that actually costs more to

make for a lower price.

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## Product Line Design: Disabling Attributes

Problem facing Intel when it introduced 486 chip (two types of early
E, G (50% of each type), E is willing to pay more and performs lots
of math calculations
Res. Price
\$1000
\$800

E
E&G

Revenues
\$1000
\$1600

## What should Intel price the 486?

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Disabling Attributes
If Intel can charge different prices to different users

\$800 to G
\$1000 to E
Total:

\$1800

## But there is a caveat..

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Disabling Attributes

The seller wants to charge G less than E for the same 486 chip.

At the same time, the seller has to prevent E from buying the
product meant for G. What does the seller do?

## The seller disables the math coprocessor for G!

Actually incurs a cost of doing so (say \$10)
But makes \$200 extra from E.

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Controlling Cannibalization
Two Methods

## Potential Cannibalization: If the low-end version is too

attractive, it may attract some customers who would other wise
pay a premium for the high-end version

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Method #1: Cut the price of your high-end version to ensure that

## Method #2: Damage your low-end version enough to make it

unattractive to the high-end segment

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## Learning: Optimal Product Line Design and Pricing

Point #1: Identify the attributes/features that are highly valued by some
customer segments yet of little importance to other customer segments

Point #2: Greater the differences among the customers in their intensity
of preference for the differentiating attribute, the wider is the product line.

## Qualitative Issues while selecting # of Versions:

Costs of complexity can be large.
Consumers may get confused if the positioning of the different versions is not
distinct.

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## In reality, firms can choose to introduce the different versions

sequentially? If you chose to introduce the versions
sequentially, what is the order of sequential introduction? Why?

## What factors would you consider while deciding whether to

introduce the versions simultaneously versus sequentially?

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