Professor Amit Pazgal

Pricing Strategy
Pricing Strategy is a game in which you find yourself in the throat cutting Bistro management competition. Actually, you will have to make only a single pricing decision in every period. Sounds simple right? Wrong! Your sales will be affected not only by your own price but by the prices of the competition as well. And you have Marketing Expense to supplement the effect of your pricing decision. Moreover, there is a link and interaction between the periods. You are a proud owner of the quaint little Le Bistro Original on West Street. Unfortunately, there are several competing restaurants in the vicinity. These fake, no good, noisy, out for a quick buck competitors should not even be mentioned in the same time as your fine institution. Alas, the poor customers are not aware of your obvious superiority. For several months all of you have been offering a $10 set dinner. You have been doing quite well selling about 300 such dinners a week. You consider your dinner deal to be the best around as you use only the freshest ingredients, your food is cooked to order and your staff is truly friendly and knowledgeable. In an effort to increase your profit, you hired the services of Market Analysis a new and promising management consulting firm. Recently, they completed a thorough, 200 page, analysis of the market aimed at determining the exact forces that influence your sales. Here is a short summery of their findings: The sales of each restaurant are determined both by its own price as well as the prices of the competing restaurants. As your prices go up you sell less dinner deals but if the prices charged by the competition rise you get more of their customers. Sales are also affected by the size of the previous customer pool. As some of your customers realize your true excellence and will continue to dine with you. For this I paid so much money? you think to yourself this stuff is obvious! You keep reading and at the very end of the document after the lengthy review of the restaurant and food industries and their relationship to French cuisine you finally find the all-important appendix J.

Strategic Pricing

Professor Amit Pazgal

"Market Analysis" - True consulting Greatness Appendix J Cost structure All of the restaurants have a direct variable cost of about $3 per dinner (the cost includes the freshest ingredients, Jean-Paul the chef, and Bob the waiter among other things.) All have a fixed cost of about $500 per week (including rent, menu printing etc.) Demand Structure New customer demand per period is best approximated by a linear function: Demand = D a*(Own Price) + b*(Average Price of Competition) Specifically for your industry: Demand = 400 40*(Own Price) + 21*(Average Competition Price) Notice that if your competitors raise their prices by $1 on average you will serve 21 new customers while if you raise your price by $1 you will loose 40 customers. Your total sales are the sum of this new demand and the previous customers who decided to remain loyal to you. The analysis estimates that this fraction is about 30% of previous customers as long as you do not raise your price by more then 30%. Total Sales = New Demand + 0.3*Previous Sales Profits Each restaurants profit per period are given by: Profit = (Price Cost) * Sales Fixed Cost (So for the past months your per week profit was: (10-3)*300 500 = $1600)

Strategic Pricing

Professor Amit Pazgal

The Game Assume that you have no control over the food quality, demand parameters or the retention rate of customers. As a matter of fact this is not entirely true. The game has a Global Parameters Screen where you can change any of the controlling parameters. Once those are set they must remain the same for the entire game. You can influence your profit only through a pricing decision, which you will have to make for 9 consecutive weeks. Once a price is set it is effective for the entire following week. At the end of every week you will be informed of your competitors prices, sales and profit. The winner of the game is the restaurant that totaled the highest profits (What else? Are you in it for the satisfaction of cooking and serving? ). You should explicitly consider the tension between getting a larger customer pool with lower margins versus a small number of high paying ones. A more advanced level of the game will allow you to increase your sales via an aggressive marketing campaign. Market Analysis estimates that spending $M on marketing will M increase your sales by a factor of 1 + . Where K is estimated to be approximately $1,500. K Note that you can never increase your new demand by more then 80% via marketing expenditures so don't waste money.

Bon Apptit!

Strategic Pricing

Professor Amit Pazgal

Illustrated Examples:

The following calculations illustrate a single period pricing by 4 restaurants, assuming that for the past weeks all charged $10 and had 300 customers per week.
1. Pure Pricing

If the new prices are 11,12,13,14 respectively the new demand per restaurant will be:
Restaurant Price 1 2 3 4 Average price Of others New demand Total Sales

$11 $12 $13 $14

$13 $12.66 $12.33 $12

400-40*11 +21*13 = 233 400-40*12+ 21*12.66 = 186 400-40*13+ 21*12.33 = 139 400-40*14+ 21*12 = 92

233+0.3*300= 323 186+0.3*300= 276 139+0.3*300= 229 92 + 0

Prices are rounded to the cent and new demand is truncated.

Note that the fourth restaurant did not retain any of its previous customers as it raised its price by 40%. Profit for each restaurant is given by:
Restaurant Price Profit

1 2 3 4

$11 $12 $13 $14

(11-3)*323 500 = $2084 (12-3)*276 500 = $1984 (13-3)*229 500 = $1790 (14-3)*92 500 = $512

As you can see the first three restaurants actually made more profit then the previous $1600 per week.

Strategic Pricing

Professor Amit Pazgal

2. Including Marketing Expenditure:

Consider the previous example allowing firms to spend money on a marketing campaign:
Restaurant 1 2 3 4 Price Marketing Expenditure ($) New demand Total Sales
1500 + 400 1500 1500 +800 1500

$11 $12 $13 $14

$400 $800 $0 $1200

233 186 139 92

233+0.3300= 385 186+0.3300= 375

139+0.3300= 229 1500 +1200 92 + 0 = 165 1500

Prices are rounded to the cent and new demand is truncated.

Profit for each restaurant is given by (marketing expenditures are deducted from the profit):
Restaurant 1 2 3 4 Price Profit

$11 $12 $13 $14

(11-3) 385 500 400= $2180 (12-3) 375 500 1000= $2075 (13-3) 229 500 = $1790 (14-3) 138 500 1200= $115

The first two restaurants made more profit by advertising, while the last one lost money.