Module 1: Customer Demand: Foundations

Price v. WTP

Price vs. WTP: Past students have brought up questions and comments about the concept of price vs. willingness to pay. Some cited examples in which the price of a product (say, a watch) changed and your WTP might have changed as a result. This is an interesting point. In the course, we emphasize the difference between price and WTP to make the point that what one pays for a good is not necessarily what one might have been willing to pay for the good. WTP is the maximum price you’re willing to buy at—so if the price is lower than your WTP, you’ll be willing to buy the good. Now, in practice, there may be situations where one’s (perception of) WTP may be affected by price (luxury goods are a natural example). The important point to keep in mind is that these are two different concepts – and it’s useful to treat them as such. Where companies often make (sometimes, large strategic) errors is to confuse the two concepts as the same.

How do companies collect data on WTP? A lot of you also wondered about how we can actually discover a customer’s WTP. This is a great question and leads us straight into the next module: Strategies for Assessing and Increasing Demand. We hope you enjoy it!

Module 2: Strategies for Assessing and Increasing Demand

WTP and Surveying Customers

Some participants raised questions about whether it is ever valid to survey consumers about their WTP directly, as the course mentions that consumers may have an incentive to lie to obtain products and services at lower prices.

While we know that consumers may often have an incentive to not accurately reveal their WTP, there are various situations where this may not be the case: one common example is after a consumer has already purchased a product (surveying past purchasers). In addition, sometimes rephrasing the question or soliciting comparisons can reduce bias; for example, asking consumers about how their WTP for a product compares to their WTP for another product (about which more is known in the market) can be effective. 

In general, surveys aren’t perfect, but they are useful to reveal some information about WTP; the important thing for a manager is to be thoughtful about the various biases that may be present, and design surveys accordingly. 

Module 3: Suppliers and Cost

Fixed vs. Variable Costs, Netflix/Blockbuster

One of the most important concepts in Economics for Managers is the distinction between fixed and variable costs. This distinction impacts the structure of a market and informs hiring and pricing decisions.

A number of you have asked in Peer Help why wages paid to an hourly worker are variable costs, but salaries are fixed costs. Here’s a way to think about it: a variable cost is a cost which increases with the amount produced and sold. In the course, we’ve assumed—as is the case in practice—that a company is able to adjust the number of hours worked by an hourly worker depending on demand. (That’s the reason they’re called “hourly workers,” after all). Thus, during weeks with high demand, total wages paid to hourly workers increase; during weeks with low demand, they would decrease. On the other hand, salaries cannot typically be adjusted week by week since they are fixed for a longer period of time (most commonly, a year). Thus, these would be fixed costs.

We also wanted to call attention to one case in the course in particular. There is usually a lot of interest in and posts related to Netflix and its topple of Blockbuster in the late 2000s. As mentioned in the course, fixed costs certainly played a significant role in this case. Regarding this, a past learner who actually consulted for Blockbuster in the 90s had the following to say:

“In the 90's I was a consultant working with Blockbuster. Netflix had been starting to really make itself known. We (and several other consultants) were advising them that they needed to really change their business model because Netflix was going to kill them. The problem here (in my opinion) was not the scaling up, it was all the sunk cost that they had in all the stores. Even when our company built an online movie rental capability for them, they insisted that the customer needed to come to the store and get the rental. I think it would be interesting to hear what the instructor would say about how hard it is to write off all your sunk-cost investments when someone reinvents the market you dominate.”

Costs were inevitably important in Blockbuster’s demise and Netflix’s rise. One way of seeing Blockbuster’s challenge was its refusal to write down sunk costs. Another similar perspective is that moving even some business online would dramatically reduce the profitability of its stores since they were largely fixed-cost operations.

Today, Netflix appears to be doing well, but as some of you may have noticed, Amazon’s Prime services are beginning to compete directly. Competition never sits still.

Module 4: Markets

Brexit, Currency Devaluation

This week’s module was all about markets, and we saw there was some discussion on markets for a certain “good” that all of us own: money! In the wake of the Brexit, we saw wild fluctuations in the value of the pound. A past participant posted a particularly strong article that documented the seismic shock on markets from Britain’s decision, in particular, the pound dropping from $1.50 per pound to $1.35, its lowest value since 1985!

Why the huge drop in the value of the pound? Thinking of the pound as a “good” with a certain supply and demand (and thus market value) can help you to understand. Prior to the Brexit, this very old “good,” over 1000 years, in fact, had a relatively stable (but still floating) value. After the vote, however, risk-averse buyers weren’t willing to pay as much as before for the same amount of the good. You can picture this as a leftward shift of the demand curve for the pound as a result of buyer uncertainty. Note here how valuations can be extremely subjective, as buyers are reacting to political news instead of conducting a formal analysis of monetary value. 

As you saw in Module 4, a leftward shift of the demand curve of currency causes the price of it to fall (a currency depreciation). A weak currency is excellent for exporters as it allows them to sell more to foreigners. Just look at China over the past twenty years or so. But, as one past participant asked in Peer Help if devalued currencies can lead to greater exports and permanent growth, why don’t other countries just do the same? Good question!

There are two main reasons. First, while it’s true that exporters may benefit from a weak currency, it’s also true that importers suffer. And if importers make up a greater percentage of a country’s population than exporters (which can often be the case), there will be political pressures to maintain a strong currency. Second, a depreciation or devaluation at home means not only that domestic exporters win, but also that foreign exporters lose. If that’s the case, countries may have the incentive to competitively devalue their currencies, a situation in which everyone loses. As in the case of China, there have also been other perils.

Module 5: Competition and Differentiation

More Profit?

In this module, we've explored the concept of pricing power in terms of traditional monopolies. We show how these principles can extend into market situations where a perfect monopoly not exist, but where a firm with a differentiated product holds pricing power or rights in their market.

A distinguishing factor between price setting in a competitive market (where price = variable cost) versus price setting for a monopoly (where price = marginal revenue = marginal cost) is that monopolies don't have to worry about price competition. However, an intrinsic flaw in setting a single price is the potential loss of revenue on inframarginal units. For this reason, monopolies must consider average revenues as well. Average revenues provide insight into total profit and allow for more holistic price setting when considering the potential margin gain and an overall loss of a price change.

Module 5 further examines how firms can maximize surplus while minimizing deadweight loss - through methods such as perfect or first-degree price discrimination, flat fee subscription cost and per unit charges, two-part tariffs, and bundling products as a solution to capture more WTP from a varied consumer. We continue to broaden our view of differentiation as a major factor of price setting in a competitive market. Here is a question many of you had in response to viewing differentiation through location.

In location 5.3.6, why does Bob make more profit than Angela, despite having symmetric locations?

This is a somewhat complicated question. The reason for the inequality between Bob and Angela is that only Bob has the ability to respond to Angela's price in this situation. If we held Bob's price to $8.13 and adjusted Angela's price, Angela could actually get more profit than Bob. But then Bob would also be able to respond and that would drive both of their profits even lower. In essence, this interactive only allows one response, Bob's response to your price. Thus you have this asymmetrical result where Bob is receiving higher payoffs. In equilibrium (where both can adjust prices instantaneously) they would both receive equal profit and be settling the same price.