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Chapter 16: Problem 13

The Danish firm a2i Systems A/S sells software that helps service stations implement dynamic pricing strategies for gasoline sales. Service stations that use the software typically offer lower prices in the morning than in the afternoon and even raise prices when competing stations with very low prices have long lines. In an article in the Wall Street Journal, the firm's CEO noted, "This is not a matter of stealing more money from your customer. It's about making margin on people who don't care, and giving away margin to people who do care." a. What does the CEO mean by "margin"? b. Briefly explain how these pricing strategies "make margin" on customers who don't care and "give away margin" on customers who do care.

Short Answer

Expert verified
In business language, 'margin' refers to the difference between the selling price and production cost of an item. In the context of a2i Systems A/S, they 'make margin' from customers who are not sensitive to price fluctuations by raising prices at high-demand periods. Conversely, they 'give away margin' to price-sensitive customers by decreasing prices at low-demand moments, ensuring business from both customer types.

Step by step solution

01

Understanding Margin

First, let's clarify the term 'margin', which is essentially the difference between a product's (in this case, gasoline) sale price and the cost to produce it. This differential is important as it allows the firm to cover its fixed costs while also making a profit.
02

Examining Pricing Strategies

The firm uses a dynamic pricing strategy, meaning they alter their prices according to demand patterns, time and competitor strategies. For instance, they lower prices in the morning when demand might be relatively low and increase them in the afternoon when demand often rises.
03

Analyzing Margin on Different Customers

Customers who 'don't care' are typically less sensitive to price changes, meaning they will buy their gasoline regardless of slight price increases or decreases. Thus, by raising prices in the afternoon, the firm 'makes margin' on these customers by gaining more profit. Customers who 'do care' are more price-sensitive, and they generally opt to buy gas when prices are lower, in this case in the mornings. By offering lower prices in the mornings, the company 'gives away margin' by accepting lesser profits from these price-sensitive customers. This balances out the overall profit and keeps both kinds of customers engaged.

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Most popular questions from this chapter

While in Shanghai, China, to teach an MBA course, Craig Richardson, an economics professor from WinstonSalem State University, asked his American students to haggle with sellers in a market where prices for the same items can vary widely. Professor Richardson explained that the same item with the same sticker price at different market stalls can have a final price that varies "by \(1,500 \%\) or more, depending on the negotiating skills of the buyer." a. Do Shanghai merchants practice price discrimination? Briefly explain. b. Which consumers are likely to pay the highest prices for similar items in the Shanghai market?

Some people- usually business travelers- have a very strong desire to fly to a particular city on a particular day, and airlines charge these travelers higher ticket prices than they charge other people, such as families who are planning vacations months in advance. Some people really like Big Macs, and other people only rarely eat Big Macs, preferring to eat other food for lunch on most days. Consider the following possible explanations of why airlines can charge different people different prices while McDonald's can't and briefly explain which explanation is correct. 1\. In most cities, there are laws against charging different people different prices for food products. 2\. Most people don't pay attention to prices when buying plane tickets, so the airlines can charge different prices without it being noticed. 3\. People don't like hamburgers as much as they used to, so McDonald's has to keep cutting the prices it charges everyone. 4\. People can't resell airline tickets, so people buying them at low prices can't resell them at high prices. People can resell hamburgers more easily.

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Instacart is a Web-based firm that offers home delivery of groceries. It buys the groceries in regular brick-and-mortar supermarkets, marks up the prices it pays, and then charges consumers the higher prices in exchange for making home deliveries. According to an article in the Wall Street Journal, Instacart marks up the price of potato chips by 26 percent, but it marks up the price of eggs by only 2.5 percent. Is it likely that Instacart believes that the demand for potato chips is more elastic or less elastic than the demand for eggs? Briefly explain.
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