MGT 525: Market Segmentation and Micro-marketing

Kevin Williams
February 2017
Micromarketing and market segmentation?

• Should I charge consumers different prices?

• Who should see my ads?

• Should I tailor my product choices?

• How will my competition react to my micromarketing strategy?

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Creating the opportunity map (HBR)

1. Define micromarket size: county, zip code

2. Determine growth potential: costs, demographics

3. Gauge market share: nature of competition, seasonality

4. Identify the cases of the differences in market share: marketing levels,

pricing, concentration

5. Prioritize growth pockets: analyze opportunities

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Types of price discrimination

I Some examples of charging consumers different prices

• student discounts / senior discounts

• quantity discounts
• discount coupons
• prices based on income

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First degree price discrimination

I First degree (Perfect) discrimination

• Set a different price for each consumer

• If the firm knows all information about a consumer, simply charge

pricei = valuationi

• Extracts all consumer surplus

I Variable-Price Coke Machine Being Tested (1999)

• Coke tested different prices based on temperature

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As the article mentions, also airlines

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Second Degree Price Discrimination

I Second degree discrimination:

• Consumers self select to reveal their type

• Quantity discounts

• Pricing menu, obtains of different quality (commonly called

versioning)

I "Uber quietly rolls out bulk pricing for S.F. riders, making it as cheap as $2
per ride"

I Netflix

$7.99/month
Watch on 1 screen at a time in Standard Definition.
$9.99/month
Watch on 2 screens at a time. HD available.
$11.99/month
Watch on 4 screens at a time. HD and Ultra HD available.

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Third degree price discrimination

I Third degree discrimination:

• Firm prices based on some attribute of the customer

• Student discounts, senior citizen discounts, Amtrak tickets

I Staples article: the price of staplers online depends on zip code

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Uniform pricing - no price discrimination

Lowe's Window Film Prices

GILA 36-in W x 180-in L Heat-Control Window Film (Model 10386586), collected 3/14/2014

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Special promotions to particular stores

Lowe's LED Light Bulbs

Utilitech 23-Watt Par38 Warm White Dimmable Outdoor LED Flood (Model LPAR381400LEDG5), collected 3/18/2014

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Lots of market segmentation

Lowe's Drywall Prices

Gold Bond 5/8in x 4ft x 8ft Fire-Shield Gypsum Board Tapered Edge (Model GB99500800), collected 1/14/2013

Price per sheet ($)

5.98 - 6.73 9.13 - 9.43 10.69 - 11.17
6.74 - 7.59 9.44 - 9.86 11.18 - 11.87
7.60 - 8.42 9.87 - 10.30 11.88 - 13.28
8.43 - 9.12 10.31 - 10.68 13.29 - 18.64

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What defines the market?

Menards 5/8" x 4' x 8' Drywall Prices

Type X Fire-Rated Panel (Model 1934614), collected 5/29/2014
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A monopoly model without price discrimination

I Consider two submarkets, each with demand Q` (p) = a` − b` p

I What are the profits under uniform pricing?

π = π1 + π2
= Q1 (p)(p − c1 ) + Q2 (p)(p − c2 )

I Working the math out yields

∗ a1 + a2 + b1 c1 + b2 c2
p =
2(b1 + b2 )

I This tells us, that a uniform price policy balances informative on how
demand is different across segments, along with differences in costs

I Ex: If costs are very high in one submarket, this will have the effect of
increasing price

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A monopoly model without price discrimination

I But what if I can’t charge different prices, but I have the option of serving
particular groups?

I What to do now?

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A monopoly model with price discrimination

I What are the profits under market segmentation?

π = π1 (p1 ) + π2 (p2 )
= Q1 (p1 )(p1 − c1 ) + Q2 (p2 )(p2 − c2 )

I Now the solution is

∗ a1 + b1 c1
p1 =
2b1
∗ a2 + b2 c2
p2 =
2b2
I Now profits only depend only on costs and demands of each market
separately

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A monopoly model with price discrimination

I What are the profits under market segmentation?

π = π1 (p1 ) + π2 (p2 )
= Q1 (p1 )(p1 − c1 ) + Q2 (p2 )(p2 − c2 )

I Now the solution is

∗ a1 + b1 c1
p1 =
2b1
∗ a2 + b2 c2
p2 =
2b2
I Now profits only depend only on costs and demands of each market
separately

I How does the firm pass along changes in costs now?

I Does the firm do better? Why?

I Are consumers better off? Why?

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A monopoly model with price discrimination

I If markets are the same, there is no difference in profits

I However, gains are possible if the markets are different

I So know πsegmentation − πuniform ≥ 0

I We can look at how the gains from segmentation vary depending on the
characteristics of the submarkets

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Where is market segmentation the most valuable?

The axes are c1 , c2 . The intensity is πsegmentation − πuniform ≥ 0

The more different the submarkets, the greater the gains from segmentation

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Preventing arbitrage opportunities

I If two nearby stores have different prices, consumers should just purchase
from the cheaper store
• Lack of transparency is an advantage
• Lack of awareness may also be good. (Send a discount via email
based on zip code or consumer demographics)

• Hassle costs: it’s why I am not driving drywall into NY or MA

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An example of consumer arbitrage

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Preventing arbitrage opportunities

I If two nearby stores have different prices, consumers should just purchase
from the cheaper store
• Lack of transparency is an advantage
• Lack of awareness may also be good. (Send a discount via email
based on zip code or consumer demographics)

• Hassle costs: it’s why I am not driving drywall into NY or MA

I Uber may face this issue on both sides

• Zone 1 is surge, Zone 2 is normal.

• This gives drivers the incentive to pass up consumers near the
border, chase the 2.3X

• Consumers would move too if they knew the boundaries of the zones!
(App idea)

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Preventing arbitrage: Damaged Goods

I The 486SX Intel chip was the 486DX, with the math coprocessor disabled.
The bins were slightly altered so you couldn’t just insert the DX

I The LaserPrinter E was the LaserPrinter, with disabled firmware, slowing it

from 10ppm to 5ppm

I Methyl methacrylate

• Used for dentures and for industrial purposes

• $22 per pound for dentists as monomer, $.85 per pound for industry
as a polymer

• Individuals found a way to convert industry polymer for dentists

• Idea to fix the problem: A millionth of one percent of arsenic to the
industrial product

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Adding competition to our model

I With competition, what does the firm need to take into account?

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Adding competition to our model

I With competition, what does the firm need to take into account? The
potential actions of competitors

I Consider the following scenario:

• You have a monopoly store in Washington.

• I have a monopoly store in Maine.
• We both have one store each, located across the street from each
other in Chicago.

• Should we charge the same price or different prices across our

stores? Why?

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Concepts apply more broadly

I Ad targeting

I Email targeting

I Product placement

I Any others?

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Targeting local demand

I Macy’s take: "We continued to refine and improve the My Macy’s process
for localizing merchandise assortments by store location, as well as to
maximize the effectiveness and efficiency of the extraordinary talent in our
My Macy’s field and central organization. We have re-doubled the emphasis
on precision in merchandise size, fit, fabric weight, style and color
preferences by store, market and climate zone. In addition, we are better
understanding and serving the specific needs of multicultural consumers
who represent an increasingly large proportion of our customers."

I The Macy’s at the Mall of America in Minnesota overlaps roughly 50% with
the downtown Macy’s [closing ;( ] in shoes – 10 miles away

I Another example: Over 1,000 different assortment sets for 3,000 Wal-Mart
stores

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Key concepts for implementation

I Micromarketing requires big data and technology

I Data: detailed demand and cost analysis

• Example problem: costs given to the pricing team are at the

market-level, but shipping costs to stores may vary substantially

I Technology: setting prices and distributing them to the system

• Staples needs to know your address before showing you the price
• Price updates to the store, "menu costs". Nontrivial: A typical Target
store may see 1,000-2,000 price changes per day

• Needs to be easy to use and update

I Investment in monitoring competitors

• If competitors have complex pricing, this requires a lot of resources

I The competitor response here is important – changing the game

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Implementation

(1) Experimental approach

• Randomly give consumers a different banner discount on your website

• Allows us to compare the results of the "treated" with the "control"

• With e-commerce, this is very easy to implement. May be more difficult in

other settings

• Two challenges: 1) How to measure competitor response? 2) What do you

do if the environment changes?

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Implementation

(2) Modeling approach

• If I know the demand curve I am facing, and know my costs, I can solve
what my new price should be under new costs (like what we do in class)

• Hence, I’ll use my data, along with assumptions, to model my competitive

environment (my competitor will just price match, for example)

• While these models can be complex, big data make them hard to
implement

• Very active area in operations research, marketing, economics, statistics,

and computer science

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Case Study: Adams and Williams (2017)

• Should retail firms adopt finer pricing, i.e. increase market segmentation?

• Profits go up, but not as much as you would expect

• Prices go up in monopoly markets (by 27%)

• Profits go down in competitive markets (by 4%)

• If competition doesn’t react, the gains are large. The competitive response
lowers the gains by a lot! (Like 40-70%)

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Price effects going to finer pricing

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