E490 E-Commerce



E312 E-Commerce. Test #2 KEY

Davis, Spring 2004.

Answer all questions

1. (12 points total) One of the critical features of network goods is that the costs of a first unit can be exceedingly high, but the costs of subsequent units may be low or zero. Consider, for example, the case of E-, a publisher of electronic textbooks. Suppose that it costs $100,000 to transfer the content of a text to an electronic form. However, suppose that per unit costs consist of only a $5 per unit royalty paid to the text writer.

a. Competitive pricing is particularly problematic for virtual goods. Suppose that E- could sell 100,000 at its unit distribution cost ($5 per copy). How much would E- earn in this case? (6 points. A calculation)

The firm will lose its $100,000 fixed cost.

b. E- thinks that it might sell 10,000 copies for $20 per copy, or 50,000 copies for $10 per copy. How should it price its product? (6 points. A calculation and an answer)

10,000($20 - $5) – $100,000 = $50,000

50,000($10 - $5) – $100,000 = $150,000

The lower price is more profitable.

2. (18 points total) ERP software for small firms is an important new software development. Undoubtedly, demand for the product is fundamentally affected by network externalities. One estimate of the network effects of an ERP technology is listed below.

|#other buyers> |0 |1 |2 |3 |4 |5 |

| | | | | | | |

|Qty | | | | | | |

|0 |$50 |$56 |$62 |$68 |$74 |$80 |

|1 |$45 |$51 |$57 |$63 |$69 |$75 |

|2 |$40 |$46 |$52 |$58 |$64 |$70 |

|3 |$35 |$41 |$47 |$53 |$59 |$65 |

|4 |$30 |$36 |$42 |$48 |$54 |$60 |

|5 |$25 |$31 |$37 |$43 |$49 |$55 |

|6 |$20 |$26 |$32 |$38 |$44 |$50 |

a. Why might it be reasonable to presume that the demand schedule shifts out as others use the product? (6 points. A sentence of explanation)

Network effects. If files or information is more easily transferred across businesses using the same software, the software becomes more valuable as others use it.

b. Once consequence of network externalities is that demand can be very sensitive to small price changes. What difference would it make above if the firm charges $46 rather than $45? (6 points. Identify sales in each case)

At a price of $46, no units will sell. At a price of $45 the 6 units will (eventually) sell.

c. Identify a positive and a negative consequence of making this new software compatible with close rival technologies. (6 points. Two short sentences)

A positive consequence of compatibility is that negative feedback can be avoided. A negative consequence is that you undermine your own Network effects.

3. (19 points total) Consider a monopolist with a linear demand curve, and constant marginal costs.

a. Illustrate in the coordinate axes below, the optimal price, quantity profits for this firm if it posts a uniform price. (6 points. One illustration. Note, be certain to point out the optimal price, quantity and profits – A FIGURE ALONE IS SUFFICIENT. I’M NOT LOOKING FOR A QUANTITATIVE ANSWER..)

|P | |

| |Extra Profits available with |

| |Perfect Price Discrimination |

| | |

|Pm | |

| |Profits from |

| |Homogenous |

| |Pricing |

| |MC |

| |MR D |

| | QM QC |

b. Suppose this firm could engage in perfect price discrimination. How many units would it sell? Illustrate in your above graph the additional profits from perfect price discrimination. (6 points. Identify point and new profits on your illustration above.)

Qc. The seller realizes the total area between demand and unit cost

c. More realistically, firms probably engage in imperfect price discrimination, rather than the perfect price discrimination you illustrate above. What kind of price discrimination strategy might the sellers use here? What conditions are necessary for such a strategy to work? (7 points. Two to three short sentences)

The firm might separate buyers into separate by idenfiable strategies, such as age, or ability to wait (for flights) Then the firm might charge different prices to each group.

Such a strategy will work only if the firm can (a) identify the high and low value buyers and (b) can keep the low value group from reselling to the high value group.

4. (24 points total) You are hired to act as a consultant to ESports Inc. a publicly held firm that will oversee the administration of a portfolio of three new sports-oriented Ecommerce firms. One of the firms, is a Listing Agent Site that facilitates the trading collectables from professional baseball. is a merchant site that sells out overstocked name brand sporting goods. Finally, the company runs a B2B site that oversees the exchange of used specialty sports training-related products, ranging form commercial exercise equipments to therapeutic whirlpools and rehabilitative weight-lifting equipment. to universities and professional sports organizations. SportsTrainer is also a Merchant site, that buys and reconditions, and then resells used commercial sports equipment.

a. What sales format would you recommend be used in each site? Why? (9 points)

is a listing agent site. Items sold are typically unique and in limited supply. An auction would probably work best for these items.

is a B2C merchant site. It sells new consumer goods that compete with goods sold at posted prices in retail outlets. They will do best by offering consumers identifiable discounts also a posted prices

, a Merchant Site may experiment both with posted prices and with auctions. The tradeoff will have to do with the uniqueness of the offered items.

b. sees Brick and Mortar Outlets such as Champs or The Athlete’s Foot as it primary competition. Identify one competitive advantage, and one “competitive challenge” or disadvantage for relative to its Brick and Mortar Counterparts. (6 points)

Advantage: Lower inventory and retailing costs

Disadvantage: No reputation. Inability to directly inspect items.

c. The C2C listing agent site presents some special problems that will likely not arise in the other two sites. Identify two such problems. What policies might you suggest be used by to surmount these problems? (9 points)

.

A listing agent site must solve the problem that neither buyers nor sellers have any assurance that negotiations are as represented. (Buyers may not sell money, sellers may either deliver goods different from those advertised, or not deliver at all.) An escrow service, a payment agent (like paypal) and ratings schemes help resolve such problems.

5. (27 points total) Users of E-, by far the largest of the internet auction sites typically list pay a fee to list items to auction over the internet.

a. Identify the primary advantages to buyers and to sellers of auctioning items on the internet.(6 points. Two short sentences)

For buyer and sellers, the scope of the market is much larger. This reduces the chances of getting great “deals”, but improves the chances of getting desired goods bought and sold at near market prices.

b. Most items are listed for sale via an English Auction. How does an English Auction work? What are the incentive properties of an English Auction? (6 points. Two short sentences)

This is an ascending price sequential auction. Bidders keep bidding prices up until a pre-announced deadline. Assuming private values, the English auction should generate prices equal to the value of the 2nd highest bidder, as a dominant strategy, and independent of risk attitudes.

c. One challenge of an extended English auction is that the auction closes at a pre-specified time. What problem does this create? How does a “bidding elf” resolve this problem? (6 points. Two short sentences)

Bidders have an incentive to wait until the last minute. I didn’t talk about this in class, but a bid elf is a proxy bidding mechanism that allows the auctioneer to raise the bids to pre-specified levels. This restores the incentive compability of the auction

d. What is a common value element? What problem can arise if bidders’ value for an item contains a common value element? How do sellers try to exploit this problem? (9 points. Three short sentences)

A common value problem occurs when some dimension of an item (e.g., resale value) is the same for everyone, but bidders only have imprecise estimates of this value. Auctions with common value elements suffer from a “winners curse,” that the bidder who wins the auction is the one making the biggest mistake in bidding.

Sellers try to exacerbate this problem by “creating momentum” in auction (for example by setting the opening price below the bid price.

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