Stanford Business

FEBRUARY 2007


Setting Wrong Price Could Mean Game Over for Video Entertainment Manufacturers

by Alice LaPlante

Video game manufacturers who set very high initial prices with the intention of gradually lowering them as demand slows can risk significantly reduced profits, according to research by Harikesh Nair, assistant professor of marketing.

Setting opening prices on products with the intention of lowering them later is a time-honored practice in many durable goods markets. Although there is a rich body of theoretical literature on this subject, Nair’s work provides a real-world framework, creating a practical model that helps manufacturers of high-tech durable goods to actually calculate optimal prices. Nair, who teaches an elective course on pricing strategy, was recently honored with the prestigious Howard Dissertation Competition sponsored by the American Marketing Association for a paper examining this process.

The marketing researcher used aggregate retail sales and prices of all new video games developed for Sony’s PlayStation console released in the U.S. market between October 1998 and March 2000. He analyzed the initial prices set for each product as well as the timing of price reductions and the corresponding effect on sales.

To best gauge how consumers will react to this pricing strategy, firms need to conduct market research, which can be expensive. Nair estimated that because profits were nearly 30 percent lower when firms incorrectly set prices too high, a firm could spend up to that amount and still come out ahead with its pricing policy.

This study is important because it puts a dollar figure on optimal pricing of games as well as on the market research that has to be done upfront to establish that pricing, says Steve Brown, the Bauer Professor of Marketing at the University of Houston, co-chair of the Howard Dissertation Competition that singled out the paper. “In his research, Harikesh addressed a very important, substantive issue.”

“It’s important for firms to do market research in the form of focus groups and surveys before a game is launched,” Nair says. “Our research shows that the maximum amount you should be willing to pay for market research is the additional profit associated with doing it right.”

Intertemporal Price Discrimination with Forward-Looking Consumers, Harikesh Nair, GSB Working Paper, October 2006. [Details]

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