Case Study: Amazon's Pricing Strategy (Econ 101) | Môn Tạo hình 3D | Đại học Văn Lang

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3.2. Amazon is playing with pricing
strategy. The Kindle case study Gabriel Staicu
Key words: price elasticity of demand, total revenue, optimal pricing policy Introduction
Price elasticity measures the responsiveness of a good’s sales to changes in its price.
This concept is important for two reasons. First, knowledge of a good’s price elasticity
allows firms to predict the impact of price changes on unit sales. Second, price elasticity
guides the firm’s profit-maximizing pricing decisions. Case study
When Amazon launched the e-reader Kindle, back in 2007, the price was set at $399.
Two years later, the price dropped to $259, then to $189 in mid-2010. For those
unfamiliar with economics, it seems that Amazon was playing with pricing strategy to
increase its market share of e-readers. But, as you will see, what Jeff Bezos did was about pure economic reasoning
According to some financial analysts, in 2009, when the price was cut to $259,
Amazon had annual sales estimated to be around 1 million units. Bezos was still
confident that the price cut to $189 made sense for his company in pushing Kindle as
the dominant platform for e-books, reporting that the Kindle sales had tripled since
then (meaning 3 million units sold for the lower price of $189). Considering the
information above, let’s explore this economic reasoning by answering the following questions: Questions
1. Did the price cut to $189 make sense for the company? What important rule
should be considered in your answer? Explain your reasoning in detail.
2. Suppose the Amazon (inverse) demand function is linear and well described by
the equation P = a – bQ, with P – price and Q – quantity (in million). Identify the
value of constants a and b, considering the price level decreased from $259 to
$189, and the quantity demanded increased from 1 to 3.
3. The sales figures listed above imply that the Kindle’s (linear) inverse demand
curve is described by the equation: P = 294 – 35Q. Double-check that the two lOMoARcPSD| 60380256
quantity-price points (Q = 1 at P = $259 and Q = 3 at P = $189) satisfy this equation.
4. Determine the price elasticity of demand for the Kindle.
5. Compute the total revenue for these price levels. Was this pricing policy optimal?
Explain in detail by taking into account the value of demand elasticity determined above.
6. Even though Bezos and Amazon are secretive about the costs of production, let’s
estimate that the marginal cost of producing a Kindle is $126 per unit. Now, apply
the marginal rule of optimization (which is marginal revenue equals marginal
cost) to find the output and price that maximize Kindle profits.
7. Furthermore, some experts in this new industry estimated that Amazon earned a
contribution margin of $4 on each e-book. Over the Kindle’s life, e-book sales
generated by each Kindle sold are estimated to be 25 e-books. This translates to
each Kindle sold generating $100 in e-book profits. Calculate Amazon’s optimal
quantity and price with respect to the total profit generated by Kindle and e-book sales.
8. What is the implication for Amazon’s pricing strategy? Explain carefully. Even
though the marginal revenue that Amazon earned for each Kindle sold has
declined, it gained an additional marginal revenue (per Kindle) of $100 due to
new e-book sales. Based on your knowledge and business experience, identify
and present a similar marketing strategy with the one that Amazon has adopted,
no matter if it was successfully or not.
“And the Amazon story goes on…” writes Claire Cain Miller in a NY Times article
about Amazon’s decision to continue this price war: “Amazon.com will introduce two
new versions of the Kindle e-reader on Thursday, one for $139, the lowest price yet for
the device. Amazon is hoping to convince even casual readers that they need a digital
reading device. By firing another shot in an e-reader price war leading up to the year-
end holiday shopping season, the e-commerce giant turned consumer electronics
manufacturer is also signaling it intends to do battle with Apple and its iPad as well as
the other makers of e-readers like Sony and Barnes & Noble. Unlike previous Kindles,
the $139 “Kindle Wi-Fi” will connect to the Internet using only Wi-Fi instead of a
cellphone network as other Kindles do. Amazon is also introducing a model to replace
the Kindle 2, which it will sell for the same price as that model, $189. Both new Kindles
are smaller and lighter, with higher contrast screens and crisper text. “The hardware
business for us has been so successful that we’re going to continue,” said Jeffrey P. Bezos. lOMoARcPSD| 60380256
Amazon is playing with pricing strategy. The Kindle case study • 65