Optimal pricing and advertising policies for bottom of pyramid markets: an analytical approach

Abstract

We propose a model for developing optimal decisions and normative policies for pricing and advertising of products/services to markets at the 'bottom of pyramid (BOP).' This concept has been popularized in the recent times by Prahalad (2006). Our model considers two types of market segments. The first type is the bottom of pyramid market, which is large in size, but has limited ability to pay. The second type of the market is smaller in size, but can pay higher prices. The product/service offered to the two markets is differentiated in such a way that the base product (of appropriate quality) is available to the BOP market, while the premium product at a higher price is available to the higher-end market. The two markets are linked to each other such that there is a positive effect of customer base in the BOP market on the diffusion of product in the premium market. Successful practices of such kind of models have been reported in widely documented healthcare case studies such as Aravind Eye Care (Rangan 1993). The product diffusion in the two markets is modeled using a pure innovation model by Fourt and Woodlock (1960). Using optimal control methodology, we derive pricing and advertising policies for two types of organizations - for-profit organization (FPO) and non-profit organization (NPO). Thus, our analytical research design follows a 2x 2 x 2 x 2 (markets - BOP vs. Premium, strategies - pricing and advertising, organizations - FPO vs. NPO, and modeling - static vs. dynamic) design. Our optimal normative policy results can be summarized as follows: (i) A non-profit organization (NPO) charges lesser price per unit in both BOP and Premium markets, as compared to the for-profit organization (FPO), (ii) A non-profit organization (NPO) spends equal amount of money in advertising or promoting the product/service as that spent by a for-profit organization (FPO), (iii) A FPO charges lesser price per unit in the BOP markets as compared to the Premium market, (iv) The FPO receives lesser contribution margin per unit in the BOP market, as compared to the Premium market, (v) For the FPO, the ratio of advertising/promotion done in BOP market to that in the Premium market is governed by the parameters such as relative advertising effectiveness, cost of advertising, and contribution margin per unit in the two markets, (vi) Our dynamic pricing policy results for a FPO show that the prices are gradually increasing in the Premium market, and gradually decreasing in the BOP market, albeit after a threshold level of sales. The dynamic advertising policy results for a FPO show that advertising should gradually be decreased in the BOP market, but should remain stable in the Premium market. The NPO dynamic pricing and advertising results are similar to their static counterparts, though at much lower price levels.