Polaroid Cameras
In 1971, Polaroid introduced its SX 70 camera. This camera was sold, not leased, to consumers. Nevertheless, because film was sold separately, Polaroid could apply a two part tariff to the pricing of the SX 70. Let”s see how this pricing strategy gave Polaroid greater profits than would have been possible if its camera had used ordinary roll film, and how Polaroid might have determined the optimal prices for each part of its two part tariff.
Why did the pricing of Polaroid”s cameras and film involve a two part tariff? Because Polaroid had a monopoly on both its camera and the film, only Polaroid film could be used in the camera. Consumers bought the camera and film to take instant pictures: The camera was the “entry fee” that provided access to the consumption of instant pictures, which was what consumers ultimately demanded In this sense, the price of the camera was like the entry fee at an amusement park. However, while the marginal cost of allowing someone entry into the park is close to zero, the marginal cost of producing a camera is significantly above zero, and thus had to be taken into account when designing the two part tariff.
It was important that Polaroid have a monopoly on the film as well as the camera. If the camera had used ordinary roll film, competitive forces would have pushed the price of film close to its marginal cost. If all consumers had identical demands, Polaroid could still have captured all the consumer surplus by setting a high price for the camera (equal to the surplus of each consumer). But in practice, consumers were heterogeneous, and the optimal two part tariff required a price for the film well above marginal cost.
How should Polaroid have selected its prices for the camera and film? It could have begun with some analytical spadework. Its profit is given by
π = PQ + nT C1(Q) C2(n)
where P is the price of the film, T the price of the camera, Q the quantity of film sold, n the number of cameras sold, and C1(Q) and C2(n) the costs of producing film and cameras, respectively.
Polaroid wanted to maximize its profit n, taking into account that Q and n depend on P and T. Given a heterogeneous base of potential consumers, managers might initially have guessed at this dependence on P and T, drawing on knowledge of related products. Later, they may have gotten a better understanding of demand and of how Q and n depend on P and T as they accumulated data from the firm”s sales experience. They may have found knowledge of C1 and C2 easier to come by, perhaps from engineering and statistical studies (as discussed in Chapter 7).
Given some initial guesses or estimates for Q(P), «r:C1(Q), and C2(n), Polaroid could have calculated the profit maximizing prices P and T. It could also have determined how sensitive these prices were to uncertainty over demand and cost. This knowledge could have provided a guideline for trial and error pricing experiments. Over time these experiments would also have told Polaroid more about demand and cost, so that it could refine its two part tariff accordingly.
In 1999, Polaroid introduced its I Zone camera and film, which takes matchbook size pictures. The camera was priced at $25 and the film at $7 per pack. In 2003, Polaroid”s One Step cameras sold for $30 to $50 and used Polaroid 600 film, which was priced at about $14 per pack of 10 pictures. Polaroid”s higher end Spectra cameras sold for $60 to over $100 and used Spectra film, priced at about $13 per pack. These film prices were well above marginal cost, reflecting the considerable heterogeneity of consumer demands.