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Well color me not surprised…
Did anyone really think that stores being open on Thanksgiving was actually going to substantially increase how much consumers buy rather than just change the timing of purchases? I like an intoxicated post-turkey Target fest as much as the next person, but this just seems largely implausible, if for no other reason than it’s difficult to increase sales without increasing consumers’ incomes. It may be tempting to conclude that the stores are making bad decisions here but, as usual, a little economics can shed a lot of light on the matter.
First…hey, remember the prisoners’ dilemma?
The basic principle of the prisoners’ dilemma is that the payoffs of the game make it such that not cooperating is superior to cooperating for a player regardless of what the other player does, and individual incentives result in an equilibrium outcome that is worse than what would happen if the parties could commit to cooperating. The prisoners’ dilemma setup has been used to explain a number of outcomes that we see in the world- including, but not limited to, arms races. And anyone who’s witnessed Black Friday shopping firsthand should not be surprised that I’m comparing it to an arms race.
Think about it…retailers would probably be better off if they all agreed to not be open on Thanksgiving, since they would likely be making pretty much the same sales without having to incur the costs of being open as many hours. BUT…if a retailer thinks that no one else will be open on Thanksgiving, it has an incentive to open on Thanksgiving in order to try to capture the sales of shoppers who are either impatient or hate their families. Similarly, if a retailer thinks that everyone else is going to be open on Thanksgiving, it’s optimal to open on Thanksgiving in order to not get left behind when shoppers get impatient. So what happens? Stores follow their individual incentives, open on Thanksgiving, and achieve the prisoners’ dilemma or arms-race outcome where they’re basically back where they started but incur an additional cost. In addition to not being great for the retailers’ bottom lines, staying open on Thanksgiving puts an unnecessary burden on those employees who are pressured or forced into working on Thanksgiving. (Those workers who are cool with working on turkey day, more power to you.)
So what can be done to mitigate the inefficiency of this situation? We know from the prisoners’ dilemma that non-binding agreements to cooperate don’t work because of the incentives to renege, and besides, cooperation (especially binding cooperation) runs afoul of that whole antitrust thing. Companies are left with what is essentially a coordination failure, leaving government as the store closer of last resort. This gets into uncomfortable territory on a number of levels, not the least of which being that it’s not obvious what companies are playing the arms race game and which have efficient reasons to stay open on Thanksgiving. (Also notice that, while some states do still have “blue laws” on the books, requiring businesses to close on a wider scale is largely uncharted territory.) So, for now, we’re stuck with the consumption arms race. That said, some companies have actively tried to buck the trend by trying to get customre cooperation rather than competitor cooperation. Case in point, from REI:
I worry that this is not entirely generalizable, but it’s at least an interesting start.
In case you haven’t heard, Adele has a new album titled 25 coming out. (If this refers to you, let me know and I will send help to get you out from that rock you are under.) Now we’re being told that we won’t be able to stream said album anytime soon:
Not gonna lie- from the numbers I’ve seen, it’s entirely possible that this withholding strategy is profit maximizing as far as recorded music is concerned. To get a handle on this tradeoff, consider some numbers:
So what is the “break even” point? At which point are Spotify listens more profitable than selling music? In other words, how many times would someone have to listen to your song on Spotify until it is the equivalent of them actually buying the song for the typical price of $1? (a typical full length now a days usually goes for $10, and a typical full length is usually around 10 songs, or $1 per song) We can calculate that quite easily. Taking the value of the song at $1 per person, we can simply divide the $1 by Spotify’s royalty payment of $.0072, and we get about 139. If you want to account for the cost of the CD to the artist, (about $1 per CD, or $.10 a song) we divide $.90 by $.0072 and get 125. If an artist can get every single fan interested in buying their music to listen to each song at least 125 times on Spotify, the artist will make out better on Spotify. If not, the artist will make out better on CD sales or downloads.
If you want to put some personal perspective on this, there are a number of applications that will look at your iTunes library and give you a play frequency distribution for your songs. To be fair, however, this analysis is a bit too simplistic in that it ignores revenue from streaming listeners who wouldn’t have actually paid for the CD or track (and, in Adele’s case, revenue from just dumped people listening to Someone Like You on repeat for days at a time). But this isn’t the main point, so let’s not get distracted…
The fact of the matter is that today’s musicians don’t only sell recorded music- they also sell concert tickets, merchandise, licensing rights, and many other things. If a musician’s team is smart, it will attempt to maximize profit over all revenue streams together and not just on recorded music by itself. Such a strategy would likely involve using streaming services (and recorded music more generally) as somewhat of a loss leader to gain exposure and drive demand for complementary goods such as the aforementioned concert tickets and merch. This approach likely explains why many artists have chosen to remain on Spotify…but then why is Adele different?
As it turns out, the incentive to cross-subsidize with a loss leader decreases when a producer doesn’t have a whole lot to drive demand to. In Adele’s case, well, she hates touring. Okay, that’s a bit of an exaggeration, but if you google “Adele hates touring” you will see what I’m talking about. For example:
During a recent interview with On Air with Ryan Seacrest, Adele said she’s not entirely sure if she’s ready to take that next step.
“I definitely will do as many shows as I’ve always done before,” she revealed. “I’d love to do a world tour and I’d love to be able to say I’ve done it in the end, but I don’t know if I’m strong enough for it.”
Before you judge, keep in mind that her view on touring is driven by not only by the fact that she doesn’t like it but that she also means “strong enough” quite literally, since a large number of shows puts a strain on her voice and has put her out of commission a few times already. Nonetheless, her strategy is exactly what the economics of the situation would predict- if you don’t have razor blades to sell, you’ve got to focus on actually making profit from the razors directly. And if you think that casual listeners are not going to make up for lost revenue from more die-hard fans (and don’t need the exposure since the world is doing that for you), then staying off of streaming maximizes profit from your recorded output.
Fun fact: it used to be the case that tours were used as loss leaders to sell recordings rather than the other way around…though when people describe Adele as retro, I don’t think that this is what they mean. Personally, I’m hoping that her long-term strategy is to engage in temporal third-degree price discrimination*, since I’m not a huge Adele fan but would like to explore her new work on Spotify eventually.
* Technically, temporal third-degree price discrimination refers to lowering the price over time once customers with higher willingness to pay have actually purchased in order to capture revenue from more price elastic customers. It applies here, however, since adding one’s product to a free (at least in a marginal sense) service can be viewed as a form of price decrease.
A little while back, I gave a talk about deviating from economic rationality might actually lead to good market outcomes, so let’s take the analysis a little further and put that theory to the test:
I guess I should’ve known better than to do that whole faith in humanity thing. =P
See, when I don’t keep up with my shows I miss out on including things like these in my posts…
So remember that time when JCPenney tried to stop BSing its customers with artificially high prices and constant sales? In case you forgot, it didn’t go so well. Now we have another attempt that appears to be about as successful:
See, it’s funny because if you ask consumers what they want, they for the most part say that they want to be treated with respect rather than be tricked by the latest marketing ploy. (or “phished,” as Akerlof and Shiller would likely put it) But then when companies give consumers what they say they want, consumers respond by taking away their dollars. The obvious answer is that consumers aren’t particularly self aware creatures (shocker, I know). But what exactly are consumers not self aware about?
The answer likely lies with the concept of transaction utility. The general idea is that transaction utility is the utility people get from feeling like they got a good deal, and, as a result, feeling like you got a good deal actually increases the perceived total utility you get from consuming an item. This, in turn, implies that feeling like you get a good deal makes it more likely that you will purchase an item, even though it doesn’t make you like the actual item more. Companies understand this (even though they likely don’t use the term “transaction utility”), so many of them manipulate the way in which they present information in order to keep your transaction utility high.
Economists generally think that transaction utility is a function of the difference between a “reference price” and the actual price charged for an item. This reference price could be what is put out as a regular price, what a consumer was expecting to pay for an item, etc.- the point is that one way companies can instill transaction utility is to figure out how to give consumers a high reference price. In this case, the company is putting what is, in my opinion, a ridiculous price on a single suit ($600-$800 for a pretty crappy suit, if I recall correctly from a while ago) and then offering a huge effective discount for those poor saps who apparently need to buy their suits in bulk. Consumers probably aren’t so stupid that they are totally unaware that something along these lines is happening, but that doesn’t necessarily mean they are immune from feeling the transaction utility and having it affect their choices.
Fortunately, there appears to be a limit as to how much companies can do to manipulate consumers’ reference prices- for example, it’s apparently illegal to call something a “regular price” of an item unless the item has in fact been sold at that price regularly. I guess what I’m really saying is to expect price tag terms such as “compare to,” “value,” etc. to become even more prevalent than they already are (just spend an hour at an outlet mall to see what I’m talking about). The upside for researchers is that we’ll get more data on whether these words have the same effect on transaction utility as a “regular price” does.
tl;dr: Dear consumers: Don’t hate the player, hate the game, especially since you all appear to be part of the problem.
OH MY GOD YOU GUYS…based on my informal data collection, I really think that we’re approaching peak Uberbitching- I’ve been called upon multiple times in the past week or so to talk about this issue and why it gets people’s panties all in a twist, and I’m not even that popular. (It’s also funny because an economist is possibly the least-qualified person to explain why a scenario that approximates a free market would be bad.) Case in point:
(For the record, Nora has the best radio voice ever, and I am not too proud to admit that it does give me a bit of a hankering for Alec Baldwin’s Schweddy Balls.) I kid because I love- I am happy to talk to anyone about anything economics-y, I just might not always say what you want to hear. I’m also sort of convinced that people are hearing about the Uber research done at Northeastern, googling to get more info, and finding me by accident. (If that’s true, hi!)
Overall, I HAVE THOUGHTS…more thoughts that can fit into sound bites, so I’ve tried to organize them here:
I can ask for things I want on the Internet, right? I guess I always figured that that is what the Internet is here for. Well, that and screaming into the void. Uber and I aren’t friends on LinkedIn yet, so I’ll just leave this here for now:
As an economist, I am certainly not against the idea of surge pricing on principle. That said, unpredictable price changes make it really hard for both drivers and riders to make rational decisions and maximize their welfare with regard to your service. Therefore, I would really appreciate it if you would try one of the following, in order of priority:
1. Based on what I’ve come up with after thinking about this issue for way longer than a reasonable person should, it occurs to me that Uber should be able to get more drivers on the road using demand information rather than price increases. While it is true that workers tend to more more when wages are higher, it’s important to keep in mind that an Uber driver’s effective wage depends not only on the surge multiple but also on how quickly a driver can find passengers. In periods of high demand, it stands to reason that drivers should be able to find riders more quickly than during slower periods. This feature by itself actually creates higher effective wages during busier periods without the need for a surge multiple! As these drivers’ (not, as per legalese, but in spirit) employer, can’t you just provide information to drivers that signals times of high demand and remind them that it’s easier to make money when there are lots of available customers? You could even do this with more than zero seconds of notice in a lot of cases, since I’m guessing your data shows some pretty regular patterns in demand. It seems like drivers don’t respond much to the price surges anyway, so it’s likely the case that there is at least as much of an information/logistical problem as there is an incentive problem.
2. I’m guessing that, as a consumer, you wouldn’t want to plan to go out to dinner and have the restaurant refuse to tell you what its prices were until you’re about to sit down to eat, and you might still be annoyed even if you were cool with the restaurant changing prices to keep supply and demand in balance. In this spirit, won’t you please consider communicating an anticipated surge schedule to drivers and riders? You could still deviate from it when there are truly unexpected events (snowstorms, etc.), but this would go a long way towards helping market participants make price-based decisions. It would also likely mean that smaller price surges could keep supply and demand in balance since drivers and riders would be better able to change their behavior in response to price changes (i.e. could be more price elastic). I know that lower prices don’t necessarily sound good to you, but you’d be getting your 25 percent on more rides than you would with a larger price surge, so you could actually end up better off. If you wanted to be really cool, you could even develop a system to let people lock in a surge multiple- their return trip from that out-of-the-way location could still send them into bankruptcy, but at least they’d know ahead of time.
In conclusion, I really do believe that, in many circumstances, markets can be very powerful tools to create economic value, but I also believe that a well-functioning market would take into account the logistical realities of the environment it is operating in.
P.S. UberPool is awesome, but I might just think that because I really like being quoted a flat fee in advance.
And now we wait.
Update: We have some more information thanks to an economist who went the extra mile, literally…
— Nathanael Snow (@NathanaelDSnow) November 6, 2015