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Pricing Experience Goods1:3 - 1(96)
Entertainment and Media: Markets and Economics
Professor William Greene
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Economic Foundations for Entertainment and Media
Pricing and Value for Experience Goods
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Demand and Value
Demand and Demand Curves Pricing
Pricing strategies Price discrimination Pricing innovations
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“Value”
What is it? From the consumer’s viewpoint From the seller’s viewpoint
Creating Value Capturing Value
Meaning Sources of value
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Pricing and Value from the Consumer’s Viewpoint
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Reservation Price:Price Strategy Under Uncertainty
Your reservation price is $2,500.
Auction to take place in 5 days.
What would you do now?
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Price and Value
The operative word in your question is “true” directly placed before the word “value.” You suggest the “true value” of a specific comic book is a few thousand dollars — but all that means is someone might be willing to pay that much for it, based on extrinsic qualities (rarity, for example). To the person running the flea market, the “true value” of the comic book is virtually nothing. There is no “true value” for any object: it’s always a construct, provisionally defined by a capricious market and the locality of the transaction. Things cost what they are being sold for, and they’re worth whatever the seller can get.…
Look at it like this: Let’s say the person at the flea market was selling that same rare comic for $2,000. You, however, would be willing to pay far more than that; because of its sentimental value and the status it will bring among your comic-book-collecting peers, you’d gladly fork over $5,000. Would you feel the need to inform the seller, “You know, I’d actually pay you $3,000 more than what you’re asking”? I don’t think you would, and no one would expect you to.
Is it ethical to buy something at a yard sale or a flea market at the seller’s asking price if you know the value of the item to be significantly higher than what is being asked? Let’s say, for example, someone is selling an old comic book worth thousands of dollars but asks for only a quarter because he or she does not know the true value. Is it incumbent on the seller to do his or her research? If the seller does not, is it fair game?
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An Important Aspect of Prices for Experience Goods: The Implicit Price
Nominal price: $170 Implicit price: $ far more than $170
Transportation Time – at least 5 hours in total.
This divergence is characteristic of experience goods. They take time to consume. The time used up having the experience is part of the price.
Kelly Clarkson,Beacon Theater
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Consumers Valuation of ProductsSurplus Value: Consumers must perceive “value” over price.
By Attributes: Hedonic Pricing
$3000+
The high price was one of the reasons for market failure. Consumers did not get enough surplus value.
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Appropriable Profits in a Market Come from Consumer Surplus
Final demand for a good or service Stages in the delivery to the consumer Total appropriable rent in a market Surplus from the seller’s viewpoint
Price
Quantity
Pm
Qm
This is the total consumer surplus that can be extracted from all stages of this market.
Different buyers have different reservation prices. Therefore, demand curves slope downward.
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Scalping: Reallocates the Surplus
Why does Ticketmaster care?
Do Hanna Montana and the Spice Girls care?
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A Merger Made in Heaven
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Why We Worry About this Merger
Horizontal Issues: Will the large market share enable them to raise prices?
Vertical Issues: Will control of venues and artists enable anticompetitive practices? Foreclosure from markets Bundling
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Live Nation Also Owns Tickets Now
Ticketmaster and Live Nation were opposed by DOJ
Tickets Now is LNE’s own scalper.
This is a vertical integration case.
We will revisit later in the vertical integration section.
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Economic Foundations for Entertainment and Media
Strategic Pricing for Experience Goods
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Demand Concepts Prices
Reservation price “Value” “Bargains
Consumer Reaction to Changes in Price ”Elasticity Long and short run effects
Consumer Reaction to Changes in Income – Recreation is the Normal Good (“Why do we work?”)
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Applying Price Theory to Experience Goods
Different results from consumption: Humdrum goods vs. Experience goods
Implications for pricing and price strategies The “price” Monopoly pricing results
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Demand Curves from the Seller’s Viewpoint
Elasticity of demand %change Q/% change x
Income, price Long run, short run
Market power Consumer surplus Relation of surplus to
profits in a market
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Pricing Strategies
Exploit pockets of market power Take advantage of market imperfections Exploit unusual market configurations
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New Broadway Math
2001: Record price: $100 Producers $480 2006 Average price about $65 2006: “Premium Seats” (The Producer) $200-$500
seats are routine. Had underestimated the number of inelastic buyers.
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Price Determination-Standard Under conditions of “intense” competition In the presence of “market power”
Market power is the ability to elevate
price above the competitive norm.
Marginal Cost
Demand
Marginal Revenue
P*
Qm
Short run profit is obtained by transferring consumer surplus from buyers to the seller.
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Monopoly PricingMonopolist will price where MR = MC. If MC > 0, this must be in the elastic region of the demand curve. For a performance, MC = 0.
Quantity
Price
|Elasticity| > 1(Elastic) |Elasticity| < 1 (Inelastic)
If the |elasticity| is < 1, the price is too low. MR is < MC.
Basic theory would not predict that a monopolist would price in the inelastic region of the demand curve.
D
MR
MC
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Concert Ticket Prices: Live Nation Effect
Connolly, M. and Krueger, Al, “Rockonomics” http://www.irs.princeton.edu/pubs/pdfs/499.pdf
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The Pricing Conundrum in Major League Baseball
• Empirical Models of Demand Produce Price Elasticities between -1 and 0. Team owners could raise revenue by increasing price Are team owners pricing irrationality?
• (I assume models that produce positive elasticities are misspecified)
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“A current finding in estimates of the gate demand for sports events is pricing in the inelastic portion of demand.” This finding has puzzled analysts who study the demand for sporting events because it suggests that owners could raise ticket revenue by raising ticket prices.
Estimated Long-run Elasticities of AttendanceElasticity Real Ticket Price ANA -0.88ATL -0.57 BAL 0.72BOS 0.57CIN 1.95CLE 2.74DET 0.78HOU -2.31KCR -1.46MIL -1.14MIN -0.46NYM 0.85NYY 0.73
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Are owners really pricing irrationally?
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A Theory That Produces Pricing in the Inelastic Region
Monopoly Pricing Model for Tickets=Q(P,q,m), P=Price, q=quality, m=market conditions
Pricing is cognizant of a second good; Concessions=C(R,P,q), R=concession price
Total profit from both Tickets+Concessions Ticket Price might be low to draw people to the
concessions.
Marberger, D., “Optimal Pricing for Performance Goods,” Managerial and Decision Economics, 1997, 18, 5, 375-381.
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Examples
Concerts and “Stuff” Sports and Skyboxes plus all the other
stuff including food Movies and the food concession stands
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Two Part Pricing Strategy: Movie Studios to Retailers –
Videotapes
Tapes: Marginal Cost = $3.00 One time: $70.00 - $80.00 Revenue Share: $8/tape + x% of rental Unclear which was the better price strategy
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The Disneyland Dilemma
Higher Fixed Fee (and lower Marginal Fee): Control the number of people who come to the park. Extract $$ from consumer surplus at the gate.
Higher Marginal Fee (and lower Fixed Fee) More people come to the park and spend more on rides.
Theoretical result: Charge a very high Entry Fee and zero Marginal Fee. Disney: Two part fees 1955-1982; One part 1982-now
Two part tariff (price): Entry Fee Fixed Marginal Fee Per attraction
A Disneyland Dilemma: Two-Part Tariffs for a Mickey Mouse MonopolyWalter Y. Oi The Quarterly Journal of EconomicsVol. 85, No. 1 (Feb., 1971), pp. 77-96
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Mixed Pricing Strategy: Adventureland, Farmingdale NY
Allow customers to sort themselves into low and high elasticity groups. (High ride price elasticity buyers will choose the POP ticket.)
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Rye Playland, Rye NY
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Pricing and Value from the Consumer’s Viewpoint
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Event Consumer Surplus
0 8 16 24 32 40 48 56 64
90
80
70
60
50
40
30
20
10
0
Price Per Ticket
Tickets (1000s)
Price=15; 9,000 people willing to pay 70 20,000 people willing to pay 60 (including the 9,000) 40,000 people willing to pay 30 (including the 20,000) 56,000 people willing to pay 20 (including the 40,000) 64,000 people willing to pay 15 (including the 56,000)
= 9,000(55) = 495,000 = 11,000(45) = 495,000 = 20,000(15) = 300,000 = 16,000(5) = 80,000 = 1,370,000
15
How can promoters capture the consumer surplus in markets like this?
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A General Rule for Price Discrimination
Greater profit extracted from the less elastic buyer Rule: (Price – Marginal Cost)/Price = price cost (profit) margin = 1 / |Price Elasticity| Generally means higher prices charged to less elastic
demanders Always greater profits than a single price
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Perfect Price Discrimination First degree discrimination Every consumer pays their reservation price The seller extracts all surplus value Profit is maximized absolutely
Price
Quantity
Demand
Marginal Cost
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Yield Management: Attempt to apply first degree price discrimination
Yield Management: A form of price discrimination Fixed, perishable product Low (or zero) marginal cost Segmentable markets
Applications Airlines: Timing of sales; fare classes Hotels: Timing of sales, length of stay Car Rental: Insurance and damage waivers, upgrades Sports: Quality of seats Concerts: Bundling, backstage passes Online sales (attempts, e.g., Amazon)
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2002 Mets Play Ball!
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2003 Mets Price Experiment
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Dynamic Pricing
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Time of PurchaseAnother tactic implemented by the airline industry is changing prices based on the time of day. They do this using analytics to determine the time of day at which most of their customers are purchasing tickets and charge higher prices at those times. This allows them to increase revenue and tailor their prices to the demand on the site. It is a little known secret that Amazon uses similar techniques and changes their prices multiple times a day to match the demand for an item. This type of variable pricing is harder to use than the other two because it requires constant monitoring to determine the appropriate price. Amazon and others have developed algorithms that do this for them and as these algorithms improve it is likely that more businesses will use time based pricing.
http://spinnakr.com/blog/ideas/2013/08/variable-pricing-models-work-for-tech-startups/
Dynamic pricing might also work for commodities priced on the internet.
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Since 2011, the show’s producers, Disney Theatrical Productions, have been relying on a previously undisclosed computer algorithm to recommend the highest ticket prices that audiences would be likely to pay for each of the 1,700 seats at every performance in the Minskoff Theater. While other shows also employ this so-called dynamic pricing system to raise seat prices during tourist-heavy holiday weeks, only Disney has reached the level of sophistication achieved in the airline and hotel industries by continually using its algorithm to calibrate prices based on demand and ticket purchasing patterns.
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Yankee Stadium Pricing
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Pricing by
Attributesat
Fenway Park
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Second Degree Price Discrimination
Quantity discounts Smaller purchaser generally has the less elastic
demand. Applications:
Groceries Multiple site theme parks (Disney)
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Quantity Discounts at Disney World
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Direct Market Segmentation
Different prices to different buyers Direct Market Segmentation by Elasticity
Senior citizen discounts at movies Business vs. coach class air fares Men’s and women’s shirts at dry cleaners
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Third Degree Price Discrimination Direct market segmentation Identify segments, higher margins where demand is less elastic
Price per ticket Price per ticket
Seniors, Kids
Others
Tickets Tickets
Demand
DemandMR MRMC
MC
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Third Degree Price Discrimination
Inelastic Market Segment
Elastic Market Segment
P,MC
PHIGH
PLOW
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Market SegmentationFor every single price regime, there is a two price regime that is more profitable. (Assuming market segments exist.)
Separable Markets; AssumeMC = 5.
One Price = 8,Revenue = 8(4)+8(28)=256Profit = 256-5(32) = 96
Two Prices:PL=5, Revenue=50PH=11, Revenue=242Total Revenue=292Profit = 292-5(32) = 132
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Two Segment Market
Why do the elasticities differ?How can North Holland prevent arbitrage?
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Two Price Regime at Amazon Prime
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Magic Pricing Kingdom
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Indirect Market Segmentation
Two price strategy by The Producers Differentiation by product attributes
Less precise than direct Special seats (experiment) in Manhattan movies Applications
Versions Books: Hardcover vs. paperback Concert seats Tickets to all sorts of entertainment events Ticket Pricing by “Value” (Examples below)
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Kelly Clarkson plays
Jones Beach, NY
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Pricing the Mac
Black Mac $1499
White Mac $1349
“How Much Is That Laptop? It Depends on the Color of the Case. And That's Fair.” Robert H. Frank. Economic Scene, New York Times, July 6, 2006.
What was going on here?
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Real Differences Not Proportional to Marginal Cost
$300 for 2GB of memory and 90GB on the hard drive. Marginal cost near zero.
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$85 includes License fee for Yankees lid.
$40 for Pink, Red, Blue, Green, Purple.
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More Price Discrimination
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High FlyingPrice
Discrimination
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The Producers Price Index
Price discrimination based on two attributes, seat location and day/time.
Further promotional discounts, day of show via TKTS = 3rd dimension of discrimination based on risk of not seeing the show.
Estimated impact on theater profit (compared to a 1 price strategy) 5%
Price discrimination in Broadway theater, Phillip Leslie, http://www.stanford.edu/~pleslie/broadway.pdf
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1. Place of the seat relative to the stage. 2. Programming3. Time and date of the show4. Time of purchase
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Price Discrimination in Concerts. About 5% impact on gross revenues
Discrimination defined as more than a single ticket price, e.g., floor vs. bleacher.
Frequency of price discrimination for acts with > 300 concerts.
The Impact of Price Discrimination on Revenue: Evidence from the Concert Industry, P.Courty and M. Pagliero, Review of Economics and Statistics, 94, 2012, 359-369.
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Pricing Downloads
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Hard Cover U.S. Version
Amazon.com September 14, 2007
($136.69 as of 9/13/10)
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Amazon.co.uk
₤50.34 = $102.30 (September 13, 2007)
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International Pirated Edition: Very Low Price!
Renmin University of China
All 827 pages
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Cannibalization
Two level pricing system – the lower level may cannibalize the higher one If the two prices are too far apart, the surplus from the lower
priced alternative may exceed that from the higher one. Potential inelastic (high price) buyers may be drawn to the
lower priced segment. Strategies
Careful setting of the difference between high and low prices When segmenting by attributes, ensure that the attributes
create real perceptible differences that consumers will value.
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Lion King, Orpheum, SFSegmentation by Attributes
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Bundling
Applications Cable TV
Basic Basic+Premium+Music Choice
Econometric Analysis 6th ed. with answers What is the strategy? (Not specific to experience goods:
Phone services Car features
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Time Warner Cable Bundles
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THE Bundling Application
Block booking by the movie studios Forced rental of sets of movies Blockbusters were bundled with dogs
THE PARAMOUNT CASE (1948) Broke up vertical arrangements (studios
owning theaters) Disallowed block booking
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Entertainment and Media: Markets and Economics
End Class 1 – Part 3