Two Articles on Pricing

1) Courtesy of your classmate Trevor Armstrong, here is a great WSJ article on price matching. Threatened by stiff competition from online retailers, some brick-and-mortar retailers such as Best Buy and Target have decided to extend a policy of matching the lowest online price. You will immediately recognize this as an attempt to reduce the elasticity of demand that market players face: by matching their competitors' lowest prices, Best Buy retains some customers that they would otherwise have lost to online retailers. If everyone matches everyone's price, then every market player faces the industry elasticity of demand, which is (in absolute value) much lower that the elasticity that each firm faces independently.

You might think that such price convergence raises antitrust concerns, but keep in mind that 1) there is no explicit price fixing here and 2) the prices are matched downwards, which benefits consumers.

The big drawback of this scheme is that it leads consumers to shop online for lower prices in the hopes of requesting these prices at Best Buy or Target. This could inadvertently lead them to conclude the transaction online instead of at the store. My guess is that an increasing proportion of transactions will continue to migrate online, and that brick-and-mortar stores will become little more than showrooms, ultimately integrated into some online retailers at some point, if not completely destined to extinction. Online retailers are about to lose their tax advantage in many states, but they will retain their cost advantage stemming from technological efficiencies and labor savings. Does this spell doom for the Best Buys of this world?

2) Courtesy of your classmate Aylon Ben-Shlomo, here is another great WSJ article on the optimal timing of airline ticket purchases. When it comes to complex pricing to extract maximal consumer surplus, airlines are the world champions. They will charge different prices to business versus leisure travelers; different prices for travel in different seasons, dates, days of the week, and hours of departure; different prices on different routes, depending on the degree of competition on each route; different prices for non-stop versus layover flights. The list goes on. Yet, as we saw in class, the drawback of charging different prices to different market segments is that it needs to be an incentive compatible price discrimination scheme: consumers should not be able to behave strategically to undermine the scheme. Sophisticated consumers can notice regularities in pricing, and take advantage of the best possible deal. The article discusses one such possibility, which arises from the fact that airlines charge different prices depending on the day of the week at which tickets are purchased. Airlines must have determined that it was more profitable to extend discounts during the early days of the week than during weekend. The optimal response of a rational consumer is to avoid purchasing tickets during the weekend, when prices are high. Might airlines decide that time-varying discounts don't make sense after all?

Comments

[Bali Majid]

Regarding the potential doom of best buy, a counter-argument below for why brick-and-mortar chains may still have a chance at survival against online retailers from the CEO of Toys"R"Us. His argument is:
1). Majority of shopping is still done in-store and there are inherent advantages to it such as immediacy of the experience.
2). In-store customer service and avoidance of shipping charges.
3). Supply chain costs are higher for online retailers so how can they offer lower prices and make higher profits?
4). The labor savings perceived don't exist since online retailers still have to pay the employees working in their large distribution networks.

Essentially he believes that "omni-channel" retailing, in which retailers have a presence in physical and online arenas, is the best way to interact with consumers and that Online retailers will have to add physical stores in the future.

Reference: http://www.retailonlineintegration.com/article/toysrus-ceo-future-retail/2

[Andrew Skrip]

I find the subject of brick and mortar obsolescence interesting for a number of reasons, but something that struck me after ready the WSJ article and blog commentary, is the different timing of obsolescence across various industries. For example the first victim of brick and mortar obsolescence was Blockbuster Video a few years ago, then more recently the second victim of obsolescence was Borders. Barnes and Noble has survived for the time being, by having their locations act as showrooms for their line of Nook products.

Looking past the current example of Best Buy and Target, an industry that will be effected by the move away from brick and mortar locations is consumer banking. For the past 2.5 years, I worked in corporate finance and business strategy for the consumer banking business unit of a regional bank. Given the growth in number of banking transactions done via online and mobile, banks will continue to shed and/or downsize unprofitable retail locations. Newer competitors in the retail banking industry, such as Charles Schwab have a light distribution channel (ideally one within 20 minutes of home or work) coupled with superior call centers, mobile and online banking.

It will be interesting to see what other industries are effected by the shift away from brick and mortar locations in the next 5-10 years.

[Ayushman]

The first article on price matching is really interesting - I watched the Google Wallet advertisement (http://www.youtube.com/watch?feature=player_embedded&v=VuFVsaFCzsw#!) last week and wondered why they did not promote the new service as something one can use to buy stuff at brick-and-mortar stores. After reading the article, it looks like even companies such as Google with tonnes of data are getting skeptical about brick-and-mortar's survival over the next 5 years. However, businesses often find creative ways to differentiate their offerings through promotions or services. For example, a fashion retail outlet can withstand competition from e-commerce because the experience of trying clothes on before buying them will still be invaluable to customers (In countries such as India, retail stores even offer free length/size alteration for clothes). Similarly, there's no real data proving that customers would prefer to replace the weekly grocery store visit by online purchases. In these cases, the TPV(total personal value) for the customer equals value of the good (which in this case is the cost of the same product online)+ value of physical touch/experience before buying. So, TPV(store)>TPV(online). One might argue that the customer might want to visit the store for the experience while making the actual purchase online, the fact is that its not trivial to find an identical product online or to find the product + services combo offered by a physical store.
(From a consumer psychology pov, one can also say that customers often end up buying things they didnt intend to buy at a brick-n-mortar store. Eg: my friend recently went to a store to check out earphones which she later planned to buy on ebay. However, she ended up buying a new phone at the store and the earphones at Amazon!)

[Jenn Hyman]

Regarding the second article, I find it interesting that the author asserts that there is a future possibility for airlines to use flash sales via social media (as popularized by sites like One Kings Lane and Rue La La). However, those sites have found flash sales successful for specific reasons that may not be able to be mimicked in the airline space:
1) Aspirational Marketing: The idea that the goods on such sites are unaffordable for most consumers but represent something they greatly desire. In the airline space, most people are willing to buy a flight if they need to and are simply looking for a cheaper price. Hence, there is a smaller subset of consumers who would not have bought the ticket otherwise.

2) The exclusivity of this price: for One Kings Lane, 80% of the deals could not be found anywhere else on the internet. However, it would be rare that the flash sale for an airline would be low enough to be lower than anything that could be found on the internet. Also, with the higher competition in this space, competitor retaliation could render this price exclusivity obsolete by price matching.

3) Thrill of the hunt: Those who are currently shopping around for the best deals (those who enjoy the thrill of the hunt) would be the same consumers who would be excited by these spontaneous price decreases. Therefore, offering a flash sale might cannibalize on the market who would have bought the fare for a higher price (granted it would be a sale price, but the sale price is presumably not as low as the flash sale price). This would result in lower profits than by other modes of price discrimination.

Reference: http://www.bloomberg.com/news/2012-10-01/anatomy-of-an-online-flash-sale-addict.html

[Jacob Gore]

Regarding the first article, I'm inclined to think that Best Buy could certainly survive if they changed their model to more closely match Amazon's. They have the distribution networks, warehouses, supplier purchase agreements, etc. in place. They just can't afford their retail front any more. They may have to simply consolidate their retail locations down to the most profitable ones. Unfortunately, this would result in massive layoffs and selling commercial real estate at a time when it is poorly valued. But, it can be done, perhaps as a last resort.

I think that Best Buy's situation is almost identical to that of the U.S. Postal Service. They can afford to operate; they just can't afford their stores. The USPS is considering downing the footprint of their locations by placing them in grocery stores, and other smaller "add-on" locations. Like Best Buy, they have the supply chain and network set up, they just need to lower their commercial real estate to allow for lower prices. Best Buy could operate out of shopping malls like GameStop or a similar electronics store. They really just need the larger items and more instant necessities if they shrink. Larger items would be TV's, speakers, etc., and instant necessities would be cables, print cartridges, etc. This would allow for lower prices on everything, although, again, the required layoffs would mean this should probably be a last resort.

Lastly, Best Buy has the ability to expand its own brands. I didn't realize that RocketFish (cable company) was a Best Buy brand until looking it up. But obviously their Insignia and Dynex could be successful. They could use this downturn as a chance to innovate and make a spectacular product. I should note that they're already working on a tablet: http://www.bloomberg.com/news/2012-10-17/best-buy-to-introduce-tablet-to-compete-with-amazon-apple.html