Global Economics and Management

Personalized Pricing

In a few weeks in Management 405, we will start a module entitled "Advanced Pricing". There, we will learn various techniques for extracting more surplus from our customer base by charging different prices to different customers or to different classes of customers. In economics, this is known as price discrimination. It can be done with auctions, with product versioning, or with prices tailored to certain classes of clients identified by characteristics that are hard to conceal. 

A recent HBR article by Rafi Mohammed usefully summarized the ins and outs of price discrimination, applied to online selling. The author resorts to a nice euphemism to characterize price discrimination, one that entails a less pejorative connotation: he calls it personalized pricing. Who does not like personalization?

The article highlights a fundamental tension: with the advent of electronic transactions and big data, it becomes easier to tailor prices to different kinds of customers by generating empirical regularities on their willingness to pay from the wealth of transactions data that online sellers possess. Can you identify gullible customers? Customers whose opportunity cost of time is such that they won't shop for lower prices? Then charge them higher prices than you would to Mr. Scrooge! The temptation is obvious, but the tension arises due to the limits of these practices. One limit is that price discrimination has to be incentive compatible. If I can delete all my cookies and project an online footprint that makes sellers believe I am Mr. Scrooge, their price discrimination schemes may fail. After all, even a high willingness to pay customer likes a good deal! Second, ethics can come in the way. After all, you are treating different classes of consumers differently. Better make sure you don't run afoul the basic rules of human decency in the process. Finally, price discrimination can be illegal, especially if it results in a monopolistic outcome or if it based on traits over which it is illegal to charge different prices. We will discuss all this in much greater detail very shortly.

For referring me to this HBR article I thank your classmate Rafael V. Almeida.

Should You Short Tesla, Uber, and Netflix?

The Economist thinks the answer to this question is yes. We saw in class that the stock valuation of a company should track the present discounted value of its future earnings. The Economist points out that Uber, Netflix, Tesla and two major energy companies jointly lost $100 billion over the last decade. Yet their stock valuations are healthy, and in most cases rising steeply. That means their valuations are entirely based on expectations of long term profits, not on their likely short term performance. Are these expectations reasonable? Read the article and make up your mind!

The Environment in India

One of the topics we did not have time to cover in the first of four classes on "The Business Environment of India" was the environment. The Wall Street Journal's famed Saturday Essay this week is all about the environment in India, and the profound environmental degradation that India is experiencing. It is a staggering read, and I also recommend a close look at the photos and videos that come with the article. The health implications of environmental degradation on this scale are nothing short of tragic. Environmental issues are a huge obstacle India faces on its development path. I recommend this article very strongly.

India is currently at the worst possible spot in the Environmental Kuznets Curve. Here is a link to data on air pollution in India, compared to other countries. Here is an entertaining blog post on India's sanitation infrastructure, also a huge challenge. And finally here is where India ranks on the Global EPI (155 out of 178 countries).

WSJ Readings for Wednesday, October 18, 2017

1. U.S. Second-Quarter Productivity Rose at Revised 1.5% Rate

A. What is the link between productivity and the cost of production?

B. What is the likely effect of stronger than expected growth in productivity on the stock market?

2. Robotic Chefs Arrive in Restaurant Industry

A. Why are restaurants increasingly automating their production processes?

B. Who is likely to gain and who is likely to lose from automation in the restaurant industry, and why?

Guest Blogging: Eric Siegel on Supreme

Your classmate Eric J. Siegel sends me very interesting observations on streetwear brand Supreme: 

I came across this article about the fashion brand Supreme and thought it would make a good addition to the GEM blog. The brand is using an extremely limited supply to generate an insane amount of demand on a weekly basis for their products.

What's especially interesting is that while they are selling at luxury brand prices, their products are hitting exponentially higher prices on the secondary markets (eBay, etc.) -- similar to Hamilton, but with the option to easily increase supply. I'm interested to hear they class's analysis (and yours!) of Supreme's pricing strategy. They're clearly leaving lots of marginal revenue on the table, so why aren't they increasing prices or slightly increasing quantity? 

The article also sites this Wired article, which infers that they actually have increased quantity, and also adds one more element to the story: there is now a market for hackers to build bots that can execute arbitrage at breakneck speeds. Supreme is aware of this, but isn't effectively shutting it down because such action would contradict their "cool man" brand."

My comments: Eric is spot on that creating artificial scarcity (what economists call "excess demand") can be a powerful way to boost excitement for products and paradoxically get more people into a store. Excess demand in this context means that the P and Q combination that the firm chooses is not located on its demand curve, but beneath it. It can be a bit puzzling to act like this, since it seems at first blush that with excess demand the firm could expand output at going prices, or raise prices to eliminate the excess demand. The only explanation for why they don't do that is that they see excess demand (i.e. artificial scarcity) as a way to create buzz and raise willingness to pay. I don't think this example is generalizable beyond niche examples such as this one, but the idea that scarcity can lead to the demand curve shifting out is not completely crazy, and Supreme seems to make it work.

This is reminiscent of a related approach taken by Zara (now a famous business school example): turn around your collection so fast that you get more impulse purchases from customers afraid that supplies will run out. Also, switch products around so fast so that your customers perceive a "need" to return to your stores frequently. I caricature Zara's business model by only devoting two sentences to it, but if you want to learn more about it here is a useful summary. And by the way, here at UCLA Anderson we have the world's leading expert on Zara, in our operations group: Professor Felipe Caro.

Taylor Swift, Auctions, and Concert Ticket Allocation

Over at Bloomberg View. Scott Duke Kominers has a nice article describing how Taylor Swift will sell concert tickets for her upcoming tour. The mechanism is an auction but not one where bidders use money directly. Rather, they use a score that reflects how many actions they took to demonstrate their commitment as fans of Taylor Swift (buying her CDs, posting on social media, etc.). 

We will see later in class that auctions offer outstanding opportunities for sellers to capture value. Does Taylor Swift's mechanism deliver the same? I can see two advantages. First, some actions that serve to raise a fan's score, like buying Taylor Swift CDs, directly raise the artist's revenues. Second, by ensuring that the tickets are allocated to those with highest valuations (as demonstrated by their commitment to TS), the mechanism makes it less likely that those who bought the tickets will then turn around and scalp them, and may also allow TS to charge a higher base price for the tickets (I say "may" rather than "will" because the cost of the actions fans have to undertake in order to win the right to buy tickets may partly or fully offset their higher willingness to pay). But perhaps Taylor Swift could do even better by selling the tickets in a regular auction, where buyers bid with money.

Incidentally, here is the video describing the scheme:

India's Demonetization: A Panel Discussion at UCLA Anderson

In class 2 of my "Business Environment of India" class, we will discuss India's recent attempt at demonetization, aimed at curbing illicit uses of cash. A few months ago I was part of a panel on the subject at our school:

Books on India

As I gear up to teach my first class on the business environment of India this evening, I was pondering which books on India to recommend to the 33 students enrolled in the class. Indeed the course does not have assigned or required readings, but reading about India before you go will make the trip a much richer learning experience. So here are a few suggested nonfiction books on India to read in the months leading up to our trip (I will keep adding to the list as I think of more):

1) India Grows at Night, by my good friend Gurcharan Das. Among many other things, Gurcharan in this book describes how the city of Gurgaon, which we will visit on our trip, sprang up from nothing. Gurcharan's earlier book, India Unbound, is also excellent, as is his more esoteric book on the concept of Dharma in Hindu culture.

2) India after Gandhi, by Ramachandran Guha. One of the best books on India's post-independence history.

3) The Argumentative Indian, by Amartya Sen. A bit dated perhaps, but also a superb book on Indian culture and identity, authored by a Nobel Prize winner who also happens to have been my professor and one of my favorite economists.

4) Kaushik Basu, formerly the chief economic adviser of the government of India under the previous government, and later the chief economist of the World Bank, wrote an excellent little book on the difficulties facing economic policy-making in India. I highly recommend this book.

5) Maximum City, by Suketu Mehta. This book is about Mumbai, which we will also visit on our trip. It is a long read, but probably the best book written on Mumbai ever, and certainly a superb way to learn about India.

6) In Spite of the Gods: The Rise of Modern India, by Edward Luce. A lucid book (sorry, I could not resist).

7) India: A Portrait, by Patrick French. I have not read this book, unlike those I recommended above. But it comes highly praised by many.

And if you would rather see an Indian movie than read a book, I cannot beat the list provided by Alex Tabarrok over at the Marginal Revolution blog.

A Follow-Up on the Whole Foods Price Cut

Your classmate Colin La Bran-Boyd sends me this useful update on Amazon's move to cut prices at Whole Foods. It turns out that price change is not all that it was cut out to be (pun intended). Colin points out: "I’ve kept up with this post-merger, and there have been a number of analyst reports coming out recently that report Amazon is sneakily raising prices on some products. Notably, the article points out, on average prices are only down about 1.2%, and in fact frozen food prices are up 7%, and snack foods are up 5%."

The article in question can be found here (including a nice video). There's a lesson here, perhaps, on loss leader pricing.

Many thanks to Colin for his contribution. 

WSJ Articles for Wednesday October 11, 2017

1. Amazon Clobbers Grocers’ Stocks With Price Cuts at Whole Foods

A. Why is Amazon cutting prices at Whole Foods?

B. Will the price cut be profitable? What factors determines whether it will be?

2. The High Cost of Raising Prices

Is the author correct that “Empires are lost on rising prices” and “Investors love protected businesses, but eventually relentless price increases kill them all” ?