Pricing Experience Goods 1:3 - 1(96) Entertainment and Media: Markets and Economics Professor William Greene

Pricing Experience Goods1:3 - 1(96)

Entertainment and Media: Markets and Economics

Professor William Greene


Economic Foundations for Entertainment and Media

Pricing and Value for Experience Goods


Demand and Value

Demand and Demand Curves Pricing

Pricing strategies Price discrimination Pricing innovations


“Value”

What is it? From the consumer’s viewpoint From the seller’s viewpoint

Creating Value Capturing Value

Meaning Sources of value


Pricing and Value from the Consumer’s Viewpoint


Reservation Price:Price Strategy Under Uncertainty

Your reservation price is $2,500.

Auction to take place in 5 days.

What would you do now?


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?


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


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.


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.


Scalping: Reallocates the Surplus

Why does Ticketmaster care?

Do Hanna Montana and the Spice Girls care?


A Merger Made in Heaven


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



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.


Economic Foundations for Entertainment and Media

Strategic Pricing for Experience Goods


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?”)


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


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


Pricing Strategies

Exploit pockets of market power Take advantage of market imperfections Exploit unusual market configurations


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.


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.


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


Concert Ticket Prices: Live Nation Effect

Connolly, M. and Krueger, Al, “Rockonomics” http://www.irs.princeton.edu/pubs/pdfs/499.pdf



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)


“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


Are owners really pricing irrationally?




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.


Examples

Concerts and “Stuff” Sports and Skyboxes plus all the other

stuff including food Movies and the food concession stands


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


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


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.)


Rye Playland, Rye NY


Pricing and Value from the Consumer’s Viewpoint


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?


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


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


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)




2002 Mets Play Ball!



2003 Mets Price Experiment




Dynamic Pricing


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.


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.


Yankee Stadium Pricing



Pricing by

Attributesat

Fenway Park




Second Degree Price Discrimination

Quantity discounts Smaller purchaser generally has the less elastic

demand. Applications:

Groceries Multiple site theme parks (Disney)



Quantity Discounts at Disney World


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


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


Third Degree Price Discrimination

Inelastic Market Segment

Elastic Market Segment

P,MC

PHIGH

PLOW


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


Two Segment Market

Why do the elasticities differ?How can North Holland prevent arbitrage?


Two Price Regime at Amazon Prime



Magic Pricing Kingdom


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)


Kelly Clarkson plays

Jones Beach, NY


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?


Real Differences Not Proportional to Marginal Cost

$300 for 2GB of memory and 90GB on the hard drive. Marginal cost near zero.



$85 includes License fee for Yankees lid.

$40 for Pink, Red, Blue, Green, Purple.



More Price Discrimination


High FlyingPrice

Discrimination




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



1. Place of the seat relative to the stage. 2. Programming3. Time and date of the show4. Time of purchase






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.


Pricing Downloads


Hard Cover U.S. Version

Amazon.com September 14, 2007

($136.69 as of 9/13/10)


Amazon.co.uk

₤50.34 = $102.30 (September 13, 2007)



International Pirated Edition: Very Low Price!

Renmin University of China

All 827 pages


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.


Lion King, Orpheum, SFSegmentation by Attributes



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


Time Warner Cable Bundles




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


Entertainment and Media: Markets and Economics

End Class 1 – Part 3

Documents

Pricing Experience Goods 1:3 - 1(96) Entertainment and Media: Markets and Economics Professor William Greene