Categories
Antitrust Monopolization

The Euthanasia of the Consumer

Have you ever paid so much for something that you had to wonder whether it was really worth it? What prices would trigger that feeling for you? $25 for toothpaste? $2,500 for a Broadway ticket? Armies of data analysts are working hard right now to help companies identify and charge those individualized prices to you.

This practice, called “price discrimination” in economics jargon, and “dynamic pricing” by industry, was pioneered in its new data-driven form by the airlines, which explains why you feel uneasy telling the passenger sitting next to you what you paid for your ticket. But serious debate about the merits of the practice has coalesced only in the past year around Broadway ticket prices, as charges for the top shows, such as Hamilton, have spiked into the $800 range.

While consumers rage about the practice, two commentators have leapt to its defense. Harvard economist Greg Mankiw claimed to be “happy about” paying $2,500 for a ticket to Hamilton. James B. Stewart, usually a perceptive critic of business practices, seemed to agree in a recent Times column that complaints reflect “anticapitalist bias.”

Dynamic pricing is neither necessary for capitalism nor consistent with it. But the practice does impoverish consumers, which is why they have good reason to be angry.

Mankiw and Stewart want us to believe that dynamic pricing is necessary for what economists call “rationing:” the problem of deciding which of a group of consumers, all of whom can afford to pay a price sufficient to cover the costs of production, should get access to a product when the supply of that product is limited. There are only 1,319 seats in the Richard Rogers theater in New York, where Hamilton plays, but on any given night many more prospective ticket buyers are willing to pay enough to cover the costs of the production. Rationing determines who gets to attend.

There are many ways to ration. Charging a price equal to cost, and providing access on a first come, first served basis, remains a popular approach. Any restaurant that takes reservations follows this approach, as does Southwest Airlines, which allocates many of the best seats on its flights to those who check in first online.

Another approach, which generates additional profits for businesses, is to grant access only to those who can afford to pay the most. This is what airlines do when they charge a premium for first class seats. Economists once argued that this was the best approach, because alternatives required consumers to waste time standing on lines or getting through to a busy phone number. But online reservations systems, which are virtual queues, have more or less eliminated that problem.

One thing that is not required for effective rationing, however, is dynamic pricing. The distinctive feature of dynamic pricing is the charging of different prices to different groups of consumers. But setting a single fixed price, as Broadway shows did until the early 2000s, does just as good a job. To choose 1,319 Hamilton audience hopefuls, charge the single fixed price that only 1,319 of them are willing to pay.

Mankiw was therefore mistaken when he wrote that only because a scalper could charge him $2,500 was there a ticket waiting for him to buy two weeks before showtime. If the theater, or the scalper, had charged the right fixed price, Mankiw’s ticket would still have been right there waiting for him when he went to buy.

But the ticket would have been a lot cheaper. Dynamic pricing is really about profits. Of the 1,319 Hamilton audience hopefuls who can afford to pay the most, some, like Mankiw, who has reportedly earned more than $42 million in royalties on his popular introductory economics textbook, can afford to pay much more than others. Dynamic pricing allows a ticket seller to segment these hopefuls into groups based on characteristics that suggest how much each is willing to pay, and raise price to those groups that are able to pay more. Broadway’s embrace of dynamic pricing has probably played a role in generating the $1.45 billion profit enjoyed by the industry last year.

But so what if consumers pay higher prices, the fact that they are still willing to buy means that they are still benefiting, right? Wrong. Getting a good deal on a purchase is not just a luxury that the economy can do without. It is the essence of what it means to enjoy a product, whether a theater ticket or a loaf of bread.

When consumers pay prices so high that they wonder whether the deal was worth it, the pleasure they get from the transaction is vanishingly small, because they must give up so much in order to gain access to the product. Because consumers still buy at such prices, the economy continues to grow, and indeed profits soar, but consumers are shut out of the fruits, engaged in joyless consumption, paying a pound of flesh for a pound of meat. By charging prices just low enough that consumers continue to buy, firms help consumers to destroy the lived value of their own wealth, which is why dynamic pricing is the euthanasia of the consumer.

Fortunately, this future has not quite arrived — firms are still learning how to categorize consumers into finer and finer groups – so some of us continue to enjoy good deals. Mankiw certainly got one, declaring that his ticket was “worth every penny.” Clearly, the scalper failed to charge him a price anywhere near the maximum he could afford.

One percenters like Mankiw suffer the least from dynamic pricing because there are so few of them, allowing them to hide among the merely affluent, and enjoy prices targeted at this less fortunate group, at least for now. Mankiw’s ticket was probably priced for lawyers or doctors, not forty-millionaires. The rest of us can try to hide too among the less fortunate, but the deals we get will not be as good, because our incomes do not differ as much from the incomes of other buyers in lower wealth segments.

Stewart observes that dynamic pricing “yields bargains along with premium prices.” But he does not seem to realize that these bargains are not by design. That $39 deal Stewart found for the show Donna Murphy was not meant for him, but for the American of median income – $53,889 — for whom $39 for a show is not something to write home about.

As firms get better at segmenting consumers, they will eventually be able to keep Stewart out of the economy seats, and to class Mankiw with other forty-millionaires, charging him enough ($100,000?) to make him think twice about declaring his good fortune to The New York Times.

Far from being anticapitalist, dynamic pricing eliminates some of the benefits of wealth, because it ensures that the more a consumer can afford, the more the consumer will be asked to pay. The practice takes us a step closer to the world of Marxist fable, in which each takes only according to his need. By contrast, rage at dynamic pricing reflects the rather capitalist desire of consumers to get the most out of their hard-earned cash.

So what should shows do? To their credit, shows have not yet used dynamic pricing to set prices as high as they could, which is why scalpers have made huge profits on resale. Rather than listen to Mankiw and try to capture the scalpers’ profits by raising their own prices, hit shows should fight the scalpers tooth and nail, on behalf of their audiences, perhaps by following the airlines in honoring only tickets presented by named purchasers. And then they should do the decent thing and start to charge prices that cover only their costs, including a reasonable return to investors, but not a penny more.

Stewart worries that without dynamic pricing, shows would be unable to pay their investors. But investors are just another production input, like sets or stagehands, each of which has a finite cost. Dynamic pricing is about what to do with what remains after those costs have been covered.

To be sure, profits from dynamic pricing could stimulate investment in more shows, but the profits also cause consumers paradoxically to derive less pleasure from those shows, as they are forced to give up more and more in order to get access to them.

The question, ultimately, is whether the audience should be made to exist for the show, or the show for the audience. Consumers already understand how that question has been answered by the airlines. As dynamic pricing spreads across the economy, from taxis to rental apartments, we must also soon ask that question of the entire economy. Broadway can take a stand. And consumers can either “get used to it,” as Stewart recommends, or rebel.

Categories
Antitrust Monopolization Regulation

Whole Food for Thought

An important point that didn’t make it into my opinion article arguing that the FTC should unwind Amazon’s acquisition of Whole Foods is this: Most people don’t buy groceries online today, but eventually they will.

That’s why I wrote that Amazon’s website, along with its voice search service, Alexa, constitute an essential marketing platform, required for future survival in grocery retail. Whole Foods now has a huge advantage over all other grocery retailers in attracting the coming wave of online grocery shoppers, because most people already use Amazon as their default search engine for finding goods to buy online. When these people start embracing online grocery shopping, they’ll log into Amazon to find a way to do that. And all they will find is Whole Foods. Even giant Walmart is unlikely to solve this problem, because its own website attracts far fewer online shoppers.

The central role of online product search to the future of the grocery market explains why Walmart responded to the Whole Foods deal by partnering with Google to offer Walmart items on Google’s Alexa competitor — Google Assistant. Google isn’t dominant in product search, or in voice search, so while that partnership may help Walmart, it won’t eliminate Amazon’s promotional advantage.

If the FTC were to unwind this deal, Amazon could still get into groceries, but only as a search platform, allowing grocery retailers to offer delivery services through Amazon, much as Amazon already opens its fulfillment centers to third party sellers. That would give existing retailers a more equal shot at search visibility on Amazon’s website. If the FTC won’t unwind the deal, it should at least order Amazon to give all grocers visibility, by including their offerings on its website, alongside those of Whole Foods.

True, the Whole Foods deal should lead to more competition in grocery retail for the time being. In order for Amazon to leverage its product search dominance to win market share, it must charge prices low enough to avoid encouraging consumers to give up using Amazon as their search default. That explains why Amazon cut Whole Foods prices immediately after the acquisition. As long as those prices stay low, consumers will stick with Amazon, and as online ordering takes off, Whole Foods will expand its share of grocery retail.

That in itself is a problem, and enough for the FTC to intervene, because it means that Whole Foods will win not by charging better prices or offering a better product, but because it can match the prices and product quality offered by others, and then tip the scale in its favor through its dominance of online product search. Competition realizes its potential only when firms win by charging lower prices or offering products of better quality.

Consumers will end up choosing Whole Foods not because it is better, but because it’s not worse, with visibility on consumers’ favorite product search platform becoming the deciding factor in the decision which grocer to use. The FTC won another case in the 1980s on precisely this ground, arguing that the maker of the ReaLemon brand of lemon juice used its promotional advantage to win market share while charging competitive prices.

A second consequence is that if Whole Foods manages to run the competition into the ground, then it will be able to raise prices eventually. Entering the grocery retail market, even an online market, is expensive, requiring a huge distribution network connecting, among other things, large numbers of suppliers of perishables to the grocer. If Walmart and other grocery retailers disappear, their distribution systems will disappear with them. And any competitor wishing to enter the market in response to eventual price hikes by Whole Foods will have to rebuild distribution from scratch.

Of course, Amazon might fail to capitalize on its advantage. Brand loyalty, or the promotional advantage bricks-and-mortar retailers have in promoting their own online delivery services to consumers shopping in their stores, might cause consumers to gravitate to the retailers they use today when they start shopping more online.

But the promotional advantage created by access to online product search platforms is real, and is likely to play a role in all consumer product markets in the future, if it does not already. The EU was concerned about precisely that when it fined Google $13.7 billion in June for privileging its own product search engine over others in its search results. Until government starts to treat product search as an essential facility or a public utility, an essential playing field that must be level if competition is to take place on the characteristics we care about, like price and quality, this problem will persist.

Categories
Monopolization

Instantaneous Defection

Algorithms may make collusion easier, by reducing the cost of monitoring and reacting to the behavior of other participants in an oligopoly. But even the fastest of algorithms can’t guarantee collusion, contrary to what Stucke and Ezrahi seem (p. 62-65) to suggest. After all, the classic model of the failure of collusion, the prisoner’s dilemma, is a simultaneous move game! And the best algorithms can do for oligopolists is to allow them to act simultaneously.

Suppose all the oligopolists in a market have super-fast algorithms that allow them to monitor the decisions of competitors and adjust accordingly. Then as soon as one firm adjusts for another firm’s decision, that other firm will adjust to the first firm’s adjustment. As adjustment times fall, the firms become unable to adjust to each others’ decisions, because they end up effectively all making their decisions at the same time.

That is precisely the setup of the basic prisoner’s dilemma game, in which no player observes the decisions of the other players in advance. The game shows that under this condition, rational firms will all choose to betray the oligopoly and charge a low price, because each firm will know that it is in the best interest of each of the other firms individually to betray the group as well.

The prisoner’s dilemma tells us that even in a world of infinitely fast algorithms, tacit collusion can fail.

Stucke and Ezrahi argue (pp. 56-64) that algorithms would facilitate oligopoly in gas station pricing because algorithms would allow each station to meet a price-cutter’s low prices before consumers have had a chance to drive over to the price-cutter to take advantage of those low prices. As a result, consumers would not flock to the price-cutter, but would buy at the low prices offered by their local gas stations instead, eliminating the reward for cutting and ensuring that all members of the oligopoly charge a high price.

What makes algorithms effective as an aid to oligopoly in this story is the inability of consumers instantaneously to take advantage of a price cut. But here’s the thing: the same technology that makes quick price changes possible also makes quick purchase decisions possible. By offering consumers the ability to use an app to commit to a low price as soon as it is offered, or to have gas delivered to their car, a price-cutter can lock in volume generated by betraying the oligopoly.

That puts us back in the prisoner’s dilemma.

I don’t mean to say that algorithms never facilitate oligopoly pricing — they may well do so today for gas stations, because the technology that would allow consumers to fight back is still in its infancy. My point is only that there’s no necessary relationship between the speed of algorithms and harm to competition.

Categories
Monopolization

What’s Left of Competition

I have on the one side anarchy, competition, and freedom, all synonyms, and on the other command, monopoly, and regulation. In general, the left wants freedom in private life (e.g., the liberation of women from their husbands) and regulation in public life (e.g., tax those sugary soft drinks). But when it comes to industrial organization, the left seems to take the opposite tack. There are fevered calls for competition (anarchy) in the public realm of the markets, but what appears to be opposition to competition in the private realm within the firm, as when a financier buys up Sears and tries to make the company’s corporate divisions compete against each other for resources.

Categories
Monopolization

A Standard Flight

Once, we standardized the price, and let the airlines compete on the product. That was nice, but elitist, because the standardized price was high.

Now, we standardize nothing, except safety. Because the consumer notices only price, the airlines compete on headline fares, to fool the consumer, and debase the product to maximize profit.

The solution is to standardize the product, and let the airlines compete on price. Federally-mandated minimum standards for leg room, food service, customer service, and so on.

Categories
Monopolization

Not a Curse

Bigness is billions of human beings working together to make each others’ lives better, in perfect harmony and love. What’s wrong with that? I’m with Galbraith, not Brandeis.

Categories
Civilization Meta Monopolization Quantity World

Optimal Prediction

When optimization arrives, either others will optimize against you or you will optimize against others. Business against you or you against business. There will be either corporate planning or central planning.

Categories
Monopolization

The Naked Sale

The pervasive problem of absence of information on sellers admits only of a government fix. Only government can extract seller information and present it to consumers in a way that maximizes consumer welfare. Buyers can try to unite, but sellers will never volunteer information. Only an agent wielding the scissors of the law can lay sellers bare.

Categories
Monopolization

Contribution of the Rich to the Economy

Paul Krugman had an interesting post a couple of years ago about the claims of the rich to contribute a unique, valuable something to the economy.  (He calls it jobcreation.)  He pointed out that if we assume that the rich get paid every penny of their contribution to output, then the rich confer no net benefit on the rest of us.  All the value they create gets paid back out to them.  So causing them to work less in response to taxes won’t make the rest of us worse off.

Krugman suggests that the fact that labor gets paid its marginal product in textbook competitive markets makes the notion that the rich might get back all the value they create seem reasonable.  Maybe I’m missing something (possibly because I haven’t read the optimal tax literature that Krugman is thinking about here), but I think the rule that being paid your marginal product results in your being paid the value of your services holds only if demand is perfectly elastic.  Otherwise, the rich get their producer surplus and the rest of us get a consumer surplus.  The rich don’t get paid the full value of what they create.  And if they work less, some of the surplus to consumers disappears.  Of course, this doesn’t mean that the rest of us are net losers if the rich work less.  Krugman has a nice monopsony take on the situation that makes clear that the nonrich can come out ahead.    They lose some surplus due to reduction of production by the rich, but they make up for that by paying the rich a lot less for the output that the rich continue to contribute.

If we do away with the assumption that the rich get paid the value that they create in textbook competitive markets, then I think the wrongness of the job creators argument actually becomes clearer.  In a world in which demand is not perfectly elastic, the rich and non rich split the surplus created by the rich.   And that’s exactly what you want.  You want production to make everyone better off.  If the productive activities of the rich were to benefit only the rich, then society shouldn’t care at all about the contributions of the rich, let alone reward them.  Suppose a great entrepreneur produces a doohickey that is worth $5000 to you.  If she charges you $5000 for it, then your net gain from it is precisely zero.  You might buy the thing, but you’d have to give up so many other comforts to pay for it that your life wouldn’t actually be any better than if the thing had never been invented in the first place.  When we think of the rich as contributing to society, we’re definitely not thinking about this scenario.  We’re assuming that the rich sell what they create for less than its value, otherwise they wouldn’t be creating any value for the rest of us to speak of.

What this means is that when the rich say that they deserve more pay because they contribute more than the rest of us to society, they’re actually just asking to reduce their net contribution to society!  Herein lies the wrongness of their argument.

But doesn’t that prove too much?  Why not pay the rich nothing in order to maximize their contribution?  The answer is that what should determine pay is not the level of contribution but the cost.  To maximize the contribution of the rich to society you need to pay them the minimum amount necessary to induce them to work at a level that maximizes that contribution, which is to say, you need to pay what it costs the rich to produce at that level.  It’s cost that should matter for pay, and not contribution.

If our great entrepreneur could have made $1000 doing something other than producing the doohickey, then you’d want to pay her just enough to induce her to produce the doohickey instead — say, $1001.  You pay the entrepreneur that amount and she makes you a doohickey that you value at $5000.  The entrepreneur has contributed $3999 of value to you.  And she’s contributed $1 of value to herself (her income less her opportunity cost).  Everyone is better off.    And the entrepreneur will do the work.

There’s an additional element to the argument of the rich that I think deserves more scrutiny and criticism.  When the rich argue that they should get paid more, they tend to refer to the uniqueness of their contribution.  They have skills that no one else has.  I think that we have to understand this appeal to uniqueness to be an argument that the rich deserve monopoly power and have a right to exercise it.

Suppose that the competitive market for doohickeys results in a market price of $1001, causing our entrepreneur to control a piddly $1 of the $4000 surplus she has created through her herculean efforts.  She can live with that in the sense that it’s still enough to keep her in the market.  But she’s created so much more value for others and it just seems unfair to her not to control more of it.  What to do?  Well, she’s unique, which means that she doesn’t have to tolerate competitive pricing.  She can raise her price and not worry that you will buy from someone else at a lower price.  So she can charge $4000 or $4999 and you’ll just have to buy at that level.  And in this way our entrepreneur will end up getting what she wants, which is to be paid the full value of her contribution to society.  And, as we saw above, she will thereby eliminate her effective contribution to society.

When a CEO tells you that he deserves his high pay because no one else can fill his shoes, he’s saying that it’s just for him to use his monopoly power to extract all the surplus from the market.  And when he uses this argument to argue against having to pay more taxes, he is saying that the government should not be permitted to interfere with his monopoly power.

Categories
Monopolization

Prima Facie Evidence of Monopolization

Does anyone think Apple’s $147 billion cash horde is a reward that was required to induce Steve Jobs to create the iPhone?  It’s obviously not necessary to cover other costs.

Monopoly profit is by definition profit that’s not necessary to induce production.  When a firm generates a large cash horde, it’s because it doesn’t know what to do with the money.  Which means: it doesn’t need the money!

In a world in which antitrust were taken seriously, a cash horde of $147 billion would be prima facie evidence of illegal monopolization.

And the government would force Apple to rebate it to consumers.

Update (11/12/14): Krugman is on the case.