There are a few basic features that Grant Achatz and Nick Kokonas should build into their online ticket sales. First, you want a good system to generate the initial allocation of tickets for a given date, second you want an efficient system for re-allocating tickets as the date approaches. Finally, you want to balance revenue maximization against the good vibe that comes from getting a ticket at a non-exorbitatnt price.
- Just like with the usual reservation system, you would open up ticket sales for, say August 1, 3 months in advance on May 1. It is important that the mechanism be transparent, but at the same time understated so that the business of selling tickets doesn’t draw attention away from the main attractions: the restuarant and the bar. The simple solution is to use a sealed bid N+1st price auction. Anyone wishing to buy a ticket for August 1 submits a bid. Only the restaurant sees the bid. The top 100 bidders get tickets and they pay a price equal to the 101st highest bid. Each bidder is informed whether he won or not and the final price. With this mechanism it is a dominant strategy to bid your true maximal willingness to pay so the auction is transparent, and all of the action takes place behind the scenes so the auction won’t be a spectacle distracting from the overall reputation of the restaurant.
- Next probably wants to allow patrons to buy at lower prices than what an auction would yield. That makes people feel better about the restaurant than if it was always trying to extract every last drop of consumer’s surplus. Its easy to work that into the mechanism. Decide that 50 out of 100 seats will be sold to people at a fixed price and the remainder will be sold by auction. The 50 lucky people will be chosen randomly from all of those whose bid was at least the fixed price. The division between fixed-price and auction quantities could easily be adjusted over time, for different days of the week, etc.
- The most interesting design issue is to manage re-allocation of tickets. This is potentially a big deal for a restaurant like Next because many people will be coming from out of town to eat there. Last-minute changes of plans could mean that rapid re-allocation of tickets will have a big impact on efficiency. More generally, a resale market raises the value of a ticket because it turns the ticket into an option. This increases the amount people are willing to bid for it. So Next should design an online resale market that maximizes the efficiency of the allocation mechanism because those efficiency gains not only benefit the patrons but they also pay off in terms of initial ticket sales.
- But again you want to minimize the spectacle. You don’t want Craigslist. Here is a simple transparent system that is again discreet. After the original allocation of tickets by auction, anyone who wishes to purchase a ticket for August 1 submits their bid to the system. In addition, anyone currently holding a ticket for August 1 has the option of submitting a resale price to the system. These bids are all kept secret internally in the system. At any moment in which the second highest bid exceeds the second lowest resale price offered, a transaction occurs. In that transaction the highest bidder buys the ticket and pays the second-highest bid. The seller who offered the lowest price sells his ticket and receives the second lowest price.
- That pricing rule has two effects. First, it makes it a dominant strategy for buyers to submit bids equal to their true willingness to pay and for sellers to set their true reserve prices. Second, it ensures that Next earns a positive profit from every sale equal to the difference between the second-highest bid and the second-lowest resale price. In fact it can be shown that this is the system that maximizes the efficiency of the market subject to the constraint the market is transparent (i.e. dominant strategies) and that Next does not lose money from the resale market.
- The system can easily be fine-tuned to give Next an even larger cut of the transactions gains, but a basic lesson of this kind of market design is that Next should avoid any intervention of that sort. Any profits earned through brokering resale only reduces the efficiency of the resale market. If Next is taking a cut then a trade will only occur if the gains outweigh Next’s cut. Fewer trades means a less efficient resale market and that means that a ticket is a less flexible asset. The final result is that whatever profits are being squeezed out of the resale market are offset by reduced revenues from the original ticket auction.
- The one exception to the latter point is the people who managed to buy at the fixed price. If the goal was to give those people the gift of being able to eat at Next for an affordable price and not to give them the gift of being able to resell to high rollers, then you would offer them only the option to sell back their ticket at the original price (with Next either selling it again at the fixed price or at the auction price, pocketing the spread.) This removes the incentive for “scalpers” to flood the ticket queue, something that is likely to be a big problem for the system currently being used.
- A huge benefit of a system like this is that it makes maximal use of information about patrons’ willingness to pay and with minimal effort. Compare this to a system where Next tries to gauge buyer demand over time and set the market clearing price. First of all, setting prices is guesswork. An auction figures out the price for you. Second, when you set prices you learn very little about demand. You learn only that so many people were willing to pay more than the price. You never find out how much more than that price people would have been willing to pay. A sealed bid auction immediately gives you data on everybody’s willingness to pay. And at every moment in time. That’s very valuable information.