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There are four major providers of national cellphone service in the U.S – Verizon, AT&T, Sprint and T-Mobile. Two of them are proposing to merge. What impact will the merger have on consumers? Senator Herbert Kohl (of Kohl’s stores fame) says:
“According to Consumer Reports, ‘T-Mobile plans typically cost $15 to $50 per month less than comparable plans from AT&T.” Removal of such a maverick price competitor from such a highly concentrated market – a competitor that disciplines price increases from all three other national cell phone competitors, not only At&T – raises a substantial likelihood that prices will rise following this merger.”
Someone can take the opposite view to ATT-TM LT to DOJ and FCC but at least it is coherently argued.
Entrepreneur Jay Goltz opines:
“If there is an aspect of running a small business that doesn’t get enough attention, I think it’s pricing.”
But it is hard and your salespeople can lead you astray:
“From my experience, many business owners do not do an analysis to calculate the effect a price increase might have on their bottom lines — again, for good reason. It is very difficult if not impossible to do. It’s more like guessing, perhaps an educated guess. I cannot tell you how to do it, but I can tell you what not to do. Do not rely on just your salespeople! Most will tell you that the sky will fall if you raise prices. They will tell you that customers are already complaining.”
Is it worth raising prices? The key variables are elasticty of demand and cost f production:
“Here’s the math: if you sell 100 widgets a week at $100 apiece and they cost you $65 apiece, you have a gross profit of $35 a widget or $3,500 a week. But because your fixed expenses have been rising and these are really good widgets, you decide you can charge $102 and still provide a good value to your customer. If you now sell only 95 widgets a week, you will have a gross profit of 95 x $37, or $3,515. But if you manage to sell 98, you will make $3,626. The point is that sales have to fall quite a bit for you not to come out ahead.”
He does not quite come out and say it but implicitly Goltz is comparing marginal revenue and marginal cost. In his examples, MR<MC so it makes sense to reduce output and increase prices.
- Jerry Seinfeld (September 1993) clearly beat Laibson (1994) to the punch on (the rebirth of) present-biased preferences, the conflict between future and current selves, and the value of commitment:
The Glasses I never get enough sleep. I stay up late at night, cause I’m Night Guy. Night Guy wants to stay up late. ‘What about getting up after five hours sleep?’, oh that’s Morning Guy’s problem. That’s not my problem, I’m Night Guy. I stay up as late as I want. So you get up in the morning, you’re … , you’re exhausted, groggy, oooh I hate that Night Guy! See, Night Guy always screws Morning Guy. There’s nothing Morning Guy can do. The only Morning Guy can do is try and oversleep often enough so that Day Guy loses his job and Night Guy has no money to go out anymore.Hey we can’t let Jerry beat us, so let’s credit this agenda to its rightful originator, Strotz (1956), before his fourteen year presidency of Northwestern.
- Gary Becker (1973) only barely edged out Sylvester Stallone (1976) on the importance of strategic complements in the marriage model. Sly had has this wonderful metaphor in Rocky: “I dunno, she’s got gaps, I got gaps, together we fill gaps.”
- Patrick Billingsley – who taught me convergence of probability measures at Chicago — was also a part-time actor. I was unaware he was a bailiff in “The Untouchables” (with Kevin Costner, Sean Connery, and Robert De Niro). His Probability and Measure textbook was his chef d’oeuvre. I find it cool that a world-renowned star of probability pursued his passion as an obscure actor.
- Why won’t the Happy Days owners release season 5 and later on dvd? After all, I have been waiting over two years to get past season 4. For the uninitiated, this is the season in which the TV series gave us the timeless metaphorical image to “jump the shark”. Perhaps they do not want to reveal this moment of futility?PS Which research agendas in the profession have also “jumped the shark”. ^_^ And could it be that their ratings (citations) decline long after their fundamentals do?
In the early 1970s, Gary Becker was hitting stride, knocking out economic theories of crime, the allocation of time, discrimination, marriage, and children in rapid succession. His theory of marriage treated the marriage scene like any other economic market, cleared by a price. Men bid for women, and women bid for men. In a shallow view of his model, women sought handsome men, and men beautiful women, and beauty was not in the eye of the beholder. Becker’s main theorem — whose proof he credits to my esteemed colleague Buz Brock — found that the men and women efficiently sorted by their beauty when their beauties were complements.
I visited the Cowles Foundation at Yale for the winter of 2006, and taught a senior elective course. Seven fortunate students took my seminar in information economics. One impressive woman student — who organized the gay and lesbian social scene — asked whether the shallow view of Becker’s model was so unrealistic. Did babes match with hunks?
We brainstormed on data sources and settled on two new web sites: facebook.com and hotornot.com. Facebook allowed users to indicate with whom they were “in a relationship with”. Facebook was still new, and not yet open to all email addresses. So the student asked her friends at various campuses across America for their logins. And so began our stealth project. Hundreds of photos of matched men and women were downloaded, and then uploaded to HotOrNot, all on the sly. HotOrNot afforded us the average evaluation of about 200 women for every man, and 2000 men for every woman.
The result: Regressing straight men’s or women’s hotness on their partner’s hotness gave a highly significant fit, with a slope of about 0.7 — so that a man rising in hotness from 7 to 8 expects his partner to rise by 0.7 points. But sorting was far closer for gays and lesbians, with a slope for each of about 0.9. As Becker implied, beauty is income in this meat market, and the “richest” men match with the “richest” women.
Hat Tip: Frank’s comment in post below
To Be or Not To Be, That is the Question…
A hard question to answer in a business school professor’s teaching life. Am I just teaching common sense? Is This Material Too Simple? Existential questions. And then comes evidence that actually rather basic knowledge is quite helpful. Witness the startling article “Real-Life Lessons in the Delicate Art of Setting Prices” in the NYT.
Lesson 1: Inelastic Demand
‘About three years ago a computer error caused all of the prices on Headsets.com to be displayed at cost rather than retail. With the lower prices on display for a weekend, Mike Faith, the chief executive, expected sales to soar. Instead, the increase was marginal. “It was a big lesson for us,” Mr. Faith said’
Lesson 2: Vertical Differentiation and Market Power
(1) Math tutor Kronenberg:
‘I learned it’s a misconception that if you raise prices too much, you’ll have no business,” Mr. Kronenberg said. “There are many customers who shop based on quality, not lowest price.’
(2) Headsets.com:
‘[Mike Faith] realized that sales for his company, which is based in San Francisco, were far less dependent on price than on what he now says differentiates his business: customer service. “Every call we get is answered by a human being within four rings,” he said, “and our reps are well trained and know a lot about the headsets.”
Since the incident, Mr. Faith has raised prices once, by 8 percent and without much fanfare, although regular customers were told in advance. The result? Revenue rose about 8 percent as well.’
(3) Artisan wheat flour producer:
`Naomi Poe, founder of Better Batter Gluten Free Flour near Altoona, Pa., learned that it is important to try to understand how your customers value your product.
In the food industry, Ms. Poe said, customers generally look for the cheapest price, but because her flour and baking mixes contain no gluten, they cost more to manufacture. She initially tried to compete with products that contain gluten on price but lost money on every sale. To raise prices, she had to convince customers her products offered added value. “In blind taste tests on regular people — not just those who are gluten-free — we heard consistently that our cakes were superior,” she said. “We also offer an unconditional guarantee as well as education and counseling.”
Her first year in business, 2008, she raised prices 20 percent, increasing her gross profit margin — the profit on each item she sells — about 11 percent and increasing sales revenue 25 percent, she said.“This helped us cover our expansion costs in 2008,” Ms. Poe said. After that, the business grew about 250 percent year to year.’
(3) Lesson 3: Price Discrimination
‘Last year [Footsyrolls, a company producing roll-up flat shoes] changed their offerings, going to two tiers of products and pricing. The Everyday Collection sells for $20 a pair and a higher-end category, Lux, for $30 a pair. “We actually have had the most interest in our higher-priced shoes,” Ms. Caplan said.
Because they brought one line down $5 and another up $5, the average price per unit remained about the same, but the impact was immediate. “We introduced the Lux line in summer 2010 and had a 100 percent increase in revenue,” she said. “We actually ran out of stock.”’
Lesson 4: These people need more lessons.
(1) Mike Faith: ‘The truth about pricing is it’s an art with a little bit of science, rather than a science with a little bit of art.’
No, Mike! It’s the other way round.
(2) Naomi Poe: ‘In January she raised prices an additional 10 percent, this time to cover broker and distributor fees as well as the rising cost of fuel and ingredients. Far from losing customers, she saw her revenue double and her gross margins leap to about 36 percent from 20 percent.’
Revenue is not the same as sales. Sales can go down when you raise price and revenue go up. If this happens, your price is in “negative marginal revenue” territory so your pricing strategy is horribly wrong. Perhaps a short exec ed course at the Kellogg School of Management taught by me for a large but well worth it fee will help you learn what marginal revenue means and make you hundreds of thousands in profits.
Cheap Talk 