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

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Presentation on theme: "Pricing Experience Goods 1:3 - 1(96) Entertainment and Media: Markets and Economics Professor William Greene."— Presentation transcript:

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

2 Pricing Experience Goods 1:3 - 2(96) Economic Foundations for Entertainment and Media Pricing and Value for Experience Goods

3 Pricing Experience Goods 1:3 - 3(96) Demand and Value Demand and Demand Curves Pricing Pricing strategies Price discrimination Pricing innovations

4 Pricing Experience Goods 1:3 - 4(96) Value What is it? From the consumers viewpoint From the sellers viewpoint Creating Value Capturing Value Meaning Sources of value

5 Pricing Experience Goods 1:3 - 5(96) Pricing and Value from the Consumers Viewpoint

6 Pricing Experience Goods 1:3 - 6(96) Reservation Price: Price Strategy Under Uncertainty Your reservation price is $2,500. Auction to take place in 5 days. What would you do now?

7 Pricing Experience Goods 1:3 - 7(96) 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: its always a construct, provisionally defined by a capricious market and the locality of the transaction. Things cost what they are being sold for, and theyre worth whatever the seller can get. … Look at it like this: Lets 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, youd gladly fork over $5,000. Would you feel the need to inform the seller, You know, Id actually pay you $3,000 more than what youre asking? I dont 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 sellers asking price if you know the value of the item to be significantly higher than what is being asked? Lets 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?

8 Pricing Experience Goods 1:3 - 8(96) 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

9 Pricing Experience Goods 1:3 - 9(96) Consumers Valuation of Products Surplus 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.

10 Pricing Experience Goods 1:3 - 10(96) 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 sellers 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.

11 Pricing Experience Goods 1:3 - 11(96) Scalping: Reallocates the Surplus Why does Ticketmaster care? Do Hanna Montana and the Spice Girls care?

12 Pricing Experience Goods 1:3 - 12(96) A Merger Made in Heaven

13 Pricing Experience Goods 1:3 - 13(96) 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

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15 Pricing Experience Goods 1:3 - 15(96) Live Nation Also Owns Tickets Now Ticketmaster and Live Nation were opposed by DOJ Tickets Now is LNEs own scalper. This is a vertical integration case. We will revisit later in the vertical integration section.

16 Pricing Experience Goods 1:3 - 16(96) Economic Foundations for Entertainment and Media Strategic Pricing for Experience Goods

17 Pricing Experience Goods 1:3 - 17(96) 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?)

18 Pricing Experience Goods 1:3 - 18(96) 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

19 Pricing Experience Goods 1:3 - 19(96) Demand Curves from the Sellers 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

20 Pricing Experience Goods 1:3 - 20(96) Pricing Strategies Exploit pockets of market power Take advantage of market imperfections Exploit unusual market configurations

21 Pricing Experience Goods 1:3 - 21(96) 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.

22 Pricing Experience Goods 1:3 - 22(96) 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.

23 Pricing Experience Goods 1:3 - 23(96) Monopoly Pricing Monopolist 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

24 Pricing Experience Goods 1:3 - 24(96) Concert Ticket Prices: Live Nation Effect Connolly, M. and Krueger, Al, Rockonomics

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26 Pricing Experience Goods 1:3 - 26(96) 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)

27 Pricing Experience Goods 1:3 - 27(96) 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 Attendance Elasticity Real Ticket Price ANA -0.88 ATL -0.57 BAL 0.72 BOS 0.57 CIN 1.95 CLE 2.74 DET 0.78 HOU -2.31 KCR -1.46 MIL -1.14 MIN -0.46 NYM 0.85 NYY 0.73

28 Pricing Experience Goods 1:3 - 28(96) Are owners really pricing irrationally?

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31 Pricing Experience Goods 1:3 - 31(96) 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.

32 Pricing Experience Goods 1:3 - 32(96) Examples Concerts and Stuff Sports and Skyboxes plus all the other stuff including food Movies and the food concession stands

33 Pricing Experience Goods 1:3 - 33(96) 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

34 Pricing Experience Goods 1:3 - 34(96) 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 Monopoly Walter Y. Oi The Quarterly Journal of EconomicsVol. 85, No. 1 (Feb., 1971), pp. 77-96

35 Pricing Experience Goods 1:3 - 35(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.)

36 Pricing Experience Goods 1:3 - 36(96) Rye Playland, Rye NY

37 Pricing Experience Goods 1:3 - 37(96) Pricing and Value from the Consumers Viewpoint

38 Pricing Experience Goods 1:3 - 38(96) 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?

39 Pricing Experience Goods 1:3 - 39(96) 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

40 Pricing Experience Goods 1:3 - 40(96) 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

41 Pricing Experience Goods 1:3 - 41(96) 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)

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44 Pricing Experience Goods 1:3 - 44(96) 2002 Mets Play Ball!

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46 Pricing Experience Goods 1:3 - 46(96) 2003 Mets Price Experiment

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49 Pricing Experience Goods 1:3 - 49(96) Dynamic Pricing

50 Pricing Experience Goods 1:3 - 50(96) Time of Purchase Another 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. D ynamic pricing might also work for commodities priced on the internet.

51 Pricing Experience Goods 1:3 - 51(96) Since 2011, the shows 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.

52 Pricing Experience Goods 1:3 - 52(96) Yankee Stadium Pricing

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54 Pricing Experience Goods 1:3 - 54(96) Pricing by Attributes at Fenway Park

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57 Pricing Experience Goods 1:3 - 57(96) Second Degree Price Discrimination Quantity discounts Smaller purchaser generally has the less elastic demand. Applications: Groceries Multiple site theme parks (Disney)

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59 Pricing Experience Goods 1:3 - 59(96) Quantity Discounts at Disney World

60 Pricing Experience Goods 1:3 - 60(96) Direct Market Segmentation Different prices to different buyers Direct Market Segmentation by Elasticity Senior citizen discounts at movies Business vs. coach class air fares Mens and womens shirts at dry cleaners

61 Pricing Experience Goods 1:3 - 61(96) Third Degree Price Discrimination Direct market segmentation Identify segments, higher margins where demand is less elastic Price per ticket Seniors, Kids Others Tickets Demand MR MC

62 Pricing Experience Goods 1:3 - 62(96) Third Degree Price Discrimination Inelastic Market Segment Elastic Market Segment P,MC P HIGH P LOW

63 Pricing Experience Goods 1:3 - 63(96) Market Segmentation For every single price regime, there is a two price regime that is more profitable. (Assuming market segments exist.) Separable Markets; Assume MC = 5. One Price = 8, Revenue = 8(4)+8(28)=256 Profit = 256-5(32) = 96 Two Prices: PL=5, Revenue=50 PH=11, Revenue=242 Total Revenue=292 Profit = 292-5(32) = 132

64 Pricing Experience Goods 1:3 - 64(96) Two Segment Market Why do the elasticities differ? How can North Holland prevent arbitrage?

65 Pricing Experience Goods 1:3 - 65(96) Two Price Regime at Amazon Prime

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67 Pricing Experience Goods 1:3 - 67(96) Magic Pricing Kingdom

68 Pricing Experience Goods 1:3 - 68(96) 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)

69 Pricing Experience Goods 1:3 - 69(96) Kelly Clarkson plays Jones Beach, NY

70 Pricing Experience Goods 1:3 - 70(96) 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?

71 Pricing Experience Goods 1:3 - 71(96) Real Differences Not Proportional to Marginal Cost $300 for 2GB of memory and 90GB on the hard drive. Marginal cost near zero.

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73 Pricing Experience Goods 1:3 - 73(96) $85 includes License fee for Yankees lid. $40 for Pink, Red, Blue, Green, Purple.

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75 Pricing Experience Goods 1:3 - 75(96) More Price Discrimination

76 Pricing Experience Goods 1:3 - 76(96) High Flying Price Discrimination

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79 Pricing Experience Goods 1:3 - 79(96) The Producers Price Index Price discrimination based on two attributes, seat location and day/time. Further promotional discounts, day of show via TKTS = 3 rd 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,

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81 Pricing Experience Goods 1:3 - 81(96) 1. Place of the seat relative to the stage. 2. Programming 3. Time and date of the show 4. Time of purchase

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86 Pricing Experience Goods 1:3 - 86(96) 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.

87 Pricing Experience Goods 1:3 - 87(96) Pricing Downloads

88 Pricing Experience Goods 1:3 - 88(96) Hard Cover U.S. Version September 14, 2007 ($136.69 as of 9/13/10)

89 Pricing Experience Goods 1:3 - 89(96) 50.34 = $102.30 (September 13, 2007)

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91 Pricing Experience Goods 1:3 - 91(96) International Pirated Edition: Very Low Price! Renmin University of China All 827 pages

92 Pricing Experience Goods 1:3 - 92(96) 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.

93 Pricing Experience Goods 1:3 - 93(96) Lion King, Orpheum, SF Segmentation by Attributes

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95 Pricing Experience Goods 1:3 - 95(96) Bundling Applications Cable TV Basic Basic+Premium+Music Choice Econometric Analysis 6 th ed. with answers What is the strategy? (Not specific to experience goods: Phone services Car features

96 Pricing Experience Goods 1:3 - 96(96) Time Warner Cable Bundles

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99 Pricing Experience Goods 1:3 - 99(96) 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

100 Pricing Experience Goods 1:3 - 100(96) Entertainment and Media: Markets and Economics End Class 1 – Part 3

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