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Entertainment and Media: Markets and Economics

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1 Entertainment and Media: Markets and Economics
Professor William Greene

2 Economic Foundations for Entertainment and Media
Pricing and Value for Experience Goods

3 Demand and Value Demand and Demand Curves Pricing Pricing strategies
Price discrimination Pricing innovations

4 “Value” What is it? Creating Value Capturing Value
From the consumer’s viewpoint From the seller’s viewpoint Creating Value Capturing Value Meaning Sources of value Slightly out of place, but an important concept, and they are going to want to talk about it.

5 Pricing and Value from the Consumer’s Viewpoint

6 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 Price and Value 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? 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.

8 An Important Aspect of Prices for Experience Goods: The Implicit Price
Kelly Clarkson, Beacon Theater 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.

9 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 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 Different buyers have different reservation prices. Therefore, demand curves slope downward. This is the total consumer surplus that can be extracted from all stages of this market. Price Pm Qm Quantity

11 Scalping: Reallocates the Surplus
Why does Ticketmaster care? Do Hanna Montana and the Spice Girls care?

12 A Merger Made in Heaven

13 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 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.

16 Economic Foundations for Entertainment and Media
Strategic Pricing for Experience Goods

17 Demand Concepts Prices Consumer Reaction to Changes in Price
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 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 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

20 Pricing Strategies Exploit pockets of market power
Take advantage of market imperfections Exploit unusual market configurations

21 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 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. Short run profit is obtained by transferring consumer surplus from buyers to the seller. P* Marginal Cost Demand Qm Marginal Revenue

23 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. Price |Elasticity| > 1 (Elastic) |Elasticity| < 1 (Inelastic) MC D Quantity MR 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.

24 Concert Ticket Prices: Live Nation Effect
Connolly, M. and Krueger, Al, “Rockonomics” Concert Ticket Prices: Live Nation Effect

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26 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 “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 ATL BAL BOS CIN CLE DET HOU KCR MIL MIN NYM NYY

28 Are owners really pricing irrationally?

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31 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,

32 Examples Concerts and “Stuff”
Sports and Skyboxes plus all the other stuff including food Movies and the food concession stands

33 Two Part Pricing Strategy: Movie Studios to Retailers – Videotapes
Tapes: Marginal Cost = $3.00 One time: $ $80.00 Revenue Share: $8/tape + x% of rental Unclear which was the better price strategy

34 The Disneyland Dilemma
Two part tariff (price): Entry Fee Fixed Marginal Fee Per attraction 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 ; One part 1982-now 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

35 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 Rye Playland, Rye NY

37 Pricing and Value from the Consumer’s Viewpoint

38 Event Consumer Surplus
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) Price Per Ticket 90 80 70 60 50 40 30 20 10 = 9,000(55) = 495,000 = 11,000(45) = 495,000 = 20,000(15) = 300,000 = 16,000(5) = 80,000 = 1,370,000 15 Tickets (1000s) How can promoters capture the consumer surplus in markets like this?

39 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 Perfect Price Discrimination
First degree discrimination Every consumer pays their reservation price The seller extracts all surplus value Profit is maximized absolutely Price Marginal Cost Demand Quantity

41 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 2002 Mets Play Ball!

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46 2003 Mets Price Experiment

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49 Dynamic Pricing

50 Dynamic pricing might also work for commodities priced on the internet.
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.

51 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.

52 Yankee Stadium Pricing

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54 Pricing by Attributes at Fenway Park

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57 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 Quantity Discounts at Disney World

60 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

61 Third Degree Price Discrimination
Direct market segmentation Identify segments, higher margins where demand is less elastic Price per ticket Price per ticket Others Seniors, Kids Demand MC MC Demand MR MR Tickets Tickets

62 Third Degree Price Discrimination
P,MC Inelastic Market Segment Elastic Market Segment PHIGH PLOW

63 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 = (32) = 132

64 Two Segment Market Why do the elasticities differ? How can North Holland prevent arbitrage?

65 Two Price Regime at Amazon Prime

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67 Magic Pricing Kingdom

68 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 Kelly Clarkson plays Jones Beach, NY

70 Pricing the Mac What was going on here? Black Mac $1499
White Mac $1349 What was going on here? “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.

71 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 $85 includes License fee for Yankees lid.
$40 for Pink, Red, Blue, Green, Purple.

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75 More Price Discrimination

76 High Flying Price Discrimination

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79 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,

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81 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 Price Discrimination in Concerts. About 5% impact on gross revenues
The Impact of Price Discrimination on Revenue: Evidence from the Concert Industry, P.Courty and M. Pagliero, Review of Economics and Statistics, 94, 2012, Frequency of price discrimination for acts with > 300 concerts. Discrimination defined as more than a single ticket price, e.g., floor vs. bleacher.

87 Pricing Downloads

88 Hard Cover U.S. Version Amazon.com September 14, 2007
($ as of 9/13/10)

89 Amazon.co.uk ₤50.34 = $ (September 13, 2007)

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91 International Pirated Edition: Very Low Price!
Renmin University of China All 827 pages

92 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 Lion King, Orpheum, SF Segmentation by Attributes

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95 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

96 Time Warner Cable Bundles

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99 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 Entertainment and Media: Markets and Economics
End Class 1 – Part 3


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