Mac Users and Price Discrimination

NB: A careful reader points out that it is only the selection of rooms and not the price of the rooms that is different.  Which is too bad: they aren't as clever as I thought...

A fascinating little tidbit from the Wall Street Journal (as reported by Briar Dudley of The Seattle Times):

If you're looking for a deal on hotel rooms, perhaps you should use a Windows PC instead of a Mac.

According to a new Wall Street Journal report, travel giant Orbitz has begun offering some Mac users more expensive hotel rooms.

That's based on past spending patterns of Mac users. After tracking and analyzing this, Orbitz decided to experiment with offering Mac users "different, and sometimes costlier, travel options," the Journal reported.

From the article:

Orbitz Worldwide Inc. has found that people who use Apple Inc.'s Mac computers spend as much as 30% more a night on hotels, so the online travel agency is starting to show them different, and sometimes costlier, travel options than Windows visitors see.

The Orbitz effort, which is in its early stages, demonstrates how tracking people's online activities can use even seemingly innocuous information—in this case, the fact that customers are visiting Orbitz.com from a Mac—to start predicting their tastes and spending habits.

Orbitz executives confirmed that the company is experimenting with showing different hotel offers to Mac and PC... (and here the paywall kicks in, but pone presumes the next word is 'users')

Students of economics will recognize this a good old fashioned price discrimination: charging different users different prices based on willingness to pay. In this case a Mac is a bit of a luxury item - Mac users pay a premium for a Mac over a PC - and thus is a sign that on average Mac users might have a higher willingness to pay for some items.

Orbitz has found that Mac ownership (or usership, really) is correlated with higher spending on hotels and so it uses this info to change them a higher price. In economics we call this information (that you are using a Mac) the 'identification' problem: being able to tell who has a higher willingness to pay. The other problem, the 'arbitrage' problem, would come about when a bunch of PC users booked hotel rooms and sold them for a discount to Man users - not likely in this case.

The thing about price discrimination is that sure it is a profit maximizing strategy for firms but it is important to note that two things happen when firms price discriminate: One, customers with higher willingnesses-to-pay end up paying more than they would under a one price regime, but customers with lower willingnesses-to-pay end up paying less than they would under a one price regime. Two, more hotel rooms get rented because by lowering the price on low willingnesses-to-pay people more and more will do so. So how you feel about price discrimination depends on whether you are a high willingnesses-to-pay person or a low willingnesses-to-pay person.

Of course, if this kind of thing takes off there is a type of arbitrage solution: use your friends PC to book, or use some kind of browser that mimics a PC. [I am no techie, but this must be a pretty easy work around, no?] But you can imagine the possibilities.  If you log into a place with your Facebook account and they can see where you live, they know the average income of your area, to give one example and can charge you a price accordingly.  This is great if you live in a low income area, not so great if you live in a wealthy neighborhood.

Econ 101: Price Discrimination Redux

It occurs to me that one reason current Timbers season ticket holders snapped up the $99 tickets is this: many of them are probably Timbers Army folks who surmised - rightly - that there will be plenty of TA section tickets available when the general public gets to buy tickets and who also surmised - possibly correctly, we'll see - that if they bought $99 season tickets, they could resell them for a lot more than face value.

In other words, the $99 tickets were an arbitrage opportunity: buy them now and buy the regular TA section tickets later (it is general admission so it doesn't matter when you purchase them).  Then sell the $99 tickets later for more money.

Methinks the TA folks knew a good opportunity when they saw it...

RCTID!

Econ 101: Price Discrimination

The Oregon State Beavers have finally learned a little something about price discrimination.  The Oregonian reports that they have increased seat sales by lowering prices - wow, who would have guessed? But you don't always want to sell every unit of a product that you can, especially when you have market power.  This is the lesson of the monopolist.

Consider the example of a downtown parking lot, you might wonder why, if a lot regularly has empty spaces, the lot owners don't just lower the price?  The reason is of course that to fill the lot they may have to lower the price so much that their total revenue actually goes down.  This is because they have to charge the same price to all of their customers.

The way around this is price discrimination which in this case means charging different customers different prices based on their willingness to pay.  Parking lots do a little of this, charging reduced all-day rates to customers that park before a certain time - the idea is that parkers who come in later in the day face a more competitive parking environment and are less price sensitive.

The general rule is that the more you can price discriminate the more you are willing to sell because selling more no longer means that you have to charge lower price to everyone. It is also generally true that the more you are able to price discriminate the more revenue you will be able to make.

In the case of a football stadium, price discrimination is easy: you can still charge a high price for the best seats while reducing the price of the more marginal seats, just as OSU has done.  Before you pass judgement on OSU for being so dense no to have figured this out before you have to realize that there is a constraint: you don't want to make it so attractive that folks that would normally pay for expensive seats find the good deal too tempting and would opt for the cheaper ones.  

An example of this that I have recently encountered is the current Timbers season ticket sales.  They started selling them first to 'priority groups' starting with current season ticket holders.  Now these would likely consist of some of the highest willingness-to-pay folks, but the Timbers also made a bunch of $99 season tickets available from the outset - and these were apparently so tempting even with their less desirable location that they were snapped up right away by the 'wrong' folks.

This decision confuses me - I would have thought that they would not have reduced the price of seats to such a low price until after season ticket sales had been opened up to non 'priority' folks.  But I guess the $99 price was a marketing gimmick to get people to consider season tickets from the start.

The difficulty in trying to get the 'right' people (the low willingness-to-pay people) to buy the low price tickets is a general difficulty in price discrimination.  When you can't tell the willingness-to-pay of customers it becomes tricky to design a pricing scheme that gets people to self-select into the right categories.  Clearly if the goal of the $99 Timbers tickets was to get marginal fans to become season ticket holders, it failed.  So whether the Beavers were smart in reducing the price of these tickets depends on whether people that would not normally have attended a game buy them or whether customers swap high priced tickets for these.  Apparently, as overall sales have increased, it looks like mostly the former.

Beeronomics: Non-Linear Pricing

Here is a picture I took the other day at the Deschutes' Portland pub.  It is a little out of focus, the iPhone not quite up to the job of low light detail work, but notice how the beers are priced: $5 for 500ml and $3 for 300ml.  In other words exactly 1 cent per ml.  This seems straightforward, but to me it was astonishing as you almost never see this kind of 'linear' pricing in beer.  Most places are like the Full Sail Tasting Room and Pub in Hood River which prices their imperial pints at $4.25 and half pints at $3.  This is what economists refer to as 'non-linear pricing:' when the price per unit changes as the total units change.  So a pint at Full Sail is about 21 cents an ounce and a half pint is 30 cents an ounce.  This is the norm and it is everywhere in product markets: beer, soda, chips, socks ($4 a pair or 3 pairs for $10), you name it. The question for all you budding economic naturalists (or Beeronomic naturalists) is, why?

One reason for this type of pricing is simple: costs.  It can be cheaper to sell in larger quantities.  I talked recently about the cube-square rule that generally affects packaging costs: the volume from bigger packages increases at a faster rate than the surface area of the packaging - so the costs per unit of the packaging decrease with volume.  There are reduced transactions costs per unit for bulk purchases as well.  In a pub setting, smaller servings may mean more glassware to bus and wash and more visits per table by servers.  So some of what we might be seeing in non-linear pricing is just a reflection of the added costs of smaller quantities.  

But not always.  Bill at the It's Pub Night blog has had an ongoing fascination with non-linear pricing in beer, focusing particular attention on the inflated price of 22 ounce bottles that have gained so much popularity.  Given the cube-square rule and the lower amount of packaging (no paperboard holders) you would assume that the six-pack would be costlier per ounce of beer and therefore if price was just a function of costs, 22 ounce bottles would be less expensive per ounce than six-packs, but Bill finds that the opposite is true.  So, again, what is going on?

The answer, to economists, is well known and goes by the term 'price discrimination,' or more specifically in this case 'second-degree price discrimination.'  Price discrimination in general is the ability to charge different customers different prices for the same good based on their ability to pay.  You charge more to people who value the good more and less to those that don't.  If you can do this two things happen: you do better as a seller, and you sell more than you would otherwise.  You do better because you get to capture most of the surplus from each transaction and you sell more because if you were forced to sell everything at the same price you would keep it reasonably high (if you had any market power) and thus the folks who didn't value it that highly might not get to buy.  If you can charge different prices, however, you are quite willing to sell at a low price to a customer with a low value of the good because you can still sell to the high valuation customer at a high price.

Portland's saturday market is a good laboratory to see how this works.  Go to a booth where an artisan does not post prices and observe how prices are quoted.  You will probably find that price will fluctuate based on some observable characteristics about the customer that might be reasonably related to willingness to pay for the artisan's wares: fancy clothes, watch, age, extra excitement, and so on.  To illustrate this phenomenon I always tell my students tales from when I was a Lewis & Clark College student studying overseas in India and would go to the market.  After a while I got to know the regular prices, but as soon as they saw an obvious westerner, the shopkeepers would immediately double, triple or quadruple the asking price (it helped to know a little Hindi to hear how the prices changed from a local to me).  The shopkeeper made the correct assumption that a westerner in general had a much higher willingness to pay than a local and thus wanted to extract more surplus from that transaction.  He was practicing price discrimination and thus showed himself (it was almost always men) to be a good economist.

This is close to what we refer to as first-degree price discrimination where you can tell something about individual willingness to pay for a good.  The problem with this type is that most market situations are more anonymous - you can't tell by looking at them anything about their willingness to pay or you don't even see them at all.  So what to do, well you might be able to get different types of customers to differentiate themselves by offering different prices.  This is 'second-degree' price discrimination.

Take the pub as an example.  Suppose you know that there are two types of customers: high demand and low demand.  Low demanders are only going to buy one beer and are willing to pay up to $6.  High demanders willingness to pay for one beer is $6, $5 for the second and $4 for a third or a total of $15 for three.  Now let's suppose there are equal numbers of both types and so let's talk about a single table of two people, one of each type.  Lets also assume the marginal cost is constant so that it costs them $2 to provide every beer.  The pub could charge $6 a beer and would sell two, get $12 in revenue, $4 in costs and clear $8 in net revenue.  Or they could charge $5 a beer and sell three, and make $9 net.  Or they could charge $4 a beer sell four (one to the low demander and three to the high), and make $8 net.  But a clever publican would offer a different deal: $6 per beer or three for $15.  The low demander will buy their one beer for $6 and the high demander will go for the three beer deal (if you prefer make it $14.99 so he strictly prefers this deal and gets $0.01 in surplus over one $6 beer).  The pub will make $6 + $15 in revenue, will have $8 in costs and will net $13!  Clearly this is a better plan for the pub and notice it does not require knowing which customers are high and low demanders - they self-select.

This is classic third degree price discrimination and can be applied to Bill's 22 ounce bottles as well.  There are low demanders for these beers who want just a wee bit to taste and high demander who will drink much more.  By pricing the 22 ounce bottle so much higher you charge a premium to the low demanders and you give a discount to the high demanders by offering them a volume discount in six packs (and generally even better deals with 12 packs).

But Bill should not despair (assuming he is a high-demander) because this strategy generally benefits the high demander - they get lower prices than they would in the absence of the price discrimination.  Thus the 22 ounce bottle is a good thing for the six-pack buyer.  Why?  Well, go back to my pub example and notice that the high demander pays only $5 per beer, rather than the $6 they would have paid without price discrimination.

This is a general rule in price discrimination: some groups benefit and some suffer from the practice.  In this case, high demanders see lower prices, but low demanders get the same price.  This is due to the particular simplicity of my example, more often low demanders see higher prices.

Cheers!

Econ 101: Price Discrimination and Arbitrage

On Craigslist just now, I found a 1995 Ford F150 truck advertised for $1000. I could buy this truck and immediately turn it in for a $4500 Cask for Clunkers rebate on a car that got at least 25 MPG. Or I could turn around and sell it to someone walking onto a new car lot who is ready to buy a car. In fact I am not sure why new car dealers are running around snapping up cars like this to offer to prospective customers so that they may take advantage of the Cash for Clunkers program (or perhaps they are). This example illustrates the difficulty of price discrimination.

Price discrimination is, among a few other things, charging different people different prices usually based on their willingness to pay (demand) for it. A classic example is the movie theater with its adult and child prices. Adults are generally willing (able) to pay more for a movie than children are. In the Cash for Clunkers program the government wants to essentially charge a lower price to people with cars that are not very fuel efficient. The challenge to such pricing schemes is that you have to be able to prevent arbitrage - the buying and selling of the same good for different prices. Otherwise you would have kids camped outside of theaters buying up tickets and reselling them to adults. Or people like me buying up old cars and reselling them to people without poor fuel efficiency cars so that they may enjoy the Cash for Clunkers rebate. In this case the program is temporary and the cost of searching for, re-titling the car and turning it in is probably enough to prevent this from happening too much - maybe. But the theater example is easy, which is why there are ticket takers at the door that check that adults are not entering with kids tickets.

Since businesses go for price discrimination it is probably pretty obvious that it is a profit maximizing strategy. In fact, in general, the more businesses are able to price discriminate the more profit they make. Interestingly, however, it is also generally true that more price discrimination leads to more sales which is good for market efficiency. Is it good for consumers? Well when it is done on the basis of group membership it usually depends on which group you are in. For example, when airlines charge more for business travelers and less for vacationers, the business travelers are paying more than they would in the absence of price discrimination, but leisure travelers pay less.

Another example of price discrimination that was brought to my attention is the reciprocal agreements that museums and zoos have. For example, a family membership in the Science Factory in Eugene costs $55, while a family membership in OMSI is almost twice that. This is a type of price discrimination as well - although the products aren't identical it is likely that the demand for science museums are different in the two cities. There is no restriction to becoming a member of the Science Factory as a Portlander and since the two museums have a reciprocity agreement, you could get into OMSI as much as you wanted on the Science Factory card. I almost didn't blog about this as I worried I would spark a surge of defecting OMSI patrons, until I scoured the OMSI website and found the link to the Association of Science - Technology centers which states this about the reciprocity agreement:

Please note—local restrictions apply

1. Based on your science center's/museum's location: Science centers and museums located within 90 miles of each other are excluded from the program unless that exclusion is lifted by mutual agreement. 90 miles is measured "as the crow flies" and not by driving distance. Science centers/museums may create their own local reciprocal program. ASTC does not require or participate in these agreements, or dictate their terms.

2. Based on your residence: To receive Travel Passport Program benefits, you must live more than 90 miles away from the center/museum you wish to visit. Admissions staff reserve the right to request proof of residence for benefits to apply.

So either they were smart at the outset or quickly learned about arbitrage the hard way (I hope OMSI staff are checking). The zoo association has only weak language about not offering to member of zoos that are too close but does not have the residency requirement. So here is a hint for you folks living in Seattle: the Oregon Zoo charges $69 for a family membership, while the Woodland Park Zoo charges $110. Why would you buy a membership up there when you can save $41 a year as an Oregon Zoo member? Oregon is much hipper anyway and this can give you the vicarious thrill of belonging, in some small way, to the state.