Category Archives: business

Damodaran on Uber’s Valuation

It is fascinating to watch this back-and-forth between NYU Prof Aswath Damodaran and Uber board member Bill Gurley on the taxi company’s valuation.

To set the context, when the latest funding round for Uber was announced, valuing it at USD 17 billion, Damodaran – a guru in valuation – wrote his own analysis which valued the company at about a third of that value. While it was a typical Damodaran post – long, detailed and making and stating lots of assumptions – it was probably intended as an academic exercise (the way I see it).

Instead it seems to have really caught the fancy of the silicon valley investment community, and led to a response by Gurley (I admit I haven’t read his full response – it seemed to attack straw men in places). And Damodaran has responded to the response. Now that the Three Way Handshake is complete I don’t expect any more backs and forths, but I won’t rule it out either (it’s possible but not plausible, to use Damodaran’s terminology).

What fascinates me is why an academic’s academic post on valuation of a company has created so much of a flutter – so much to merit a long-winded response from the board member. I’m reminded of two things that my valuation professor had told me some 10 years back when I was in business school.

1. Valuation is always wrong
2. Value of a company is what the market thinks it’s valued at

The first of these is a bit of a motherhood statement and adds no value to this particular discussion so let’s not take that into account. It’s the second reason that has got the investors’ knickers in a twist.

In the past, I’ve seen Damodaran publish valuations of companies that are about to go public, or are already public – Tesla and Twitter for example. It is usually an academic exercise, and Damodaran’s valuations value these companies at lower than what the market values. However, given that these posts have appeared after there has been a broad consensus of a company’s valuation, it has not really impacted a company’s valuation, and thus have been treated as an academic exercise.

The problem with Uber is that it is a private company, and unlikely to go public for a very long time. The problem with a private company is that it is difficult for investors to agree on its valuation – there are very few trades and the stock is illiquid (by definition). And illiquidity means extremely high bid-ask spreads (to put a technical spin on it) and widely varying valuations.

Sometimes, when nobody knows what something is valued at (like Uber – which is creating a new category which no one has any experience in valuing), what people look for is some kind of a peg, or an “anchor”. When they see what they think is a reasonable and broadly reliable valuation, they tend to use that valuation as an “anchor” and if a large number of investors agree on one such anchor, the anchor ends up being the company’s valuation itself.

To reiterate, value of a company is what the market thinks it’s valued at. Nobody knows what Uber is valued at. Investors and existing shareholders agreed at a particular valuation, and did a deal at that valuation. However, this valuation is not “deep” – not too many people agree to this valuation.

It is in this context that an (very well renowned) academic’s valuation, which values the company at far less than the last transacted price, can act as an anchor. Damodaran is extremely widely respected in investing circles, and hence his valuation is likely to have received much attention. It might even be possible that his valuation becomes an “anchor” in investors’ minds of Uber’s valuation. And this is where the problem lies.

Even if you were to account for the consistent downward bias in Damodaran’s valuations and adjust Uber’s valuation accordingly, it is likely to lead  to a much lower anchor compared to the last transacted price. And this is not likely to be good for existing investors. Hence, they need to take steps to quickly debunk Damodaran’s valuation, to make sure it doesn’t end up as an anchor! And hence the long response by Gurley, and the silicon valley investor community in general!

To summarize, all that this entire brouhaha on Uber’s valuation shows is that its price discovery so far has been rather shallow.

Available only on flipkart

This mornings mint has a full page advertisement on the front page announcing the launch of the moto x phone in India. The ad mentions that the phone is available in India exclusively on flipkart the online retailer. The question is if this is a good idea.

While it is true that online retail offers the best costs and prices – thanks largely in part to the massive savings on real estate and inventory costs, I’m not sure if we are still thee at a stage where retail can be online only. In fact people like to touch and feel the stuff that they’re buying. Especially when it comes to big ticket purchases such as a phone. Without giving people the opportunity to do so – shops won’t carry the dummy model unless they’re also selling it, at a good margin – I’m not sure how many will want to make the jump and buy.

On a related note I saw a report last week, again in mint, talking about pushback from offline retailers and malls to the online retail phenomenon. This brings into focus how retail will evolve going forward since people now have a low cost (low inventory, zero real estate) option for making their purchases. We’re already seeing some “progress” in that direction where people go to malls and high streets to browse and get a touch and feel and then buy online where the prices are lower.

This points to one direction in which retail might evolve – soon stores in malls and high streets might be set up with the primary purpose of building the brand and letting customers get a touch and feel. Any sales from these stores for the brands will only be a bonus – the primary purpose being to let people know what is out there and to let them touch and feel and experience it.

If this were tO happen we can expect malls and high streets to move to more brand stores and less multi brand stores – unless the latter can somehow either match the cost and price structure of online or get paid for purely providing the experience to the customers.

Either ways we can expect the overall demand for retail real estate space to come down in the next few years. If there are any malls or retail real estate firms which are listed its time to short them. Or by hedging against them by going long on online retail.

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Countercyclical business

I realize being a freelance management consultant is countercyclical business. For two years in succession, I’ve had a light March – both years I’ve ended up finishing projects in Jan/Feb. With March being the end of the Indian financial year, most companies are loathe to commit additional spending in March, and it is a bad time to start new projects!

This is counter-cyclical because most other businesses end up having a bumper March, since they have end-of-year targets, and with a short sales cycle, they push their salespersons hard to achieve this target in March!

Differential levels of service

On Wednesday I had to send a package to Mumbai by courier. I walked over to the nearby DTDC office and was told that I had two options – i could pay Rs. 85 for “standard courier” or Rs. 180 for “next day guaranteed delivery”.  I asked the guy at the counter when the courier would be “cleared” (i.e. leave the booking office) and he said “this evening”. Assuming that courier gets sent by flight, it would reach Mumbai the next day, so it made me wonder what would take a courier longer to  reach.

I’m reminded of this famous story of HP (or was it Xerox? Or Epson?) adding an additional component to their printer to slow it down so that they could sell it as an “economy model”. The problem with offering differential levels of service in what is essentially the same product is that you know that the service provider has an incentive to willfully offer mediocre service when you go for the cheaper option.

Let us get back to courier, and assume that it is theoretically possible for DTDC to deliver my courier to Mumbai in a day. Suppose they start delivering most “standard” (Rs. 85) packages the following day, then people will have no incentive to go for the “premium” (Rs. 180) service! Because a “premium” service exists, they actually have an incentive to provide poor service for the “standard” package.

It is a similar case with Indigo’s “fast check in” counter at airports. For Rs. 200 you can skip the lines in the airport and go to a special “fast check in” counter. There is the same conflict of interest there – if the regular check in counters were efficient and there were no long lines, there would be no incentive for anyone to go to the “fast check in” counter. So if Indigo has revenue targets for the fast check in counter, it makes sense for them to make the regular check in more inefficient and create longer lines.

Coming back to DTDC, how is the market likely to react to their premium service? Let’s say that I’m someone who regularly sends couriers (but not regularly enough for me to have a deal with DTDC). I’ve been using the “standard” package so far. Most of my letters arrive in Mumbai the next day but a small number (let’s say 10%) take two days to arrive. Now, DTDC introduces the premium package, but I continue using the standard package. What do I see now? Rather than 90% of the letters arriving the next day, only 10% do, and 90% take longer (in line with DTDC’s revised incentives). It is likely that I’ll either start using the premium service or I’ll move to another operator.

The ostensible reason for DTDC introducing an “overnight guaranteed” courier service is easy to see – earlier, 90% of the packages were arriving in a day, and now they guarantee that it is 100%. The problem, however, is that the company will soon want to target increased sales of this “premium” service, and so will start taking steps to prevent the “standard” service from “cannibalizing” the premium sales.

Cartels, good and bad

This post is about two professional cartels in India, and why one is better than the other. The “better” cartel is the Institute of Chartered Accountants of India (ICAI). The “worse” is the Medical Council of India (MCI). As the names suggest, they regulate the profession of chartered accountants and doctors respectively. And the way the former works is better than the latter.

First of all, let me convince you that these two are cartels. The basic concept is that in order to practice as a Chartered Accountant in India, you need certification from the ICAI. And who does the ICAI consist of? Other CAs. So it is nothing but a trade guild, which tries to control who gets to join the guild. It is a similar case with the MCI and doctors. Doctors trying to control who else can be doctors. As the more perceptive of you might have figured out, it is in the interest of both these guilds to not admit too many new members, since that would lead to supply of their profession to a level that significantly affects profit margins for the incumbents.

Now that we have established why these two are cartels, and that they both have an interest in restricting membership, let us see how they go about the process.

The ICAI follows what can be described as “exit level testing”. There are no restrictions on anyone wanting to be a CA – all you need is a high school (12th standard) degree with mathematics as one of your subjects. They have three levels of examination – “basic”, “intermediate” and “final”, and one needs to clear all of these in order to become a member of the guild. And how does the guild control membership? By making these examinations super-tough, so that only a select few pass these exams every year. There are several “CA institutes” who train students for these examinations. And there is no restriction (AFAIK) on anyone opening one such institute.

The MCI does it differently. Anyone with a recognized degree in medicine is automatically a member of the MCI. They regulate the numbers instead by controlling the number of medical colleges, so that only a select few can even aspire to get into the MCI. More importantly, the entry to medical colleges is not strictly on “merit” – colleges are free to allocate a certain portion of the seats on discretion, and they do so based on recommendations, donations, etc. I’m not really saying any of this is wrong. Just describing the situation as it is. However, when you combine this with the fact that an entry into a medical college guarantees membership of the MCI (provided you pass your college exams, which shouldn’t be too hard), it effectively means that you can buy your way into the MCI.

Actually, thinking about it, this option of creating additional membership of the MCI “upon payment” is a masterstroke by that guild. The concept is that when people pay large sums of money to gain entry, they are not going to be in a hurry to look to slash profit margins (key here is the fact that the amount of work a doctor can do is constrained by his/her time, so doctors cannot play  the “volume game”). So the pricing of these seats ensure additional revenue for the MCI and their constituent colleges, while not compromising on the members’ margins.

Note, however, that it is not possible to buy your way into the ICAI. Yes, aspiring members who seeks to buy their way in might buy “training” and “apprenticeship” under the best CAs who are members of the cartel, but still, to get a membership they need to pass the examination, which is not easy at all. Contrast this with the MCI where either money or the right connections get you straight in.

I’m not saying that the ICAI is a wonderful guild. Cases such as the Price Waterhouse – Satyam case or the Deloitte-FTIL case have shown that the profession is deeply flawed, and doesn’t regulate itself adequately. All I’m saying that the entry criteria it uses, as opposed to the one used by the MCI, ensures a higher quality in terms of the ability of its members.

As for me, I’m happy that I’m involved in a profession (or professions) that don’t need any certification or guild membership.

Coase

In the wake of the passing of Ronald Coase, two incidents, both professional. The first was with an established company to whom I suggested a partnership – they are in a space where I don’t have much skill, but have access to companies who I would love to sell to, and they don’t have my skill and our skills are complementary. So I reached out to them (through common contacts) suggesting that we could work together. They came back to me saying they would love to work with me, but would want me to join them as an employee.

The second was an incoming lead. This was a rather small company doing something similar to what I’m doing but with bigger ideas. They want me to join this “innovation hub” they are trying to create. This is a loose federation they are creating including professionals from various fields. Nobody is obliged to work full time for the hub, but this gives people an opportunity to get together and work together on projects where their respective expertise can combine well.

As the more perceptive of you who would have read every Coase obituary in the last two weeks would have figured out, the piece of work that Coase is most well known for is about the theory of the firm. The question is rather simple – why should you and I get together and form a firm if we have to work together, if we can remain independent and just come together for projects. The answer lies in transaction costs.

The advantage of coming together as a firm is that you negotiate only once. Let us suppose you are a graphic designer and I’m a data scientist. If we decide to work together on a visualization project, how do we decide how much you get and how much I get? We will need to negotiate. Let’s say we negotiate and agree on a price. And complete a project and split the spoils. What would happen the next time we were to bid for a project? We will need to negotiate again on how we will share the spoils.

If on the other hand we were to form a partnership firm, then for every project that we do, our respective share is fixed! Thus we don’t have to negotiate before every single projects. Thus, firms exist so that you don’t have to repeatedly negotiate.

However, there is a downside to this. What if I form a firm with a graphic designer, and then we see a significant opportunity in projects that involve a lot of analysis but little visualization? In that case, I have no use of my partner, and would loathe to pay him his share of the profits. Or consider if I were to somehow become much better at my job, while my partner stagnates. There is little I can do, for we’ve been locked in into the financial arrangement.

These are only some of the complications that arise when you need to decide whether you want to become a firm. I just thought it is pertinent that I’m having some of these dilemmas (employee versus consultant versus partner versus member of federation) in the few weeks after Coase’s passing.

Indigo’s Food Policy

My last few flights on Indigo Airlines have not been pleasant, at least from a food perspective. It is said about the airline that they put a great amount of thought into each of their processes, but while it might have been working earlier (I used to positively prefer Indigo’s food experience a while back) of late it doesn’t seem to be doing too well.

Firstly, I don’t have a problem with the food itself. I most definitely prefer Indigo’s cold sandwiches and Real Activ fruit juice to the reheated omelette/pulao that Jet Airways serves. It is much lighter on the stomach and feels healthier, and doesn’t give you that usual bad aftertaste of “airline food”. I also understand that it makes sense from the company’s perspective, since the lack of hot food reduces their cost of serving it and also makes the plane easier to clean.

The problem, however, is with the process. Firstly, Indigo has these “corporate program customers” (I’ve never understood how to get into one of these), whose meal is pre-paid. So you have stewardesses walking around with printouts to know who is eligible for a free meal. I’ve also noticed some kind of priority in terms of service – that the corporate program customers are served before others (which is logical, since they’ve already paid), which disrupts the flow.

Then there is the problem of cash management. For whatever reasons the price points are not in multiples of 50 (sandwiches cost Rs. 170, fruit juice Rs. 70), so change management (!!) is a huge problem. While they have credit card machines they don’t work uniformly, and end up causing further delays.

The biggest issue, however, is the choice! For probably good reason Indigo serves a variety of meals, enough variety that the menu runs up to a full page in their in flight “retail therapy magazine”. There are two problems that result from this – firstly, there is a problem of inventory. When you offer so much choice, how much of each type do you carry? I know there must be some science going into how many packets of ready-to-make Uppit they carry and how many chicken sandwiches. However, on days when I’m (unfortunately from a food perspective) seated in the vicinity of Row 14 or Row 30, it is reasonably unlikely that I don’t end up getting my preferred choice.

The second problem with the variety in food is the time lost in decision-making. “Give me a chicken sandwich. Oh, it isn’t there? Then give me biryani! Oh, but that’s a Ramen kind of thing? No I don’t want that. Give me cashew nuts. Not pepper flavour, give me chilli”. The amount of time it takes for a passenger on Indigo to decide on what to eat is significantly more than the corresponding time it takes for a passenger in a so-called full-service carrier (veg/non-veg). Again, it doesn’t help (from this perspective), that an Indigo flight operates with four stewards, as opposed to six in a “full-service” carrier of the same size.

Overall, it makes the entire process of ordering for, paying and getting a meal rather unpleasant for significant proportions of passengers. My solution to this would be two-fold. Firstly, include the cost of the meal in every ticket. The current cost of an Indigo meal is Rs. 240 (170 for sandwich, 70 for juice). With economies of scale (everyone ordering a meal) I’m sure this can be brought down to about Rs. 200. When I’m paying Rs. 5000 for a flight, I wouldn’t mind the extra Rs. 200. I may not eat (note that half the time I fly Jet I don’t eat), but the point here is that given the brand Indigo has built I may not change my decision on flying Indigo because it costs Rs. 200 more.

The second idea is to drastically reduce the choice. Yes,  I know that might end up pissing off some customers who have their own favourites from the Indigo menu (mine is spinach-corn-cheese sandwich) but it makes the logistics much easier to handle. Imagine having just two choices of sandwich and two choices of juice (and no more, maybe less) and you think of how much quicker the service will get then. Going even more drastic is also an option (this is something Jetlite used to do in 2008, and I’ve noticed the same with Turkish Airline’s low-cost brand Anadolujet). Give absolutely no choice and just deposit one sandwich and one can of juice on every single tray-table. They could even.

The point of this post is that uncertainty hurts, and sometimes even those that it is intended to benefit. The choice in the Indigo menu is meant to be a boon for the passengers, but it has significant costs attached – in terms of availability and timeliness.

PS: There are no good food stalls in the airport terminal (Mumbai 1B) also that one can peacefully carry on to flights. Last two times I carried muffins from Cafe Coffee Day and Cafeccino respectively and both were downright horrible. I miss Delhi’s terminal 1D and the double chocolate chip muffin at the Costa there.

Market makers and executionists

There are two kinds of people in the world – market makers and executionists. Market makers are great at spotting gaps in markets, and deriving business ideas out of them. They could also be great at finding and executing solutions, but their primary skill is in identifying the gaps in the market and framing the problem.

Executionists are great at execution and problem-solving. However, they need the problem to have been defined in the first place. Their ability to spot gaps in markets and thus lay out problem statements is questionable, though.

Executionists fall under different levels. It has to do with how much ambiguity they can handle. There are some for whom the problem must be defined as well as the method to solve the problem. “here is a problem. Do a logistic regression and solve it”, you need to tell them and they will use logistic regression (assuming they are trained in the subject) to solve the problem. At the next level you have people whom you can ask to find patterns in some data, but then they will figure out that the problem can be framed as a logistic regression problem and will then proceed to solve it. Further up, you just give them a business problem, and then they will figure out what data set can be used ot solve it, figure out that doing a logistic regression will solve the problem and then they will solve it. And so forth.

Then again, the first line of this blog post is wrong. There is no real barrier between market makers and executionists. There are people who are both (good for them) and those who are good at neither. However, you realize that if you are an executionist of level i, you will need the guidance of an executionist of level i+1 or above. And that if you are a highest level executionist you will need the guidance of a market maker.

Levi’s Price Discrimination

So I’ve never managed to buy jeans on discount. Let me explain. Unlike most other people (if you go by what the store assistants tell you), I don’t like to wear faded jeans. It is perhaps an inherited hangover since my father used to consider jeans to be inherently dirty and would make me discard jeans as soon as they faded a little bit. It could also be more practical – since I sometimes like to wear jeans to official meetings, I want to wear jeans that look neat.

Now I’ve managed to drive my wife crazy with my shopping (and we’ve known each other for barely four years, shopped together for three maybe). She thinks I’m way too fussy about clothes, and can’t make up my mind easily. I’ve explained earlier on this blog why I take a long time over shoes (my sandals are now wearing out, so I’m getting ready for another ordeal). But the more fundamental differences that my wife and I have is with respect to jeans.

The problem is that we fundamentally disagree on what purpose jeans serve. I have traditionally looked at jeans as comfort wear. Trousers I’m absolutely comfortable in (I sometimes even sleep in my jeans), which I don’t need to wash too frequently, and which can be worn even after they get torn in non-strategic places. I’ve always bought “comfort fit” jeans, and after I graduated to branded jeans towards the end of my teens, my staple had been the comfort-fit Lee Chicago.

The problem is that my wife thinks of jeans as fashion-wear – things you need to necessarily look good in. Some of the jeans she owns are so skinny that sometimes she takes a really long time to change. She looks great in them, no doubt, but the problem is that she expects that I too wear such jeans. And so after some ten years, I have given up my loyalty towards Lee Chicago, and instead have to try out various skinny fits (as things stand now, I own only one pair of Lee Chicago, bought in 2009).

Ok all this is besides the point of this post (and the point of another post which I never wrote). Coming back to the point of this post, the deal is that nowadays I find it extremely hard to shop for jeans. Of course it doesn’t help that I don’t live in Kathriguppe (with its dozens of factory outlets) any more, and that in my part of town (Malleswaram-Rajajinagar) the only place you can find decent branded clothes is in malls, which are a pain. The bigger problem, though, is that it is very hard to find stores that stock my kind of jeans.

In the last couple of years, our strategy for shopping clothes has been to visit a multi-brand outlet in one of the two malls near our place, so that we have a wide variety of choice. Except that I have no choice. Because stores such as Lifestyle or Shopper’s Stop or Westside (which now mostly stocks private labels) or Central don’t stock my kind of jeans. At all. If you happen to locate a store clerk and ask him for “mid blue straight cut non-faded jeans” he will look at you as if you have just landed from another planet. He can be excused for giving you those looks, for his store simply doesn’t stock non-faded jeans, because of which he has never sold them!

So I happened to be on Brigade road over the weekend, and I had a small gap of about half an hour between two meetings, and thought I should visit the Levi’s flagship store there. I must mention that the salespeople there were definitely significantly more polite than I’ve ever seen at a multi=brand store. However, as soon as I repeated my mantra (mid blue straight cut non-faded jeans), the first thing the salesperson who approached me told me  was “oh Sir, but there’s not discount on that!”.

It’s clever price discrimination by Levi’s, to not sell non-faded jeans on discount. For they know that people who buy non-faded jeans tend to be older (hey I’m only thirty), or will be buying them for office wear, and they are less price elastic than the typical college kid who buys faded stuff. So while the college kid needs discounts to be attracted during the “discount season”, the “formal jeans” buyer needs no such attractions, and will pay full price for his stuff.

It is interesting to note, however, that companies that make formal clothes (not Levi’s) also offer massive discounts during the “discount seassons” (one of which is on now). That, though, can be explained by the fact that most people need a few sets of formal clothes (even those that normally wear faded jeans), and discounts are necessary to attract customers.

Now I’m beginning to think that the market for “formal jeans” in India is extremely niche, and if I”m acting above my age because I prefer such jeans. I half-expect my wife to call me an “uncle” be cause of this.

Inefficiency of Restaurant Reservations

Quartz reports that restaurant reservations have been taken over by bots in San Francisco. Certain restaurants in that city are incredibly hard to get reservations at, so people have started letting lose bots that check for availability every minute and grab the table as soon as it’s available. In fact, there are enough bots out there that at a particular restaurant which opens reservations at 4 am, all tables are taken by 4:01. Every day.

In Kannada, there is an idiom that says “gubbi mEle brahmAstra”, which means using the weapon of Brahma (widely recognized in Hindu epics are the most powerful weapon) to annihilate a sparrow. Using a bot for restaurant reservations is a solution that falls under this category. However, that someone had to think up of this solution shows that there is something wrong with the restaurant reservation market. And it is not just in San Francisco (I guess this solution was first implemented there thanks to the penetration of online restaurant reservations and the high number of techies in the city. Bangalore fails on the first count).

The problem with the way restaurant reservations currently work is that the option is priced at zero. And thus gets allocated on a first come first served basis. Suppose I want to go out on a date tonight but am not sure what cuisine my wife is craving today. Anticipating crowds, given that it is a Saturday, I will make reservations in four different restaurants serving four different cuisines. There is nothing that currently prevents me from doing that. And it costs me nothing (apart from the cost of four phone calls).

A restaurant reservation is essentially an option to occupy a table of a certain size at a certain restaurant in a particular time period. If you show up at the restaurant at the appointed time, the restaurant is obliged to offer you a table. However, the way it is currently implemented is that you are not obliged to show up at that restaurant at that particular time. If you don’t show up, the table the restaurant had “reserved” for you will go empty for that evening, thus resulting in loss of business.

How can a restaurant handle this? One idea is to overbook. If you have 10 tables, allow 12 people to make reservations, in the hope that on an average day, 10 or less will show up. While this may lead to higher occupancy, problem is when all 12 show up. You then run the reputational risk of making a reserved guest wait, or worse, turning them away. Another option is to book only a fraction of the tables. If you have 10 tables, give out reservations only for 8, and let people know that you are open to walkins (if someone calls after the 8 are taken, you can say “I’m sorry, but we can’t take any reservations. However, we have some unreserved tables. You can come and check it out. If you’re lucky you’ll get it”). That way, by keeping yourself open for walkins, you can prevent loss of inventory- except that if you are a high end restaurant you are unlikely to get too many walk in customers.

Another option (which I believe is a method online retailers in India use for cash-on-delivery customers) is to maintain a list of people who called you along with their phone numbers and whether they showed up. That way, you can deny habitual offenders a reservation. However, considering that if you are a high end restaurant people are unlikely to visit you very often this may not work either.

The ideal economic solution, of course, would be to charge for reservations. People pay a small deposit when they make a reservation. If they do show up, this amount gets adjusted against their bill. However, given that most reservations happen over the phone (except in SF), you have no way to charge for it. So is the solution that you move your reservations exclusively online, so that you can charge for it? Then you could lose out on customers who are uncomfortable with making reservations online.

Even if all your reservations were online (like in SF), there is a problem in charging for reservations – you wouldn’t want to be the first restaurant doing that. One thing high end restaurants pride themselves on is their reputation, and charging for reservations can make them appear “cheap”, and they wouldn’t want to do that unless it is the done thing.

So how are restaurants managing the situation now? My take is that they are adjusting for it in the price. They are not overbooking, but assuming the cost of empty tables (as a result of no shows) in their overall pricing. This way, customers who are honouring reservations are effectively subsidizing those that don’t. While the market “clears”, the implicit subsidy towards customers who don’t honour their reservations leads to dead weight loss. There is also moral hazard – since desirable customers (the ones who show up) are subsidizing the un-desirable (the ones that don’t).

Is there a solution to this? One way to look at this would be for restaurants to centralize their reservations. I’m surprised no one has done it yet. You can have a website and a call centre from which you can take reservations for a large number of restaurants. The restaurants will pay for it since it will mean that they don’t need to have someone by the phone taking and managing reservations. And given that the same call centre manages bookings for multiple restaurants, they can identify duplicate bookings and overbook accordingly. Customers can be incentivized to use the same ID for booking for multiple restaurants by introducing a multi-restaurant loyalty card. And then – once there is a large number of restaurants that have moved their reservations to this call centre, they can start thinking of collectively moving towards a system of penalizing for unfulfilled reservations.

There – I’m giving a business idea away for free!