Who do you subsidise?

One basic rule of pricing is that it is impossible for all buyers to have the same consumer surplus (the difference between what a buyer values the item at and what he paid). This is because each buyer values the item differently, and is thus willing to pay a different price for it. People who value the item more end up having a higher consumer surplus than those who value it less (and are still able to afford it).

Dynamic pricing systems (such as what we commonly see for air travel and hotels) try to price such that such a surplus is the same for all consumers, and equal to zero, but they never reach this ideal. While the variation in consumer surplus under such systems is lower, it is impossible for it to come to zero for all, or even a reasonable share of, customers.

So what effectively happens is that customers with a lower consumer surplus end up subsidising those with a higher consumer surplus. If the former customers didn’t exist, for example, the clearing price would’ve been higher, resulting in a lower consumer surplus for those who currently have a higher consumer surplus.

Sometimes the high surplus customer and the low surplus customer need not be different people – it could be the same person at different times. When I’m pressed for time, for example, my willingness to pay for a taxi is really high, and I’m highly likely to gain a significant consumer surplus by taking a standard taxi or ride-hailing marketplace ride then. At a more leisurely time, travelling on a route with plenty of bus service, I’d be willing to pay less, resulting in a lower consumer surplus. It is important to note, however, that my low surplus journey resulted in a further subsidy to my higher surplus journey.

When it comes to markets with network effects (whether direct, such as telecommunications, or indirect, like any two-sided marketplace), this surplus transfer effect is further exacerbated – not only do low-surplus customers subsidise high-surplus customers by keeping clearing price low, but network effects mean that by becoming customers they also add direct value to the high surplus customers.

So when you are pleasantly surprised to find that Uber is priced low, the low price is partly because of other customers who are paying close to their willingness to pay for the service. When you pay an amount close to the value you place on the service, you are in turn subsidising another customer whose willingness to pay is much higher.

This transfer of consumer surplus can be seen as an instance of bundling, but from the seller’s side. Since a seller cannot discriminate effectively among customers (even with dynamic pricing algorithms such as Uber’s surge pricing), the high-surplus customers come bundled with the low-surplus customers. And from the seller’s perspective, this bundling is optimal (see this post by Chris Dixon on why bundling works, and invert it).

So the reason I thought up this post is that there has been some uncertainty about ride-hailing marketplaces in Bangalore recently. First, drivers went on strike alleging that they weren’t being paid fairly by the marketplaces. Then, a regulator decided to take the rulebook too literally and banned pooled rides. As i write this, a bunch of young women I know are having a party, and it’s likely that they’ll need these ride-hailing services for getting home.

Given late night transport options in Bangalore, and the fact that the city sleeps early, their willingness to pay for a safe ride home will be high. If markets work normally, they’re guaranteed a high consumer surplus. And this will be made possible by someone, somewhere else, who stretched their budget to be able to afford an Uber ride.

Think about it!

Cross-posted at RQ

InMails and the LinkedIn backfire

A few months back I cleaned up my connections list on LinkedIn. Basically I removed people who I don’t “know”. I defined “know” as knowing someone well enough to connect them to someone else on my network (the trigger for a cleanup was when someone asked me to connect them to someone else on my network who I hardly knew).

The interesting thing about the cleanup was that a lot of the spurious connections I had on LinkedIn were headhunters. Thinking back at how they got in touch with me, in most cases it was with respect to a specific opportunity for which they were finding candidates. Once the specific opportunity had been discussed there was no value of us being connected on LinkedIn, and were effectively deadweight on each other’s networks.

Over the last couple of days, ever since I wrote this piece for Mint on valuation of startup ratchets, I’ve got several connection requests, all from people I don’t know. Normally I wouldn’t accept these invitations, but what is different is that most requests have come with non-standard messages attached. Most have mentioned that they liked my Mint piece and so want to either connect or discuss it.

When you want to simply exchange messages with someone, there is no need to really add them as a “friend”. Except that LinkedIn’s pricing policy makes this kind of behaviour rational.

LinkedIn offers a small number of “InMails” which you can send to people who you aren’t directly connected to. Beyond this number, each InMail costs you money. So if you want to have a discussion with someone you’re not connected with, there’s an element on friction.

There’s a loophole, however. You can send messages for free as long as they go along with a connection request. And if that request is accepted, then you can have a “free” conversation with that person.

So given the current price structure, if you want to have a conversation with someone, you simply send your initial message as part of a friend request. If the person wants to continue the conversation, the request will get accepted. If not you haven’t lost anything!

Then again, there are mitigating features – an InMail won’t get charged unless there is a reply, and LinkedIn’s UI is so bad that it takes effort to read messages attached to connection requests. So this method is not foolproof.

Still, it appears that LinkedIn’s pricing practice (of charging for InMails) is destroying the quality of the network by including spurious links. I guess they’ve done a cost-benefit analysis and believe that the cost of spurious connections is far lower than the revenue they make from InMails!


Water, IPL and the ease of doing business

The latest controversy surrounding the just-about-to-start ninth edition of the IPL (a court case challenging its staging in Maharashtra while farmers are dying in Vidarbha) is a clear illustration of why the ease of doing business in India doesn’t look like it will improve.

At the bottom of it, the IPL is a business, with the IPL and teams having invested heavily in team building and marketing and infrastructure. They have made these investments so far hoping to recover them through the tournament, by way of television rights, gate receipts, etc.

Now if the courts were to suddenly decide that the IPL should not take place in Maharashtra, it will mean that alternate arrangements will have to be found in terms of venues and logistics, teams which have prepared grounds in Nagpur, Pune and Mumbai will have to recalibrate strategies, and most importantly, the people of these cities who have bought tickets (they clearly believe that the value of these tickets is higher than the price) will also end up losing.

Farmers dying for lack of water is a real, and emotive, issue. Yet, to go after a high-profile event such as the IPL while not taking other simpler measures to curb fresh water wastage is a knee-jerk reaction which will at best have optical effects, while curbing the ability of businesspersons to conduct legitimate business.

There has been much talk about how policy measures such as the retrospective taxation on Vodafone or Cairn have been detrimental to investor sentiment and curbed fresh investments in India. This court case against the IPL days before it began is no different, and a strong signal that India’s policy uncertainty is not going away quickly.

Unless the political class manages to fix this, and provide businesses more stable environments to operate in, it is unlikely we’ll see significant increase in investments into India.

The problem with premium ad-free television

I watched snippets of the just-concluded ICC WorldT20 final using an illegal streaming service, which streamed content drawn from SkySports2.  The horrible quality of the streaming aside (the server seemed to have terrible bandwidth issues), the interesting thing to note was that it was completely devoid of advertisements.

With the quality of cricket coverage in India currently being abysmal due to the frequent cutting for advertisements (I remember getting thoroughly pissed off with the cuts for advertisements before the replay of a wicket was shown during the India-Australia series earlier this year), it made me think about the economics of a separate premium service that is ad-free.

The infrastructure for delivery is in place, given that internet-based legal streaming services are fairly common now (the likes of HotStar). Internet-based delivery also makes it easy to charge pay per view, so payment is also not a problem. This raises the question of whether it is a good idea for channels to monetise the demand for ad-free cricket by providing the service through online streaming, leaving the mainstream broadcast to be monetised via advertisements.

While in theory this appears like a good idea, the problem is with the kind of people who will migrate to the new service – they will be people who have the ability and willingness to pay for a higher quality broadcast. Such people are likely to belong to two overlapping categories – loyal fans of the game and people who can afford to pay a premium.

It is unlikely that the union of these two sets will comprise of too high a proportion of the overall viewership of the game, but the point is that these are the two groups who are likely to be most lucrative to advertisers – the loyal fans watch regularly and the people who are able to pay have more disposable income.

Moving such customers to an ad-free online channel might reduce the supply of advertisements which can be used to reach them, and this might not make advertisers happy. And given that television channels have cosy relationships with advertisers (or at least media buyers), they are unlikely to piss them off by moving the most lucrative customers to a premium platform.

Of course if this segmentation (between ad-free and free broadcasts) is implemented, it will also impact the price of advertisements in the free broadcast. That will need to be taken as an input while setting prices for the ad-free service. In other words, pricing is going to be a challenge!

If some television channel wants to work on this, I’m available for hire as a consultant. I’ve done a fair amount of prior work on pricing and dynamic pricing, am pretty good at quantitative methods and am in the course of writing a popular economics book.

Pricing season tickets

One observation about the crowd when I attended my first game at the Camp Nou (in October 2014, against Ajax in the 2014-15 Champions League) was how people around me all seemed to know each other. There were friendly nods and handshakes, and it was evident that these men and women were familiar with each other. They all arrived and departed independently, though, and there wasn’t much conversation during the game, suggesting they were acquaintances rather than friends.

On my second visit to the Camp Nou (ten days ago, for the 2015-16 Champions League game against Arsenal), I noticed hordes of empty seats. I was in a stand two tiers higher than where I had sat for the Ajax game, and despite that stand being priced at a princely €150, there were plenty of empty seats (my wife sat next to me for the duration of the game despite her assigned seat being one rank and a few files away). It was a cold and rainy day, but not so rainy that €150 be treated as “sunk cost”!

The common feature that explains both these phenomena is the “season ticket”. As the official club website explains,

The complete season ticket gives members the right to attend, always from the same seat, games played at the Camp Nou in official competitions: Spanish League, Champions League, Copa de Rey and UEFA Cup (emphasis added)

The reason people seated around me at the Ajax game were acquainted with each other was because they were season ticket holders, and would watch every game seated in close proximity to one another. And the empty seats for the Arsenal game were a result of season ticket holders, for whom the marginal cost of not attending the game was far less than €150, not attending the game (there is a “free seat” program that lets season ticket holders sell their ticket through official channels, but considering that the decision to not go would have been made in the last minute (given the rain) many season ticket holders may not have exercised this option.

Football clubs (and other performance venues) sell season tickets in order to create a “base load” of demand for their tickets. While these season tickets are sold at a deep discount (relative to what it costs to buy a ticket for each game), the fact that they are sold at once and at the beginning of the season means that the club can be sure of a certain amount of revenue from ticket sales, and can be assured to fill a certain proportion of seats at the stadium in every round.

Season tickets are also important because they help create a sense of loyalty among the fans, and the same fans sitting in the same spaces week after week can bond and help create a better viewing atmosphere at the club. In other words, season tickets seems like a no-brainer. Except that Hull City, which plays in the English Championship, has decided to do away with season tickets starting next season.

The official statements related to this move seem like sanitised PR (refer link above), but the linked article gives away an important piece of information that suggests why this new ticket scheme might have been brought into play:

The club said the Upper Stand would be closed, meaning 1,800 fans must be relocated, but would be opened for high-profile matches

While the club doesn’t want to admit it, the reason it is doing away with season tickets is that attendance at the KC Stadium has been falling, and it appears that there have been lots of empty seats in the stadium.

As I had noted in my earlier piece on pricing Liverpool FC tickets, there are network effects to watching a football game in the stadium. You gain value not only from what happens on the pitch, but also from the atmosphere that fans at the stadium (including you) build up. And while there are many ways in which fans can affect the watching experience of co-fans, it shouldn’t be hard to understand that empty seats do not add to the stadium atmosphere in any way.

The problem with season tickets is that even with programs such as “free seat” (where the season ticket holder can get paid for giving up their seat), the cost for a season ticket holder to not attend a game is extremely low. And when several season ticket holders decide to not attend certain games, it can lead to rather low attendances, and diminished stadium experience for the fans who do end up attending.

This network effect – of fans helping shape experience of fellow fans – makes the sale of football season tickets different from that of long term cargo contracts, for example. You not only seek to assure yourself of revenues by selling season tickets, but also seek to fill a certain portion of the seats for every game through such a program, and help create the experience.

And when your fans are being delinquent (by purchasing season tickets but not attending), your first action would be to increase the price of such season tickets so that only “serious fans” will buy it and the (sunk) cost of not attending a game is higher. It seems Hull City has already gone through one such exercise, and raised its season ticket prices, which hasn’t helped drive overall attendances.

Hence, the club has decided to do away with season tickets altogether. With the new rolling monthly ticket program, fans will purchase if and only if they are confident of attending a certain number of games. On the one hand, this pushes up the cost of not going for a game, and on the other, allows the club to manage its revenues on a larger portion of the tickets.

From a revenue point of view, this is a risky strategy, as the club foregoes assured revenues from season tickets in favour of more volatile monthly ticket revenues, and greater tickets to sell in the open market before every game. However, considering the network effects of watching football in a stadium, what the club is banking on is that this measure will help them fill up their stadium more than before, and that the improved atmosphere that comes out of that can be monetised in the long run.

It’s a bold move by Hull City to improve football attendances. If it works out, it offers a way out for other clubs that are currently unable to fill their stadiums. But you must remember that optimisation here takes place on two axes – revenues and crowds!

Airline pricing is strange

While planning our holiday to al-Andalus during my wife’s Easter break (starting later this week), we explored different options for flights from different destinations in al-Andalus to Barcelona before we confirmed our itinerary.

As it turned out, it was cheapest (by a long way) to take a flight back from Malaga to Barcelona on Good Friday (meaning we were “wasting” three days of Priyanka’s vacation – which we were okay with), and so we’ve booked that.

Now, Vueling (Iberia’s low cost version where we’ve booked our tickets) sends me an email offering credits of €40 per passenger if we could change our flight from Friday to Saturday (one day later). In other words, it turns out now that the demand for Friday flights is so much more than that for the Saturday flight that Vueling is willing to refund more than half the fare we’ve paid so that we can make the change!

I don’t know what kind of models Vueling uses to predict demand but it seems to me now that their forecasts at the time we made our booking (3 weeks back) were a long way off – that they significantly underestimated their demand for Friday and overestimated demand for Saturday! If this is due to an unexpected bulk booking I wouldn’t blame them, else they have some explaining to do!

And “special occasions” such as long weekends, and especially festivals such as Good Friday, are a bitch when it comes to modelling, since you might need to hard code some presets for this, since normal demand patterns will be upset for the entire period surrounding that.

PS: Super excited about the upcoming holiday. We’re starting off touristy, with a day each in Granada and Cordoba. Then some days in Sevilla and some in Malaga. If you have any recommendations of things to do/see/eat in these places, please let me know! Thanks in advance.

Revenue management at Liverpool Football Club

Liverpool Football Club, of which I’ve been a fan for nearly eleven years now, is in the midst of a storm with fans protesting against high ticket prices. The butt of the fans’ ire has been the new £77 ticket that will be introduced next season. Though there will be few tickets that will be sold at that price, the existence of the price point has been enough to provoke the fans, many of whom walked out in the 77th minute of the home draw against Sunderland last weekend.

For a stadium that routinely sells out its tickets, an increase in ticket prices should be a no-brainer – it is poor revenue management if either people are scrambling for tickets or if there are empty seats. The problem here has been the way the price increase has been handled and communicated to the fans, and also what the club is optimising for.

At the outset, it must be understood that from a pure watching point of view, being in a stadium is inferior to being in front of a television. In the latter case, you not only have the best view of the action at all points in time, but also replays of important events and (occasionally) expert commentary to help you understand the game. From this point of view, the reason people want to watch a game at the ground is for reasons other than just watching – to put it simply, they go for “the experience”.

Now the thing with stadium experience is that it is a function of the other people at the stadium. In other words, it displays network effects – your experience at the stadium is a function of who else is in the stadium along with you.

This can be complex to model – for this could involve modelling every possible interaction between every pair of spectators at the ground. For example, if your sworn nemesis is at the ground a few seats away from you, you are unlikely to enjoy the game much.

However, given the rather large number of spectators, these individual interactions can be ignored, and only aggregate interactions considered. In other words, we can look at the interaction term between each spectator (who wants to watch the game at the ground) and the “rest of the crowd” (we assume idiosyncrasies like your sworn enemy’s presence as getting averaged out).

Now we have different ways in which a particular spectator can influence the rest of the crowd – in the most trivial case, he just quietly takes his seat, watches the game and leaves without uttering a word, in which case he adds zero value. In another case, he could be a hooligan and be a pain to everyone around him, adding negative value. A third spectator could be a possible cheerleader getting people around him to contribute positively, organising Mexican waves and generally keeping everyone entertained. There can be several other such categories.

The question is what the stadium is aiming to optimise for – the trivial case would be to optimise for revenue from a particular game, but that might come at the cost of stadium “atmosphere”. Stadium atmosphere is important not only to galvanise the team but also to enthuse spectators and get them to want to come for the next game, too. These two objectives (revenue and atmosphere) are never perfectly correlated (in fact their correlation might be negative), and the challenge for the club is to price in a way that the chosen linear combination of these objectives is maximised.

Fundamental principles of pricing in two-sided markets (here it’s a multisided market) say that the price to be charged to a participant should be a negative function of the value he adds to the rest of the event (to the “rest of the crowd” in this case).

A spectator who adds value to the crowd by this metric should be given a discount, while one who subtracts value (by either being a hooligan or a prude) should be charged a premium. The challenge here is that it may not be possible to discriminate at the spectator level – other proxies might have to be used for price discrimination.

One way to do this could be to model the value added by a spectator class as a function of the historic revenues from that class – with some clever modelling it might be possible to come up with credible values for this one, and then taking this value into account while adjusting the prices.

Coming back to Liverpool, the problem seems to be that the ticket price increase (no doubt given by an intention to further maximise revenue takings) has badly hit fans who were otherwise adding positive value to the stadium atmosphere. With such fans potentially getting priced out (in favour of fans who are willing to pay more, but not necessarily adding as much value to the ground), they are trying to send a message to the club that their value (toward the stadium atmosphere) is being underestimated, and thus they need greater discounts. The stadium walkouts are a vehicle to get across this point.

Maximising for per-game revenue need not be sustainable in the long term – an element of “atmosphere” has to be added, too. It seems like the current worthies at Liverpool Football Club have failed to take this into account, resulting in the current unsavoury negotiations.

Now that I’ve moved to Barcelona, Liverpool FC need not look too far – I’ve done a fair bit of work on pricing and revenue management, and on two-sided markets, and can help them understand and analyse the kind of value added by different kinds of spectators, and how this can translate to actual revenues and atmosphere. So go ahead and hire me!