Category: Pricing

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!

 

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.

Maximum Retail Price is a conspiracy by FMCG companies

A few months back, Anupam Manur, a colleague at the Takshashila Institution, had written an Op-Ed in The Hindu that the Maximum Retail Price (MRP) mechanism is archaic and needs to be shelved.

Introduced in 1990 by the Department of Civil Supplies, this regulation governs that the maximum price at which packed goods can be sold be printed on the packet, and makes any transactions at a price higher than this price illegal. This was intended to be a mechanism to protect consumers from usurious shopkeepers (remember this was introduced just before economic reforms were launched), and Anupam’s piece also treats the intention as such.

Having now briefly lived in a country with no such regulations (Spain), I must say that my entire perspective of how retail works has been turned upside down (and this, having spent a year consulting for a major retail chain in India).

The existence of the MRP in India means you tend to look at everything in retail from that perspective – the manufacturer/packager, for example, can set margins (a percentage of the MRP) that each segment of the supply chain can earn. As a consequence, players in the chain have little leverage on what prices to charge – at best, they can forego a part of their (usually tiny) margins in order to drive sales.

Without the existence of MRP, however, the (power) equation is turned upside down. Two supermarkets close to my home in Barcelona (about 200m from each other), for example, charge €0,79 and €0,96 respectively for identical cartons of milk (of the same brand, etc.). This price difference (17% or 21% the way you look at it) of a retail commodity between two nearby stores would be impossible to see in India.

Given the broad similarity in these two supermarkets, it is unlikely that there’s too much difference in what they would have paid to procure these cartons of milk. In other words, one supermarket makes a far higher margin selling this milk (which is possibly compensated by the other’s higher sales).

In other words, in a market without MRP, the manufacturer/brand loses control over the pricing once he has sold products down the chain – it is up to the respective player in the chain to determine what he will charge for from his buyers, and thus manage his own revenues. While free markets mean that prices of products broadly converge across stores, the manufacturer/brand can do little in order to dictate them beyond a point.

With this kind of pricing power missing from retailers in a market like India (with MRP), the retailer is at a greater mercy of the manufacturer. The manufacturer can allow the retailer some leeway in pricing, for example, by setting an artificially high MRP, but the question is whether the manufacturer wants the retailer to have this leeway.

Under the current system (MRP), the retailer is mostly at the mercy of the manufacturer. The manufacturer has bargaining power over how much stocks to distribute to the retailer and when, and there is little leeway for the retailer to manage his stocks intelligently. In fact, for some products, manufacturers even control discounts and don’t allow retailers to sell below a particular price (threatening to stop supplies in case they do so). Without the MRP, this kind of coercion on behalf of manufacturers will be significantly reduced.

In this context, it is useful to look at the MRP as a tool that shifts the balance of power in the packaged goods supply chain in favour of the manufacturers/brands and away from the retailers. As Anupam has established in his piece, customers don’t necessarily benefit from this regulation. They are merely an excuse for manufacturers of packaged goods to exert bargaining power over the retailers.

In other words, the MRP is a conspiracy by the FMCG companies, who stand to benefit most from such regulations (at the cost of retailers and customers).

With the current union government supposedly enjoying support of the trading community, there is no better opportunity for this MRP regulation to go.

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!

Bias in price signals from ask only markets

Yesterday I listened to this superb podcast where Russ Roberts of the Hoover Institution interviews Josh Luber who runs Campless, a secondary market for sneakers (listen to the podcast, it isn’t as bizarre as it sounds). The podcast is full of insights on markets and “thickness” and liquidity and signalling and secondary markets and so on.

To me, one of the most interesting takeaways of the podcast was the concept that the price information in “ask only markets” is positively biased. Let me explain.

A financial market is symmetric in that it has both bids (offers to buy stock) and asks (offers to sell). When there is a seller who is willing to sell the stock at a bid amount, he gets matched to the corresponding bid and the two trade. Similarly, if a buyer is willing to buy at ask, the ask gets “taken out”.

The “order book” at any time thus contains of both bids and asks – which have been unmatched thus far, and looking at the order book gives you an idea of what the “fair price” for the stock is.

However, not all markets are symmetric this way. In fact, most markets are asymmetric in that they only contain asks – offers to sell. Think of your neighbourhood shop – the shopkeeper is set up to only sell goods, at a price he determines (his “ask”). When a buyer comes along who is willing to pay the ask price of a good, a transaction happens and the good disappears.

Most online auction markets (such as eBay or OLX) also function the same way – they are ask only. People post on these platforms only when they have something to sell, accompanied by the ask price. Once a buyer who is willing to pay that price is found, the item disappears and the transaction is concluded.

What makes things complicated with platforms such as OLX or eBay (or Josh Luber’s Campless) is that most sellers are “retail”, who don’t have a clear idea of what price to ask for their wares. And this introduces an interesting bias.

Low (and more reasonable) asks are much more likely to find a match than higher asks. Thus, the former remain in the market for much shorter amount of time than the latter.

So if you were to poll the market at periodic intervals looking at the “best price” for a particular product, you are likely to end up with an overestimate because the unreasonable asks (which don’t get taken out that easily) are much more likely to occur in your sample than more reasonable asks. This problem can get compounded by prospective sellers who decide their ask by polling the market at regular intervals for the “best price” and use that as a benchmark.

Absolutely fascinating stuff that you don’t normally think about. Go ahead and listen to the full podcast!

PS: Wondering how it would be if OLX/eBay were to be symmetric markets, where bids can also be placed. Like “I want a Samsun 26 inch flatscreen LCD TV for Rs. 10000”. There is a marketplace for B&Bs (not Airbnb) which functions this way. Would be interesting to study for sure!

Uber’s anchoring problem

The Karnataka transport department has come out with a proposal to regulate cab aggregators such as Uber and Ola. The proposal is hare-brained on most  counts, such as limiting drivers’ working hours, limiting the number of aggregators a driver can attach himself to and having a “digital meter”. The most bizarre regulation, however, states that the regulator will decide the fares and that dynamic pricing will not be permitted.

While these regulations have been proposed “in the interest of the customer” it is unlikely to fly as it will not bring much joy to the customers – apart from increasing the number of auto rickshaws and taxis in the city through the back door. I’m confident the aggregators will find a way to flout these regulations until a time they become more sensible.

Dynamic pricing is an integral aspect of the value that cab aggregators such as Uber or Ola add. By adjusting prices in a dynamic fashion, these aggregators push information to drivers and passengers regarding demand and supply. Passengers can use the surge price, for example, to know what the demand-supply pattern is (I’ve used Uber surge as a proxy to determine what is a fair price to pay for an auto rickshaw, for example).

Drivers get information on the surge pricing pattern, and are encouraged to move to areas of high demand, which will help clear markets more efficiently. Thus, surge pricing is not only a method to match demand and supply, but is also an important measure of information to a cab aggregator’s operations. Doing away with dynamic pricing will thus stem this flow of information, thus reducing the value that these aggregators can add. Hopefully the transport department will see greater sense and permit dynamic pricing (Disclosure: One of my lines of business is in helping companies implement dynamic pricing, so I have a vested interest here. I haven’t advised any cab aggregators though).

That said, Uber has a massive anchoring problem, because dynamic pricing works only in one way. Anchoring is a concept from behavioural economics where people’s expectations of something are defined by something similar they have seen (there is an excellent NED Talk on this topic (by Prithwiraj Mukherjee of IIMB) which I hope to upload in its entirety soon). There are certain associations that are wired in our heads thanks to past information, and these associations bias our view of the world.

A paper by economists at NorthEastern University on Uber’s surge pricing showed that demand for rides is highly elastic to price (a small increase in price leads to a large drop in demand), while the supply of rides (on behalf of drivers) is less elastic, which makes determination of the surge price hard. Based on anecdotal information (friends, family and self), elasticity of demand for Uber in India is likely to be much higher.

Uber’s anchoring problem stems from the fact that the “base prices” (prices when there is no surge) is anchored in people’s minds. Uber’s big break in India happened in late 2014 when they increased their discounts to a level where travelling by Uber became comparable in terms of cost to travelling by auto rickshaw (the then prevalent anchor for local for-hire public transport).

Over the last year, Uber’s base price (which is cheaper than an auto rickshaw fare for rides of a certain length) have become the new anchor in the minds of people, especially Uber regulars. Thus, whenever there is a demand-supply mismatch and there is a surge, comparison to the anchor price means that demand is likely to drop even if the new price is by itself fairly competitive (compared to other options at that point in time).

The way Uber has implemented its dynamic pricing is that it has set the “base price” at one end of the distribution, and moves price in only one direction (upwards). While there are several good reasons for doing this, the problem is that the resultant anchoring can lead to much higher elasticity than desired. Also, Uber’s pricing model (more on this in a book on Liquidity that I’m writing) relies upon a certain minimum proportion of rides taking place at a surge (the “base price” is to ensure minimum utilisation during off-peak hours), and anchoring-driven elasticity can’t do this model too much good.

A possible solution to this would be to keep the base fare marginally higher, and adjust prices both ways – this will mean that during off-peak hours a discount might be offered to maintain liquidity. The problem with this might be that the new higher base fare might be anchored in people’s minds, leading to diminished demand in off-peak hours (when a discount is offered). Another problem might be that drivers might be highly elastic to drop in fares killing the discounted market. Still, it is an idea worth exploring – in my opinion there’s a sweet spot in terms of the maximum possible discount (maybe as low as 10%, but I think it’s strictly greater than zero)  where the elasticities of drivers and passengers are balanced out, maximising overall revenues for the firm.

We are in for interesting days, as long as stupid regulation doesn’t get in the way, that is.

Charging for parking

In a potentially interesting move, the Delhi government has declared that starting from 2016, only half the stock of Delhi’s cars will be allowed on the road each day, based on the parity of the number plate.

While in theory it might work, the dependence of Delhi people on cars, ownership of multiple cars and possible number-trading might render it moot. Also, given that not everyone uses their car every single day, a simple car swap arrangement (like Zipcar; but we need to figure out liability properly) might defeat this regulation.

The more sure-fire way to reduce the number of cars on the road is to impose a congestion surcharge but it it is not an easy regulation to implement – given that you’ll need electronic modes to collect tolls, devices in cars, etc (not that it hasn’t been done, but given India’s scale it’s considerable effort).

A better way to implement congestion surcharge is to charge economic rates for parking. In most cities in India nowadays, parking is highly subsidised (in terms of money) which results in more people taking their cars out, not being able to park them, and creating further congestion by driving around looking for a place to park (Brigade Road in Bangalore is a good example of parking-led congestion thanks to slow-moving cars looking for a place to park).

The question is what an economic rate for parking must be, and that can be determined by looking at the prevailing real estate rates in that area. In the area I live in Bangalore, for example, the “guidance value” (rate used by the municipal corporation to determine the “fair value” of a property in order to tax sales) is about Rs. 8000 per square foot.

Assuming a price to earnings ratio of 20, this translates to Rs. 400 per square foot per year, or little more than a rupee per square foot per day. A parking lot is about 9 feet wide and 18 feet long (based on US standards, assuming India is the same). Let us assume a 50% overhead for space needed to move the car in and out of the lot. Based on this, the “fair rent” for one car parking space in my area is 18 * 9 * 3/2 * 400 / 365 = ~Rs. 270 per day, or translates to around Rs. 11 per hour.

Notice that all the calculations above were either multiplications or divisions, and hence the per hour parking price is directly proportional to the guidance value of property in the area. Based on the numbers above, a good rule of thumb for “economic cost” of an hour parking space is 11 / 8000 or about 14 basis points (a basis point is one hundredth of a percentage point) of the per square foot guidance value.

Of course, there are transaction costs (of putting the car in and out) and demand varies by time of day (so we might have an element of “surge pricing”). Yet, what we have is a good rule of thumb to decide the per hour parking rates.

Revisiting IPOs

I’ve written several times (here, here and here) that the IPO pop is unfair to existing shareholders since they end up selling the stock cheaper than necessary. Responses I’ve received to this (not all on the blog comments) have mostly been illogical and innumerate, talking about how the pop “increases the value of the entrepreneurs’ holdings”, and that the existing shareholder “should be happy that the value has gone up” rather than wondering why he sold his shares at the low value.

Thinking about this in the context of the impending Cafe Coffee Day IPO, I realised that a pop is necessary (though not maybe to the extent of the MakeMyTrip and LinkedIn pops), because investors need some incentive to invest in the IPO rather than buying the stock in the secondary market after listing.

Secondary markets have superior price discovery compared to primary markets since the former have several (close to infinite) attempts at price discovery, while the latter have only one attempt. Also, prices in the secondary market change “slowly” (compared to the price difference between primary and secondary market), so even if someone has invested at a price they later have dissonance with, they can reverse the investment without incurring a high cost.

For this reason, if you want to invest in a company and want to know that you are paying a “fair price”, investing in secondary markets is superior to investing in primary markets. In other words, you need a higher incentive in order to buy in primary markets. And this incentive is provided to you in the form of the IPO pop.

In other words, the IPO pop is an incentive paid to the IPO buyer in exchange for investing at a time when the price discovery is in a sense incomplete and cannot be particularly trusted. Rather than pricing the IPO at what bankers and bookbuilders think is the “fair price”, they will price it at a discount, which offers IPO investors insurance against the bankers having made a mistake in their pricing of the IPO.

And how much to underprice it (relative to any “fair price” that the bankers have discovered) is a function of how sure the bankers are about the fair price they have arrived at. The greater their confidence in such a price, the smaller the pop they need to offer (again, this is in theory since investors need not know what fair price bankers have arrived at).

The examples I took while arguing that the IPO pop is unfair to existing shareholders were MakeMyTrip and LinkedIn, both pioneers in some sense. LinkedIn was the first major social network to go public, much before Facebook or Twitter, and thus there was uncertainty about its valuation, and it gave a big pop.

MakeMyTrip was a travel booking site from India listing on NASDAQ, and despite other travel sites already being public, the fact that it was from an “emerging market” possibly added to its uncertainty, and the resulting high pop.

So I admit it. I was wrong on this topic of IPO pops. They do make sense, but from a risk perspective. Nothing about “wealth of existing shareholders increases after the pop”.