A number of famous Business Schools in the UK and US such as MIT Sloan, NYU Stern and Imperial College have launched new programmes in business analytics. These courses have been nicknamed ‘Big Data finishing school’. Why might qualifications in this area be highly valued by firms?
Employees who have the skills to collect and process Big Data might help firms to successfully implement a pricing strategy that approaches first-degree price discrimination.
First-degree price discrimination is where the seller of a product is able to charge each consumer the maximum price he or she is prepared to pay for each unit of the product. Successfully implementing this type of pricing strategy could enable a firm to make more revenue. It might also lead to an increase in economic efficiency. However, the strategy might be opposed on equity grounds.
In reality, perfect price discrimination is more of a theoretical benchmark than a viable pricing strategy. Discovering the maximum amount each of its customers is willing to pay is an impossible task for a firm.
It may be possible for some sellers to implement a person-specific pricing strategy that approaches first-degree price discrimination. Firms may not be able to charge each customer the maximum amount they are willing to pay but they may be able to charge different prices that reflect customers’ different valuations of the product.
How could a firm go about predicting how much each of its customers is willing to pay? Traditionally smaller sellers might try to ‘size up’ a customer through individual observation and negotiation. The clothes people wear, the cars they drive and their ethnicity/nationality might indicate something about their income. Second-hand car dealers and stall-holders often haggle with customers in an attempt to personalise pricing. The starting point of these negotiations will often be influenced by the visual observations made by the seller.
The problem with this approach is that observation and negotiation is a time-consuming process. The extra costs involved might be greater than the extra revenue generated. This might be especially true for firms that sell a large volume of products. Just imagine how long it would take to shop at a supermarket if each customer had to haggle with a member of staff over each item in their supermarket trolley!! There is also the problem of designing compensation contracts for sales staff that provide appropriate incentives.
However the rise of e-commerce may lead to a very different trading environment. Whenever people use their smart phones, laptops and tablets to purchase goods, they are providing huge amounts of information (perhaps unconsciously) to the seller. This is known as Big Data. If this information can be effectively collected and processed then it could be used by the seller to predict different customers’ willingness to pay.
Some of this Big Data provides information similar to that observed by sellers in traditional off-line transactions. However, instead of visual clues observed by a salesperson, the firm is able to collect and process far greater quantities of information from the devices that people use.
For example, the Internet Protocol (IP) address could be used to identify the geographical location of the customer: i.e. do they live in a relatively affluent or socially deprived area? The operating system and browser might also indicate something about a buyer’s income and willingness to pay. The travel website, Orbitz, found that Apple users were 40 per cent more likely to book four or five star hotel rooms than customers who used Windows.
Perhaps the most controversial element to Big Data is the large amount of individual-level information that exists about the behaviour of customers. In particular, browsing histories can be used to find out (a) what types of goods people have viewed (b) how long they typically spend on-line and (c) their previous purchase history. This behavioural information might accurately predict price sensitivity and was never available in off-line transactions.
Interestingly, there has been very little evidence to date that firms are implementing personalised pricing on the internet. One possible explanation is that effective techniques to process the mass of available information have not been fully developed. This would help to explain the growth in business analytics courses offered by universities. PricewaterhouseCoopers recently announced its aim to recruit one thousand more data scientists over the next two years.
Another possible explanation is that firms fear a backlash from customers who are deeply opposed to this type of pricing. In a widely cited survey of consumers, 91% of the respondents believed that first-degree price discrimination was unfair.
Articles
Big data is coming for your purchase history – to charge you more money The Guardian, Anna Bernasek and DT Mongan (29/5/15)
Big data is an economic justice issue, not just a Privacy Problem The Huffington Post, Nathan Newman (16/5/15)
MIT’s $75,000 Big Data finishing school (and its many rivals) Financial Times, Adam Jones (20/3/16)
The Government’s consumer data watchdog New York Times, Natasha Singer (23/5/2015)
The economics of big data and differential pricing The Whitehouse blog, Jason Furman, Tim Simcoe (6/2/2015)
Questions
- Explain the difference between first- and third-degree price discrimination.
- Using an appropriate diagram, explain why perfect price discrimination might result in an economically more efficient outcome than uniform pricing.
- Draw a diagram to illustrate how a policy of first-degree price discrimination could lead to greater revenue but lower profits for a firm.
- Why would it be so difficult for a firm to discover the maximum amount each of its customers was willing to pay?
- Explain how the large amount of information on the individual behaviour of customers (so-called Big Data) could be used to predict differences in their willingness to pay.
- What factors might prevent a firm from successfully implementing a policy of personalised pricing?
The European Commission has recently carried out a number of investigations into the various sectors of the industry that supplies parts to car manufacturers. Firms have been found guilty of engaging in anti-competitive practices in the supply of bearings, wire harnesses and the foam used in car seats. The latest completed case relates to firms that supply alternators and starters – both important components in a car engine.
On January 27th the European Commission announced that it was imposing fines on some Japanese manufacturing companies. Melco (Mitsubishi Electric), Hitachi and Denso were found guilty of participating in a cartel between September 2004 and February 2010 that restricted competition in the supply alternators and starters to car manufacturers.
The Commission gathered evidence showing that senior managers in the three businesses held discussions about how to implement various anti-competitive practices. These either took place on the phone or at meetings in offices/restaurants. In particular the firms agreed:
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to co-ordinate their responses to tenders issued by car manufacturers. This involved them agreeing on the price each firm would bid. |
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to exchange commercially sensitive information about pricing and marketing strategies. |
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which of them would supply each car manufacturer with alternators and starters. |
These activities are in breach of Article 101 of the Treaty on the Functioning of the European Union (2009). The European Commissioner for Competition, Margrethe Vestager, stated that:
“Today’s decision sanctions three car part producers whose collusion affected component costs for a number of car manufacturers selling cars in Europe, and ultimately European consumers buying them. If European consumers are affected by a cartel, the Commission will investigate it even if the cartel meetings took place outside of Europe”
The fines imposed on the three businesses were as follows:
– Denso €0
– Hitachi €26 860 000
– Melco €110 929 000
How are these fines calculated? When calculating the size of the fine to impose on a firm the Commission takes into account a number of factors. These include:
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the size of its annual sales affected by the anti-competitive activities. |
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its market share. |
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the geographical area of its sales. |
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how long it had taken part in the cartel. |
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whether it had previously been found guilty of engaging in anti-competitive practices. |
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if it initiated the cartel in the first place i.e. was it the ring leader? |
In this particular case the size of the fine imposed on both Hitachi and Melco was increased because they had both previously been found guilty of breaking EU competition rules.
If a member of the cartel comes forward with information that helps the Commission with its investigation, a reduction in the size of the fine can be applied under a provision called a Leniency Notice (2006). Timing as well as the quality of the information provided influences the size of this reduction. For example, only the first firm to come forward with relevant information can receive a reduction of up to 100% i.e. obtain full immunity. This explains how Denso could be found guilty but not have to pay a fine. (This firm’s initial approach to the Commission actually triggered the investigation.) Any subsequent firms that come forward with information receive smaller fine reductions. Hitachi and Melco received reductions of 30% and 28% respectively.
If a firm accepts the Commission’s decision a further reduction of up to 10% can be applied. This is called a Settlement Notice (2008). All three firms were awarded the full 10% discount in this case.
The European Commission is currently investigating the behaviour of firms that supply car thermal systems, seatbelts and exhaust systems.
Articles
Car parts price-fixing fines for Hitachi and Mitsubishi Electric BBC News 27/01/16
EU antitrust regulators to fine Japanese car part makers: sources Tech News 26/01/16
Mitsubishi Electric and Hitachi get $150 EU cartel fine Bloomberg 27/01/16
EU fines Mitsubishi Electric, Hitachi for car part cartel Reuters 27/1/16
Questions
- What market conditions would make the formation of a cartel more likely?
- Draw a diagram to illustrate the impact of a profit maximising cartel agreement on the price, output and profit in an industry.
- Draw a diagram to illustrate the incentive that each firm has to cheat on an agreed cartel price and output.
- Why did the European Commission introduce Settlement Notices?
Recent reports in the media have included headlines such as “Sexist surcharge” and “Pink premium?” Various claims have been made that women pay significantly higher prices for similar products than men.
The Times newspaper recently published the results from an investigation it carried out on the prices of hundreds of similar products that were marketed at both men and women. The study found that those products marketed at women cost 37% more on average than similar versions that were marketed at men. Examples included:
- Disposable razors: Tesco priced a packet of five of its own-brand disposable razors for women at £1. The key characteristic that targeted the razors at female customers was the colour – they were pink. For the same price, a packet targeted at male customers (i.e. they were blue) contained 10 disposable razors.
- Ballpoint pens: Staples priced a packet of five pastel-coloured Bic pens marketed ‘for her’ at £2.99. A packet of five Bic pens that were not in the ‘for her’ range (i.e. they had transparent barrels) were priced at £1.98.
- Scooters: Argos increased the price of a child’s scooter by £5 if it was pink instead of blue.
Maria Miller, the chair of the Women and Equalities Select Committee, stated that:
“It is unacceptable that women face higher costs for the same product just because they are targeted at women. Retailers have got to explain why they do this.”
A more detailed study carried out by New York City’s Department of Consumer Affairs was published in December 2015. Average prices were collected for 794 individual items across 5 different industries. The key findings were that products marketed at women were:
- 7 per cent more for toys and accessories
- 4 per cent more for children’s clothing
- 8 per cent more for adult clothing
- 13 per cent more for personal care products
- 8 per cent more for health products
Interestingly whereas the investigation in the UK only found examples of women paying higher prices than men, the New York study found some goods where the price was higher for men.
Reports in the media have claimed that this is clear evidence of price discrimination. Although this is likely to be true, it is impossible to say for certain without more detailed information on costs.
For example, when referring to the higher price for the razors marketed at women in the UK study, Richard Hyman, an analyst at RAH Advisory, stated that:
“the packaging will be different and they will sell fewer so it could be to do with the volume”
If economies of scale and the different costs of packaging can fully account for the difference in prices between the razors then it is not an example of price discrimination.
Articles
Questions
- Define price discrimination.
- Outline and explain the three different categories of price discrimination.
- Could a situation where a firms charges all of its customers the same price for a good or service ever be classed as an example of price discrimination?
- A firm with market power may still not be able to successfully implement a policy of price discrimination. Explain why.
- Under what circumstances could price discrimination improve allocative efficiency?
Wikipedia is a free on-line encyclopedia which is compiled and maintained by some of the people who use it regularly. It has been estimated that on any given day 15% of all internet users visit the website. Anyone can write new articles or edit existing material. The encyclopedia has over 5 million entries. So how is it financed?
If you visit the Wikipedia website at the moment you will be greeted by the following message:
DEAR READERS, We’ll get right to it: This week we ask you to help Wikipedia. To protect our independence, we’ll never run ads. We’re sustained by donations averaging about £10. Only a tiny portion of our readers give. If everyone reading this right now gave £2, our fundraiser would be done within an hour. That’s right, the price of a cup of coffee is all we need. We’re non-profit with costs of a top website: servers, staff and programs. We believe everyone should have access to free knowledge, without restriction or limitation. If Wiki We believe everyone should have access to free knowledge, without restriction or limitation. If Wikipedia is useful to you, please take one minute to keep our work going another year. Thank you.pedia is useful to you, please take one minute to keep our work going another year. Thank you.
Wikipedia Foundation, the not-for-profit company that manages the Wikipedia website, has been running these donation drives for a number of years. The 2014/15 financial year was their most successful to date as 4 million donations were made by people from all over the world. 
A total of $75 million was raised compared with $15 million in 2009/10. Although the average contribution was $15.20 in 2014/15, some people contributed over $250,000!
Many of you studying economics might find these figures surprising as Wikipedia would appear to have some of the characteristics associated with public goods. On the one hand, the material is perfectly non-rival. If someone decides to read an entry on Wikipedia it does not prevent other users from being able to read the same article. The article does not get used up or depleted in the act of being read. On the other hand, however, it is possible to exclude non-payers from gaining access to the material. For example in June 2010, the Times and Sunday Times introduced a subscription service for access to on-line versions of the newspapers. The New York Times recently announced that it had one million digital subscribers. However given its non-rivalrous nature, material could be shared between payers and non-payers. Groups of people could even get together and share one subscription.
The statement provided by Wikipedia clearly expresses the importance it attaches to free access. Given that it is non-rivalrous in consumption and free of charge to all users, does economic theory predict that people will (i) make voluntary monetary donations (ii) contribute and edit the on-line entries?
If all users are driven by narrowly self-interested preferences and act in a rational manner, then they will not pay and no donations will be made. People will choose to free ride as they can read exactly the same material whether they have paid for it or not.
Given the results of the fund-raising drive are so at odds with this prediction, it suggests that a significant number of Wikipedia users have either altruistic preferences and/or respond to social norms.
If a rational self-interested person receives no monetary payment for writing or editing an entry would they ever contribute to the website? Given the effort involved it would seem highly unlikely. However the Wikipedia website claims that over 125,000 people contribute regularly. They are referred to as ‘Wikipedians’.
One possible explanation for this behaviour is that some individuals gain utility/pleasure from other people reading and finding their entries both useful and interesting. This utility might increase with the number of potential readers. Therefore keeping access free is a motivating factor for a number of contributors as it maximises the potential readership of their entries. However, the number of contributors fell by a one third between 2007 and 2014.
An interesting question is whether the quantity and quality of contributions would increase if Wikipedia implemented a subscription service which generated enough revenue to enable contributors to be paid but also significantly reduced the number of users.
An alternative way of generating revenue would be to allow advertisements on the website while keeping access free of charge. This option has been resisted so far.
Articles
The Wikipedia fundraising banner sad but untrue Wikipediocracy, The Masked Maggot and friends (11/12/2014)
Newsonomics:10 numbers on the New York times 1 million digital-subscriber milestone Nieman. Ken Doctor (6/8/2015)
The trouble with “Free Riding” Freedom to tinker, Timothy B. Lee (24/8/2008)
The future of Wikipedia: Wikipeaks? The Economist (1/3/2014)
Wikimedia publications
Fundraising report 2014-2015 Wikimedia foundation (26/10/2015)
Wikipedia community
Questions
- How do economists classify goods or services that have a low degree of rivalry but where it is relatively easy to exclude non-payers? Give some real world examples to illustrate your answer.
- How do economists classify goods and services that have a high degree of rivalry but where it is relatively difficult to exclude non-payers? Give some real world example to illustrate your answer.
- Explain why an economically rational individual might still make a donation towards the running of the Wikipedia website.
- Why do you think the number of contibutors has fallen?
- People often complain that Wikipedia entrees are badly written and contain numerous mistakes. To what extent do you think that paying contributors would help to overcome this problem?
- What are the possible advantages/disadvantages of financing Wikipedia by using advertising revenue?
Pubs are closing down in the UK at the rate of 29 per week. The total number has fallen from 67,000 in 1982 to approximately 52,000 this year. In response to this decline the government has recently announced some changes to the way the relationship between pub owners and their tenants are regulated.
The ownership of pubs in the UK changed dramatically after a report on the beer market was published by the Monopolies and Mergers Commission (MMC) in 1989. When this investigation took place over 75% of the beer in the UK was produced by the six largest brewing businesses (Bass, Allied Lyons, Grand Metropolitan, Whitbread, Scottish and Newcastle, Courage) which owned over half the pubs. The nature of the relationship between these breweries and the landlords of the pubs they owned caused the greatest concerns.
Some pubs are run as managed houses. In this type of business relationship the person who manages and runs the pub (the publican) is a direct employee of the brewery. However, in many instances this is not the case. Instead they are independent entrepreneurs who enter into a tenancy agreement with the owner of the pub. In other words they rent the pub from the brewery and have some freedom over the way it is run including the setting of prices.
These arrangements have proved to be very controversial because of one particular aspect of many of the tenancy agreements – the exclusive supply contract. Known as the ‘tied lease model’, ‘beer tie’ or ‘wet rent’, it significantly reduces the freedom of publicans to run the business, as they have to purchase almost all their beverages from the brewery that owns the pub.
The MMC report in 1989 concluded that a significant reason for the increasing real price of beer was the market power exerted by the brewers through the tied lease model. It recommended that the number of pubs owned and operated by the brewers should be substantially reduced. Known as the ‘Beer Orders’, the brewers responded by gradually selling off 14,000 pubs. They also eventually sold the breweries to international rivals and companies such as Whitbread and Bass moved into the retail, leisure and hotel sectors. Whitbread currently owns Costa, Brewers Fayre and Premier Inn hotels while Bass, renamed Intercontinental Hotels Groups, owns both Crown Plaza and Holiday Inn hotels.
The beer tie between the pubs and the big national breweries might have disappeared but the tied lease arrangement still exists. Instead of being tied to national brewers, many publicans are tied to either smaller regional breweries, such as Everards and Adnams, or another type of business – the pub company known as ‘pubcos’. Some of the larger pubcos include Enterprise Inns, Punch Taverns, Mitchells&Butlers and JD Weatherspoon. They negotiate deals with the breweries and then supply the beer to their pubs.
In 2014, The British Beer and Pub Association estimated that two-fifths of pubs in the UK were owned by pubcos, while another fifth were owned by regional breweries. In 2013, The Department for Business, Innovation and Skills estimated that 48 per cent of pubs in the UK had landlords who were tied to either a regional brewer or a pub company.
The ownership of pubs may have changed radically over the past 20 years but the tied lease system continues to be extremely controversial. The main argument against the system is that it leads to tied publicans having to pay significantly above free market prices for their beer. The pubcos accept this claim but maintain that, in return for being in a tied lease, the publican pays a lower rent and receives business support services.
Parliament passed the Small Business, Enterprise and Employment Act in March 2015 (see Part 4). This included provisions for the introduction of:
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a statutory Pubs Code to govern the relationship between the businesses that own the pubs and their tenants; |
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a new independent Adjudicator to enforce the code; |
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a Market Rent Only (MRO) option. |
In October 2015 the government announced some proposals for how the MRO option could be implemented as part of its consultation process with the industry. These include giving the tied publican the right to ask for a rent assessment every five years or whenever the owner of the pub significantly changes the beer prices it charges the tenant. As part of this rent assessment the publican can take the option to switch to an MRO contract. This gives them the freedom to purchase beer from any supplier rather than being tied to those supplied by the owner of the pub.
Enterprise Inns, the largest pubco, operates nearly all of its pubs on the tied lease model. In response to the changes proposed by the Government, the company has announced plans significantly to increase the number of its directly managed pubs from just 16 to 800.
Could the tied lease system finally be about to end?
Articles
Enterprise Inns to grow pub numbers after death of the ‘beer tie’ The Telegraph, Ben Martin, and Peter Spence (12/05/15)
What is the ‘beer tie’ The Telegraph, Denise Roland (19/11/14)
Q&A: Calling time on the beer tie BBC News, Katie Hope (19/11/14)
Chin chin! Fair deal for pub tenants under a new beer tie crackdown City AM, Suzie Neuwirth (29/10/15)
Industry Reacts to New Statutory Pubs Code Eat Out, Nathan Pearce (29/10/15)
What does new pub code mean for the leased pubs? Burton Mail, Andrew Musgrove (04/11/15)
Questions
- What has happened to the big six national brewers which once dominated the beer industry in the UK?
- What factors have caused the decline in the number of pubs?
- Using a diagram, illustrate the impact that the market power of the pubcos might have on the prices paid by publicans in a tied lease.
- Discuss some of the potential advantages of the tied lease model.
- The global brewers and pubcos might create a situation where market power exists in successive stages of the vertical supply chain. Analyse some of the potential implications of this structure and discuss the concept of double marginalisation.
A number of famous Business Schools in the UK and US such as MIT Sloan, NYU Stern and Imperial College have launched new programmes in business analytics. These courses have been nicknamed ‘Big Data finishing school’. Why might qualifications in this area be highly valued by firms? 
How could a firm go about predicting how much each of its customers is willing to pay? Traditionally smaller sellers might try to ‘size up’ a customer through individual observation and negotiation. The clothes people wear, the cars they drive and their ethnicity/nationality might indicate something about their income. Second-hand car dealers and stall-holders often haggle with customers in an attempt to personalise pricing. The starting point of these negotiations will often be influenced by the visual observations made by the seller.
