Tag: first-degree price discrimination

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Disgruntled Oasis fans react to dynamic pricing

On Saturday 31 August, tickets for the much-heralded Oasis reunion tour went on sale through the official retailer, Ticketmaster. When the company sells tickets, the acts or their promoters can choose whether to use a static pricing system, where each type of ticket is sold at a set price until they have all been sold. Or they can use a dynamic pricing system (‘in-demand’ or ‘platinum’ tickets, as Ticketmaster calls them), where there is a starting price quoted, but where prices then rise according to demand. The higher the demand, the more the price is driven up. Acts or their promoters have the option of choosing an upper limit to the price.

Dynamic pricing

The Oasis tickets were sold under the dynamic pricing system, a system previously used for Harry Styles, Bruce Springsteen, Coldplay and Blackpink concerts, but one rejected by Taylor Swift for her recent Eras tour. Standing tickets for the Oasis concert with a face value of around £135 were quickly being sold for over £350. There were long online queues, with the prices rising as people slowly moved up the queue. When they reached the front, they had to decide quickly whether to pay the much higher price. Some people later suffered from buyer’s remorse, when they realised that in the pressure of the moment, they had paid more than they could afford.

Dynamic pricing is when prices change with market conditions: rising at times when demand exceeds supply and falling when supply exceeds demand. It is sometimes referred to as ‘surge pricing’ to reflect situations when price surges in times of excess demand.

Dynamic pricing is a form of price discrimination. It is an imperfect form of first-degree price discrimination, which is defined as people being charged the maximum price they are willing to pay for a product. Pricing in an eBay auction comes close to first-degree price discrimination. With dynamic pricing in the ticket market, some people may indeed pay the maximum, but others earlier in the queue will be lucky and pay less than their maximum.

Ticketmaster justifies the system of dynamic pricing, saying that it gives ‘fans fair and safe access to the tickets, while enabling artists and other people involved in staging live events to price tickets closer to their true market value’. The company argues that if the price is below the market value, a secondary market will then drive ticket prices up. Ticket touts will purchase large amounts of tickets, often using bots to access the official site and then resell them at highly inflated prices on sites such as Viagogo and Stubhub, where ticket prices for popular acts can sell for well over £1000. The day after Oasis tickets went on sale, Viagogo had seats priced at up to £26 000 each!

Oasis and Ticketmaster have tried to stamp out the unofficial secondary market by stating that only tickets bought through the official retailers (Ticketmaster, Gigsandtours and SeeTickets) will be valid. If fans want to resell a ticket – perhaps because they find they can no longer go – they can resell them on the official secondary market though Ticketmaster’s Fan-to-Fan site or Twickets. These official secondary sites allow holders of unwanted tickets to sell them for anything up to the original face value, but no more. Buyers pay a 12% handling fee. It remains to be seen whether this can be enforced with genuine tickets resold on the secondary market.

Examples of dynamic pricing

Dynamic pricing is not a new pricing strategy. It has been used for many years in the transport, e-commerce and hospitality sectors. Airlines, for example, have a pricing model whereby as a flight fills up, so the prices of the seats rise. If you book a seat on a budget airline a long time in advance, you may be able to get it at a very low price. If, on the other hand, you want a seat at the last minute, you may well have to pay a very high price. The price reflects the strength of demand and its price elasticity. The business traveller who needs to travel the next day for a meeting will have a very low price sensitivity and may well be prepared to pay a very high price indeed. Airlines also learn from past behaviour and so some popular routes will start at a higher price. A similar system of dynamic pricing is used with advance train tickets, with the price rising as trains get booked up.

The dynamic pricing system used by airlines and train companies is similar, but not identical, to first-degree price discrimination. The figure below illustrates first-degree price discrimination by showing a company setting the price for a particular product.

Assume initially that it sets a single profit-maximising price. This would be a price of P1, at an output of Q1, where marginal revenue (MR) equals marginal cost (MC). (We assume for simplicity that average and marginal costs are constant.) Total profit will be area 1: i.e. the blue area ((P1 – AC) × Q1). Area 2 represents consumer surplus, with all those consumers who would have been prepared to pay a price above P1, only having to pay P1.

Now assume that the firm uses first-degree price discrimination, selling each unit of the product at the maximum price each consumer is willing to pay. Starting with the consumer only willing to pay a price of P2, the price will go on rising up along the demand with each additional consumer being charged a higher price up to the price where the demand curve meets the vertical axis. In such a case, the firm’s profit would be not just the blue area, but also the green areas 2 and 3. Note that there is no consumer surplus as area 2 is now part of the additional profit to the firm.

Although dynamic pricing by airlines is similar to this model of first-degree price discrimination, in practice some people will be paying less than they would be willing to pay and the price goes up in stages, not continuously with each new sale of a ticket. Thus, compared with a fixed price per seat, the additional profit will be less than areas 2 + 3, but total profit will still be considerably greater than area 1 alone. Note also that there is a maximum quantity of seats (Qmax), represented by a full flight. The airline would hope that demand and its pricing model are such that Qmax is less than Q2.

Dynamic pricing also applies in the hospitality sector, as hotels raise the prices for rooms according to demand, with prices at peak times often being considerably higher than off-season prices. Rather then pre-setting prices for particular seasons, dates or weekends/weekdays, many hotels, especially chains and booking agents, adjust prices dynamically as demand changes. Airbnb offers property owners what it calls ‘Smart Pricing’, where nightly prices change automatically with demand.

Another example is Uber, which uses dynamic pricing to balance demand and supply location by location. In times of peak demand on any route, the company’s algorithm will raise the price. This will encourage people to delay travelling if they can or use alternative means of transport. It will also encourage more Uber drivers to come to that area. In times of low demand, the price will fall. This will encourage more people to use the service (rather than regular taxis or buses) and discourage drivers from working in that area.

Where dynamic pricing varies with the time or date when the purchase is made, it is sometimes referred to as inter-temporal pricing. It is a form of second-degree price discrimination, which is where a firm offers consumers a range of different pricing options for the same or similar products.

Another example of dynamic pricing, which is closer to first-degree price discrimination is the use of sophisticated algorithms and AI by Amazon, allowing it to update the prices of millions of products many times a day according to market conditions. Another is eBay auctions, where the price rises as the end date is reached, according to the willingness to pay of the bidders.

Attitudes to dynamic pricing

Consumers have grown accustomed to dynamic pricing in many industries. People generally accept the pricing model of budget airlines, for example. What makes it acceptable is that most people feel that they can take advantage of early low-priced seats and can compare the current prices on different flights and airlines when making their travel plans. Pricing is transparent. With the Oasis concert, however, there wasn’t the same degree of price transparency. Many people were surprised and dismayed to find that when they got to the front of the online queue, the price had risen dramatically.

People are familiar of dynamic pricing in the context of price cuts to shift unsold stock. Supermarkets putting stickers on products saying ‘reduced for quick sale’ is an example. Another is seasonal sales. What is less acceptable to many consumers is firms putting up prices when demand is high. They see it a profiteering. Many supermarkets are introducing electronic shelf labels (ESLs), where prices can be changed remotely as demand changes. Consumers may react badly to this if they see the prices going up. The supermarket, however, may find it a very convenient way of reducing prices to shift stock – something consumers are hardly likely to complain about.

Returning to the Oasis tour, the UK government responded to the outrage of fans as ticket prices soared. Culture Secretary, Lisa Nandy, announced that the government will investigate how surge pricing for concert tickets is used by official retailers, such as Ticketmaster. This will be part of a planned review of ticket sales that seeks to establish a fairer and more transparent system of pricing.

The problem is that, with some fans being prepared to pay very high prices indeed to see particular acts and with demand considerably exceeding supply at prices that fans would consider reasonable, some way needs to be found of rationing demand. If it is not price, then it will inevitably involve some form of queuing or rationing system, with the danger that this encourages touts and vastly inflated prices on the secondary market.

Perhaps a lesson can be drawn from the Glastonbury Festival, where prices are fixed, people queue online and where security systems are in place to prevent secondary sales by ticket touts. The 2024 price was set at £355 + a £5 booking fee and purchasers were required to register with personal details and a photo, which was checked on admission.

Update

On 5 September, the CMA announced that it was launching an investigation into Ticketmaster over the Oasis concert sales. Its concerns centred on ‘whether buyers were given clear and timely information, and whether consumer protection law was breached’. This followed complaints by fans that (i) they were not given clear and timely information beforehand that the tickets involved dynamic pricing and warned about the possible prices they might have to pay and (ii) on reaching the front of the queue they were put under pressure to buy tickets within a short period of time.

Meanwhile, band member stated that they were unaware that dynamic pricing would be used and that the decision to use the system was made by their management.

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Articles

Questions

  1. What is the difference between dynamic pricing and surge pricing?
  2. What is buyer’s remorse? How could dynamic pricing be used while minimising the likelihood of buyer’s remorse?
  3. Distinguish between first-degree, second-degree and third-degree price discrimination. Do the various forms of dynamic pricing correspond to one or more of these three types?
  4. Distinguish between consumer and producer surplus. How may dynamic pricing lead to a reduction in consumer surplus and an increase in producer surplus?
  5. Should Ticketmaster sell tickets on the same basis as tickets for the Glastonbury Festival?
  6. Is Oasis a monopoly? What are the ticket pricing implications?
  7. Are there any industries where firms would not benefit from dynamic pricing? Explain.
  8. What are the arguments for and against allowing tickets to be sold on the secondary market for whatever price they will fetch?
  9. How powerful is Ticketmaster in the primary and secondary ticket markets?
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Is personalised pricing possible?

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

  1. Explain the difference between first- and third-degree price discrimination.
  2. Using an appropriate diagram, explain why perfect price discrimination might result in an economically more efficient outcome than uniform pricing.
  3. Draw a diagram to illustrate how a policy of first-degree price discrimination could lead to greater revenue but lower profits for a firm.
  4. Why would it be so difficult for a firm to discover the maximum amount each of its customers was willing to pay?
  5. 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.
  6. What factors might prevent a firm from successfully implementing a policy of personalised pricing?
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Different prices for the same tourist attraction

Merlin Entertainments PLC is one of the largest operator of visitor attractions in the world and owns over a third of the most popular theme parks in Europe. It runs the four most visited parks in England – Alton Towers, Legoland Windsor, Thorpe Park and Chessington World of Adventures as well as the most popular theme park in Italy – Gardaland. Alton Towers alone had 2.5 million visitors in 2013. Anybody thinking of going to one of these attractions is faced with a wide range of different entry fees .

Theme parks and tourist attractions have market power so their owners have to make some interesting pricing decisions. They have to tackle the same dilemma that confronts any seller that faces a downward sloping demand curve for its goods/services.

One option for the firm would be to increase the entry fee. This would produce higher profits per visitor as some of the surplus from the transaction previously enjoyed by the consumer will be extracted by the seller and converted into producer surplus. Unfortunately for the business the higher price, all other things equal, will also result in fewer visitors. Some people will be deterred from visiting because of the higher price and the seller will lose out on potential revenue.

An alternative strategy would be for the theme park to reduce its entry fee. All other things equal, this will increase the number of visitors. However, it would also mean that the profit per customer would fall. The frustrating issue for the seller is that some of its customers, who would still have visited the attraction at the higher price, are now able to get a better deal.

This dilemma exists if the seller has to charge all of its different customers the same entry fee. If it could charge a higher entry fee to those customers who would be willing to pay more and a lower entry fee to those who would be willing to pay less then it could make more money. Extra revenue could be obtained from those additional sales that take place at the lower price while more consumer surplus could be extracted from those still paying the higher price.

Is it possible for a firm to charge different prices to different customers for the same or a similar good or service? Table 1 below shows the entry fees for Warwick Castle, another tourist attraction owned by Merlin Entertainments PLC.

It can immediately be seen from this table that some groups of customers pay a different entry fee from others. For example adults have to pay £24 to enter on the day while people aged 60 and over pay a lower price £16.80. The entry fee for children aged between 4 and 11 is £21.00 while those aged 3 and under go for free. Students aged 16-18 can gain entry for a price of £13.50 if they can provide valid ID and purchase the tickets from the visitbritainshop website.

In this example, the company has allocated people into different categories by age (i.e. senior, adult, student, older children and younger children) and has set the entry fee that customers in each group have to pay.

The table also shows that if customers purchase on- line then they can get the tickets more cheaply. The entry fee for each category is 25% lower if the ticket is booked seven days in advance i.e. the prices shown in the last column in the table. If the booking is made between 2-6 days in advance then the discount is only 10% i.e. an adult ticket would cost £21.60. The on-line discounts are open to everyone. People are given the choice to either book on-line in advance or pay on the day. This is different from a situation where you are placed into a category by the firm. For example the customer cannot choose whether they are over 60!

If people are prepared to spend more time searching on the internet then other cheaper prices can also be obtained. Once again these offers are open to anyone willing to spend the time and effort in order to find them.

All the ticket prices above give people access to exactly the same attractions on the day. They do not give the visitor access to two of the attractions at the castle – the Dragon Tower and Castle Dungeon. Entry to the Dragon Tower would cost an adult on the day an extra £1.80 while entry to the Castle Dungeon would cost an extra £5.40.

Warwick Castle Ticket Prices Warwick Castle (accessed on 04/09/14)
Alton Towers Alton Towers (accessed on 08/09/14)
Warwick Castle Tickets visitbritainshop (accessed on 02/09/14)
Global Attractions Attendance Report teaconnect (accessed on 05/09/14)
Merlin Entertainments Merlin Entertainments (accessed on 08/09/14)

Questions

  1. What pricing decisions do firms have to make if they operate in a perfectly competitive market?
  2. Explain why an individual tourist attraction will have a downward sloping demand curve
  3. Paying an entry fee and an extra payment per attraction is known as what type of pricing? What advantages does this type of price strategy have for the seller?
  4. How would you calculate the profit per customer? What factors other than the entrance fee would determine the profit made per customer in a theme park or tourist attractions?
  5. Paying a different price depending on which category you have been assigned to by the seller is known as what type of pricing strategy? Can this type of pricing strategy ever be in the interests of society?
  6. In the example used in the case, customers are assigned to different categories by age. Can you think of any other ways that firms could categorise their customers?
  7. Given the category customers have been assigned to they can pay different prices depending on whether they buy the tickets on line. What is the price strategy called when customers can choose from a variety of pricing options for the same or similar product? Can you think of any different methods that could be used by the seller to carry out this type of pricing strategy?
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Entrance this way!

As students, many of you probably have a student identification card, which you might use when you go to the cinema or when you buy something in a shop offering student discounts. Your parents or grandparents, if they are 60 or over, may get similar discounts, and your younger siblings or nieces and nephews may pay nothing for certain services.

It doesn’t cost a cinema more to provide a seat for an adult than it does for a child, a student or a senior citizen. So, why is it that firms can charge different groups of consumers different prices, even though they are consuming the same good or service? We are, of course, referring to the ability of a firm to price discriminate. The following short cases look at the concept in action.

Price discrimination: Russians get a discount Daily Markets, Mark Perry (12/10/10)
Theme park tickets and passes for Florida residents Walt Disney World 2010
Price discrimination: India and Disney World Daily Markets, Mark Perry (10/10/10)
Freedom’s just another word for getting a state subsidy The Economist (18/10/10)

Questions

  1. What are the different types of price discrimination?
  2. In the cases in the articles above, what type of price discrimination is being used?
  3. Illustrate this concept on a diagram and explain why a firm would use price discrimination. How will it affect revenue and profits?
  4. What are the key conditions needed for price discrimination to take place? In the cases above, why is it that British consumers are charged a higher price? What does this tell us about their price elasticity of demand?
  5. What forms of price discrimination (a) are being practised by US private universities and (b) being proposed in the Browne report for students at English universities?
  6. What other examples of price discrimination can you think of? Try and think of examples that fit into the different types of price discrimination.