Thursday, December 2, 2021

Look ahead and reason back: buying a franchise

Individual franchisees (like an individual hotel owner) pay to use the brand and business formula of the franchisor (like Best Western, Comform Inn, Days Inn, Econolodge, Hampton Inn, Holiday Inn, Ramada, or Super 8). The value of the brand to the franchisee depends, among other things, on how much "within brand" competition there is.

Unless the contract grants the franchisee an "exclusive territory," the franchisor may have an incentive to set up more franchisees in the same area. Using a ten year data set of Texas Hotels, Arturs Kalnins find that when new franchisees open up nearby, incumbent franchisees lose 2-3% of their revenue. Interestingly, there is no cannibalization when a new company-owned hotel enters near an existing company-owned hotel (e.g., La Quinta and Motel 6 own most of their own hotels).

If franchisees anticipate that future franchisees will cannibalize sales, this will reduce the amount that they are willing to pay for the franchise. If franchisees do not anticipate cannibalization, they are in for a rude awakening.

Franchisees are powerful politically (easy to organize, common purpose) and often lobby state legislatures to enact franchisee "bill of rights" giving them, among other things, right of first refusal for new franchises. In states with strong franchisee bills of rights, companies with strong brands opt for company-owned stores, which are easier to control instead of the franchisee organizational form..

Thursday, November 25, 2021

Governments learn from the consequences of their mistakes

 If a firm makes a decision that increases costs or reduces quality, there are two immediate consequences: reduced sales as consumers turn to lower-priced, or higher-quality, alternatives; and a higher cost of capital, as lenders and investors turn to more profitable opportunities.  Product market competition thus aligns the incentives of a firm with the goals of consumers, and capital market competition, with the goals of lenders and investors.  

In contrast, if a government makes a bad decision, one that makes the state a less desirable place to work or do business, residents must wait until the next election, or move.  This kind of pressure is weaker and delayed, as it is costly and takes time to start over in a new state.  As a result, incentives for state government to better serve its residents are not as strong or immediate.

For example, Illinois has decided to under-fund state pensions for decades.  Its taxpayers now face a huge future tax burden, and the prospect of reduced government services, like police protection.  Current taxpayers are leaving because they can see a costly and crime-ridden future, and would-be taxpayers are locating in better-run states.  This kind of competitive pressure is slowly building and should eventually lead to reform.

However, if Democrats raise the SALT (State and Local Tax) deduction for federal taxes, other states will end up paying for Illinois' mistakes, shielding Illinois from the full consequences of its bad decisions.  This can only delay reform because governments, like children, do not learn from their mistakes, they learn from the consequences of their mistakes.  

Wednesday, November 24, 2021

How to raise prices without raising prices

 From WSJ:

1. Unbundling services, lowering product quality and devaluing reward programs

... airlines have unbundled services so that fliers pay extra for checking luggage, boarding early, selecting a seat, having a meal and so on. The charges for these services don’t show up on the ticket price, but they are substantial. Second, the airplane seat’s quality, as measured by its pitch, width, seat material and heft, has declined considerably, meaning customers are getting far less value for the ticket price. And third, many airlines have steadily eroded the value of frequent-flier miles, increasing costs for today’s heavy fliers relative to those in 1996.

These practices are also common in other industries, whether it’s resort fees in hotels, cheaper raw materials in garments and appliances, or more-stringent restaurant and credit-card rewards programs.

2. Shrinkflation and the quantity surcharge

To raise prices covertly, the brand or the grocery store sells more of the higher-margin items by increasing their availability and visibility in the store, or withdrawing popular lower-margin items from circulation for a period. The prices don’t change, but customers pay more.

3. Disappearing deals and coupons

...Even increasing the threshold for free shipping, from $49 to $99, is tantamount to a price increase. 

4. The sunk costs of memberships

...f you consider that the warehouse club requires a separate mandatory membership fee, the customer is actually paying more per ounce at the warehouse club.

5. From good to better and from better to best

Another way to raise prices covertly is to introduce new, higher-quality versions at higher prices. 

BOTTOM LINE:  The smartest companies don’t raise their prices with great fanfare, because direct price increases are often met with customer resistance.

HT:  Quinn C.

Monday, November 22, 2021

Why does government always expand, and how should we respond?

 The Economist suggests 3 reasons:

  • Inertia and mission creep make government hard to pare back. Voters and lobbyists who benefit from a regulation or item of spending have every reason to work hard at preserving it, ...
  •  The second force is a fact of life. Prices of the services welfare states provide, such as health care and education, grow faster than the economy because of their high labour intensity and low rates of productivity increase. ...
  •  The third force is that governments today have more things to get done. As voters became richer over the 20th century they demanded more education and more of the expensive health care that takes advantage of the latest science. ...
...and offers some criticism of President Biden
  • One task is to maximise the role of markets and individual choice. Climate change should be fought with a price for carbon, ... not by rationing flights, promoting green national champions or enlisting central banks to distort financial markets. 
  •  The welfare state should focus on redistributing cash and letting those in need choose what to do with it, not setting up new bureaucracies such as President Joe Biden’s proposed federal child-care system.

Saturday, November 20, 2021

Run experiments to measure the effects of advertising (and make money)

Readers of this blog know that we are big fans of randomized control trials (RCT's).  Here is a story from a new book, The Power of Experiments, taken from a review by Strategy & Business.

 eBay used to pay Google about $50 million annually for ads by search terms that included the company name, such as eBay or eBay shoes. To determine whether this was worth the money, they ran an experiment, turning Google ads on and off, and tracking the traffic coming to eBay from Google ads (paid) vs. traffic coming from organic search (unpaid). They discovered that paid advertising was cannibalizing traffic from organic search:
...the experiments found that in markets where the company didn’t advertise, it got a spike in traffic from unpaid organic links. “Evidently, users who Googled ‘eBay’ (or another eBay-related search term), who had been clicking on the ad because they saw no reason to scroll down to the organic link just below it, were now instead clicking on the first organic search result.

Revealed preference

Progressives say the only way to achieve their climate goals is to raise the price of fossil fuels. Their problem is that consumers don’t want to pay more for energy, and as the latest proof behold Connecticut Gov. Ned Lamont’s retreat this week from a Northeast state climate pact. ...
Mr. Lamont finally gave up trying to pass the scheme this week. “Look, I couldn’t get it through when gas prices were at historic lows. So I think the legislature has been pretty clear it is a tough rock to push when gas prices are so high,” he said. Massachusetts GOP Gov. Charlie Baker then threw in the towel too, causing the climate pact to effectively combust.
...This summer the Swiss rejected higher taxes on driving and flying in a referendum.  (link)

Is inflation transitory and how long will interest rates stay low?

Right now, interest rates (mortgages) are 3% and inflation is 5%.  This cannot last because those who lend are getting paid back with dollars that cannot buy as much as the dollars they lent.  If inflation stays at 5%, interest rates have to rise to compensate lenders, e.g., to 8%.

MarginalRevolution.com has an answer:

“I think the inflation will last two to three years, and it will be bad,” Cowen said. But really grim hyper-inflation à la Carter-era, he thinks is unlikely. It could only happen if the Federal Reserve decides it’s too risky to trim the sails of cheap money. “I’d put it at 20% chance that the Fed will think, ‘Trump might run again, and we don’t want Biden to lose . . . history’s in our hands, so we’ll wait to tighten.’ And then it just goes on, and then it’s very bad.”
But a recession is also bad. It’s hard to sort it all out. “As the saying goes, ‘If you’re not confused, you don’t know what’s going on,’” Cowen told me.

Thursday, November 18, 2021

Why does De Beers' sell bags of uncut (and unappraised) diamonds for a single take-it-or-leave it price?

Yoram Barzel, writing in 1977, argued...  “Had the contents of a particular bag been available for appraisal by all buyers,” Barzel explained: “[E]ach would have spent resources to determine the properties of the diamonds. … 

In other words, because buyers were spared the costs of evaluating individual stones, they were willing to pay De Beers more for the average stone.  (link)

Monday, November 15, 2021

Does our tolerance for inequality make us rich?

In Chapter One, we learn about the importance of incentive alignment: designing organizations so that decision makers have (i) enough information to make a good decision; and (ii) the incentive to do so. But incentives, i.e., linking pay to performance, necessarily creates some inequality as some people work harder or are more productive than others. The Economist notes that this tradeoff is not new.
In 1975 Arthur Okun, an American economist, argued that societies cannot have both perfect equality and perfect efficiency, but must choose how much of one to sacrifice for the other.
However, political views on this tradeoff diverge:
Views of income inequality are divisive. Leftists blame uneven distribution on outside factors, such as poor education and corporate misconduct. Conservatives, meanwhile, tend to view these differences as a fair consequence of an individual’s choices and abilities.
Views on income inequality diverge across countries as well.
Today, Americans seem far more willing to tolerate inequality than people in most rich countries. “In the United States”, reflects Mr Monks, “nobody minds Bill Gates making $49 billion. He is an American hero. There's no sense of the virtue of a homogenous culture.”
Bottom line:
Countries, like companies, will remain free to engineer greater or lesser degrees of equality. But there will be a price—as Sweden is discovering, and as Germany has already noticed. As the market for top talent grows more international, so it may force greater tolerance for inequality on countries that have spent half a century trying to root it out.
HT: Bill Wilson