Using Demand Signals to Re-Price

A CNBC story indicates that Starbucks repeatedly raised menu prices over the past several years. Initially, this strategy worked well. Higher prices more than offset modest declines in customer traffic, increasing average revenue per transaction. More recently, however, the company's quarterly earnings have shown declining customer visits, and new CEO Brian Niccol has shifted the company's emphasis away from broad price increases and toward improving service, simplifying the menu, and restoring the in-store experience, i.e. product differentiation. While many factors undoubtedly contributed to Starbucks' slowdown, the company's strategic pivot suggests that management believes customers have become increasingly willing to substitute away from Starbucks when prices rise. The available evidence is consistent with demand becoming more price elastic than it was only a few years ago.

Demand elasticity is not a fixed characteristic of a product or brand. Firms may consider premium brands' demand characteristics as permanent, but elasticity depends on the availability of substitutes and customers' willingness to switch. As time passes after a price increase, more consumers become aware that the price has changed, become more willing to experiment with competing brands, and discover acceptable alternatives. With better informed customers, future price increases can trigger much larger reductions in sales than before. The Starbucks experience is less a story about charging "too much" for coffee than about how repeated price increases may inadvertently encourage customers to search for substitutes, making demand progressively more elastic. Every price increase is also an experiment that provides information for future pricing decisions.

Specrtum Auctions Address Economies of Scope

The Federal Communications Commission (FCC) auction can demonstrate economies of scope. The FCC periodically auctions off additional spectrum licenses for advanced services. It recently raised $3.5 billion from recent AWS-3 (Advanced Wireless Services) auctions and expects to raise $30-$6 billion from upcoming Upper C-Band auctions. In telecom, these frequencies are not independent assets; their value is multiplicative. This additional spectrum will allow for greater capacity to handle the exponentially growing demand for wireless data transmission.

Spectrum auctions are usually run as Simultaneous Multiple-Round Auctions (SMRAs). US coverage is divided into many distinct geographic areas that are auctioned simultaneously across many rounds. An aggregation problem arises when a bidder risks winning fragmented licenses that are less valuable without their complementary counterparts. Since transmission has origin and a destination, it is more valuable to win a license in, say, Chicago if the operator can also secure one for Dallas. SMRAs allow bidders to cobble together desired regional capacity by aggregating multiple licenses.

The cell towers, base stations, and cables that link them are huge fixed costs. The ability to defray these costs over more volume reduces average costs. Economies of scale in these fixed costs generate economies of scope across these fixed costs in different regions.

Curating Complements: Apple & USB-C

One of the strongest arguments for industry standards is that they increase competition. A common charging connector means consumers can choose from hundreds of competing cable manufacturers instead of being locked into a single supplier. The resulting competition lowers prices and increases consumer welfare. When the EU required Apple to transition from its proprietary Lightning connector to USB-C in 2023, it illustrated that this logic, while generally sound, is incomplete. The WSJ reports that one independent repair specialist saw Apple iPhone failures associated with poorly designed or non-compliant USB-C cables and chargers. While these failures appear to be relatively uncommon, they highlight an economic tradeoff that is easy to overlook: greater competition among complementors can also increase quality variation. Under the Lightning ecosystem, Apple exercised tight control over accessory manufacturers through its Made for iPhone (MFi) certification program. Consumers paid more for certified cables, but they also purchased into a curated ecosystem with stronger quality assurance. By requiring Apple to adopt the industry-standard USB-C connector, regulators and policymakers may have increased competition, but they may also have exposed consumers to a much broader range of accessory quality.

Firms sometimes vertically integrate to solve coordination and quality-control problems, and not to exploit market power. Apple had strong incentives to ensure that its phones, chargers, cables, and software functioned reliably as an integrated system because failures reflected directly on the Apple brand, regardless of who manufactured the accessory. A proprietary standard gave Apple greater ability to police quality and exclude unreliable suppliers. This is likely the case for many of the Apple iPhone’s complements. An open standard like USB-C creates incentives for lower prices, interoperability, and reduced electronic waste. It also may have shifted more responsibility to consumers, who must distinguish between high-quality and low-quality accessories in a crowded marketplace. In this case, it is unclear if the pre-purchase consumer search costs and post-purchase repair costs were comparable to the competitive benefits from allowing open entry. But the episode demonstrates that a tradeoff could exist.

Can you Go to Jail if your AI Engages in Collusion?

The stereotype of price fixing is fat, cigar-chomping executives meeting secretly in smoke-filled rooms to agree to raise prices. But the Justice Department's recent consent decree with RealPage anticipates that AI collusion may look different. RealPage sold revenue-management software that used confidential pricing information from competing landlords to recommend rents. Although the software generated the recommendations, the DOJ alleged that the system facilitated unlawful coordination among competitors. I had my doubts. Nevertheless, the settlement requires RealPage to stop using certain competitively sensitive data and to change features of its pricing software.

AI can still recommend prices. Firms have used sophisticated pricing software for decades. A broader implication is that firms cannot avoid antitrust liability by outsourcing pricing decisions to an algorithm. If competing firms provide confidential information to a common AI system that helps coordinate pricing decisions, regulators may view the arrangement much like traditional collusion.

This distinction will become increasingly important as companies deploy AI agents to make autonomous business decisions. An AI pricing system that independently analyzes a firm's own costs, demand, and inventory is generally very different from one that relies on competitors' confidential information or otherwise facilitates coordination among rivals. The RealPage consent decree is consistent with antitrust law focusing on economic outcomes rather than how those outcomes were produced.

Use It or Lose It: The Perverse Incentives Draining the American West

If you wanted to design a property rights regime that guaranteed the waste of a scarce resource, you could hardly do better than Western water law's doctrine of prior appropriation. It requires rights holders to put water to "beneficial use" or—after five consecutive years of non-use—forfeit the right. [1] The result is a textbook perverse incentive: a farmer who irrigates more efficiently risks losing the conserved portion of her right, so the private return to conservation is negative even when the social return is big.

Oregon tried to eliminate the perverse incentive with its 1987 Instream Water Right Act that made instream flow a beneficial use. [2] On the Deschutes, conservancies now lease and buy water for the river. [3], but legalizing the trade didn't create a liquid market. Rights are mostly held by irrigation districts rather than individual farmers, so every deal needs board approval, and transaction costs run high: quantifying how much water actually reaches crops through leaky, century-old canals is expensive, and farmers still fear that proving they can conserve invites a future challenge to their right.

In the Colorado River, states face the same problem. If an Upper Basin state conserves, the saved water flows downstream to be consumed by someone else which creates the risk of becoming the baseline for future cuts. [4] Instead, the feds pay farmers billions to fallow fields—a costly government subsidy trying to address the perverse consequences of another government policy. [5]

BOTTOM LINE: any rule tying an asset's ownership to its continuous consumption—budget lines that vanish if unspent, headcount that shrinks if unfilled—will be consumed regardless of value. 

NOTES

[1] Schwabe, Williamson & Wyatt, "Oregon Water Law Questions and Answers" — beneficial use requirement and five-year forfeiture rule. https://www.schwabe.com/publication/oregon-water-law-questions-and-answers/

[2] Oregon Legislature, "Background Brief on Water Rights" — the 1987 legislation adding instream water rights as a beneficial use. https://www.oregonlegislature.gov/lpro/Publications/2004HM_Water_Rights.pdf

[3] University of Oregon School of Law, "Evaluating Instream Flow Programs" — Oregon's 1,100+ instream leases and transfers, including the Deschutes River Conservancy's role. https://law.uoregon.edu/sites/default/files/ai61_ch._22_with_legend1.pdf

[4] High Country News, "Why Colorado River negotiations are so difficult" — prior appropriation dynamics and the interstate stalemate. https://www.hcn.org/articles/why-colorado-river-negotiations-are-so-difficult/

[5] Congressional Research Service, "Management of the Colorado River" (R45546) — federally compensated conservation, including 2.3 million acre-feet paid for with congressionally approved drought funds. https://www.congress.gov/crs-product/R45546

HT:  Claude Fable

Extracting Information from Supply Disruptions

On Sept. 16, 2025, a fire at Novelis's aluminum rolling mill in Oswego, New York disrupted roughly 40 percent of the automotive aluminum sheet used in North America. The importance of this supply disruption can be determined using standard stock market event study analyses. Ford was one of the firms most exposed to the disruption because it relied heavily on automotive aluminum sheet. As analysts began estimating the impact on vehicle production and profitability, Ford's stock price fell sharply. Similarly, investors also penalized Hindalco, Novelis's parent company. The interesting question is what happened to competitors. If one supplier exits temporarily, shouldn't rivals benefit?

Firm	Relationship to Event	Approximate Stock Market Reaction
Ford	Customer of automotive aluminum sheet	-7% abnormal return
Hindalco (owner of Novelis)	Directly affected supplier	-6% abnormal return
Kaiser Aluminum	Potential substitute supplier	+3% to +5% short-term gain
Constellium	Potential substitute supplier	Little measurable effect

Investors appeared to believe that Ford would suffer large costs from the disruption, but they did not assign equally large gains to Novelis's competitors. While aluminum itself is a commodity, automotive aluminum sheet is not. Suppliers must invest in specialized equipment, satisfy demanding quality standards, and undergo lengthy qualification processes with automakers. Even if competitors wanted to absorb Novelis's lost volume, they may not have had sufficient spare capacity or approved production lines to do so quickly. Ford's stock market loss was several times larger than analysts' estimates of immediate production costs because investors recognized that replacing a critical supplier is expensive and time-consuming. There are no doubt benefits to Ford and Novelis from contract exclusivity. This episode highlights the costs.

Rethinking Strategy at Cracker Barrel

Julie Felss Masino was recruited to become the new CEO of Cracker Barrel in 2023 to reinvigorate the brand. Should strategy focus on growing demand by increasing attractiveness to new customers or should it focus on keeping existing customers comfortable? As the WSJ reports, it opted for the former:

The goal was to modernize its stores, menu and design to help bring new customers to the vintage chain. The company had seen some promising results from food updates and marketing tie-ins when, as part of a fall marketing campaign in 2025, it unveiled a new, simplified logo.

And then Cracker Barrel became an unexpected flashpoint in the culture wars. The new logo was described as "going woke" and the changes alienated many of its more traditional patrons. Visits plummeted and the company lost $100 million in market capitalization in a week.

Well that didn't work. To her credit, Masino quickly reversed course.

She cut ties with the marketing firm behind the chain’s rebranding campaign and revamped the company’s leadership structure, bringing back a former vice president for menu strategy and elevating a veteran field operator to oversee store operations. 

They doubled-down on the traditional experience. Even the old logo has returned. The pivot seems to be working. Customers are beginning to return and the share price is rebounding, though not to the $60-$70 range prior to these events.

A strategic decision is a sunk cost. Abandon it when new information indicates a mistake.

Hidden Cost of Environmental Protection

 REASON:

Greenpeace and its activists allies have blocked for more than two decades the adoption of Golden Rice, which is genetically enhanced to produce the vitamin A precursor beta-carotene. The result, according to new calculations by DC Abundance founder and research director at the Golden Gate Institute for AI Abi Olvera, is that "delay has killed about 106,000 children and left another 210,000 to 425,000 blind."

What Set-Asides Cost: A Lesson from Timber Auctions.

California's Public Utilities Commission is pressuring utilities to steer about 1.5% of procurement toward state-certified "LGBT-owned" firms.  Setting aside the certification debate, what will this cost the state? 

In every auction, the winner has to outbid the second-best bidder, so the second-best bidder sets the price. Weaken the field and you weaken that price-setter. But which way the price moves depends on whether the government is buying or selling.

When the government buys, it runs a procurement auction: bidders compete to sell to the government, and the lowest-cost bidder wins, while second-lowest-cost bidder sets the price. Restrict who can bid and the price the government pays goes up.

When the government sells, bidders compete to buy, and the highest-value bidder wins, while the second-highest-value bidder sets the price. Restrict who can bid and the price the government receives goes down.

A set-aside moves price through two separate channels, and they push the same direction. 

• First, it shrinks the number of bidders, so the second-lowest cost is higher (or the second-highest value is lower). 
• Second, the set-aside bidders themselves may be higher-cost or lower-value than the bidders they replace. 

Both channels move price against the government.  An article by a pair of middling economists shows by how much.  Prices in Forest Service small-business set-aside auctions—where only small businesses may bid—run about 15% lower than in open auctions. 

The lesson applies to California. Fewer, weaker bidders mean a worse deal for the government. 

AI and the Shrinking Firm

The way that Artificial intelligence (AI) is changing worker productivity may also be changing the optimal scale of the firm itself. According to a recent Axios report, AI-powered tools are enabling entrepreneurs to launch and operate businesses with little or no staff. Tasks that once required specialists in coding, graphic design, marketing, customer support, and bookkeeping can increasingly be performed by a single entrepreneur assisted by AI. The result is a growing number of "one-person firms" capable of generating revenue levels that previously required a small team. This contrasts with the trend since the industrial revolution in which ever more mechanization generated ever greater economies of scale and ever larger enterprises.

Some aspects of AI fit nicely into theories of the firm.

•          Transactions costs can be reduced by engaging with AI rather than an employee.
• AIs eliminate employee principal/agent issues.
• However, a more personalized AI may represent a relationship-specific sunk cost that can lead to holdup.