Competition is good

Warren Buffett’s Berkshire Hathaway and Jorge Paulo Lemann’s 3G Capital just purchased Heinz for $23.3 billion.  This raises an obvious question, "why is Heinz worth more to its new owners?"

The value creation can be seen in the actions of its new owners. 

Since taking over, Hees has eliminated hundreds of jobs, grounded corporate jets, limited spending on office supplies and pulled the plug on mini-fridges at the office. Savings will help pay down $12.6 billion in borrowing supporting the deal.

In other words, the old owners were letting executives shirk, or incur unnecessary costs.

If executives do not maximize shareholder value, it gives someone else the opportunity to come up with a better plan, buy the company, and execute it. 

If someone else can do things better, faster, cheaper, or more attractively, then consumers will abandon the products of the old company (product market competition), or someone will buy the company and make sure they do (competition in the market for corporate control).

Both types of competition help align the incentives of firms (who want higher profit) with the goals of consumers (who want lower prices, and higher quality).  

EXTRA CREDIT:  how do we align the incentives of those providing government services, like mail service or regulation, with the goals of consumers? 

Christmas Bundles

I am torn. Part of me is proud that they understand pricing so well. And part of me thinks they mis-understand Christmas.

How t-shirts get made

Good five part series by NPR that is making me rethink my opposition to government subsidies for public radio. 

Shows how the invisible hand of the market gets farmers in Mississippi to cooperate with factories in India to make a t-shirt. 

Car Dealership Quota: 129 Cars

A nice story on "This American Life" was about a car dealership trying to make its monthly quota.

So they have to make October. And when I say "have to make," this is not some sort of abstract, feel good, compete with the dealership down the block just for fun kind of competition. They're part of Chrysler. And if they sell 129 cars and trucks by the end of October, Chrysler will pay them a bonus that's pretty much the difference between the dealership being in the black or being in the red for the month-- somewhere between $65,000 and $85,000, depending on which models they sell. Different cars earn different amounts. If they sell 128 cars-- fall just one car short-- they get nothing.

Lots in the story about high-powered incentives, bargaining, negotiations, and even the Art of War.

What happens when you post medical prices online?

You attract Canadians,

Smith knew that putting his prices online had been a great idea when Canadians began flying down to the SCO for treatment: “The first thing that happened once we started posting our prices online was the Canadians started showing up. They could pay $3,200 from Vancouver for a hernia operation to step out of line.” The line Smith refers to is Canada’s single-payer, government-run healthcare system, which boasts some of the longest wait times for surgical care in the Organisation for Economic Co-Operation and Development (OECD), the rich-country club. Smith contracts with a Canadian health broker specializing in finding wait-listed Canadians access to care and describes the high number of Canadians he sees as “fascinating because that’s the healthcare system that everybody in this town thinks we need.”

 and Americans with high-deductible plans:

Smith has also had success in appealing to people with high deductibles and to mid-sized companies in Oklahoma and North Texas. He has directly courted companies that feel that they are overpaying for their HMOs, asking CEOs, “Why would you be OK with paying $14,000 for a tonsillectomy across town for one of your employee’s children when we’ll do it for $2,900?” In response, many companies have moved their health plans to the SCO, offering to eliminate employee copayments for treatment on the condition that surgeries are performed at the SCO. As a result, one medium-sized bank in the region was able to drop its premiums by 10 percent. Smith’s corporate accounts have significantly improved his profitability: “In the last year, as a result of our outreach to CEOs of big companies, we are 40 percent busier than we were a year ago, and it’s primarily due to us posting these prices.”

HT:  Blake

Distinguishing FB Friends from FB Trolls

Suppose part of your marketing campaign involves creating a Facebook page to engage in social media marketing but you many of the comments are from disgruntled customers who constantly complain about your product. If you are Burger King Norway, you entice them to go away, e.g. "unfriend" you, by offering them your competitor's product for free.

Those who wanted the giveaway had to agree not to join the new Facebook page, receiving their voucher for a Big Mac plus a signed goodbye letter from Burger King in exchange.

About 1,000 accepted the vouchers but even more left.

Burger King lost 30,000 followers as a result, but says its new fan base of 8,000 are more engaged and interact with the brand in a more positive way.

Losing 29,000 to get rid of 1,000 may seem like a steep price to pay. Perhaps the 8,000 remaining are more likely to post something positive which will show up in all of their friends' news feeds. If the 29,000 who left without the voucher were not "engaged," perhaps there was no ongoing flow of posts in their friends' news feeds to lose.

REPOST: Consult an economist before buying a wedding dress

When Stephanie (her name has been changed to avoid embarrassment) went shopping for a wedding and bridesmaid dresses, she found valuable advice from an unusual source, Chapter 23 of her favorite economics text.  And it was not about sleeve options, figure flattery, or bustles.

She was puzzled that over half of the stores that sell wedding dresses do not permit photos, and do not have tags in the dresses that would identify the manufacturer and style type.  

These retail stores want to prevent customers from "free riding" on their fitting and display services:

I just spoke with someone who had all her bridesmaids sized in the store only to go online and buy them from a discount site. I would assume many of the brides are doing this as well.

Note that this is not just a problem for the store, but also a problem for the dress manufacturer: if stores cannot prevent free-riding, they will invest less in point-of-sales fitting services, and dress sales will suffer.  See our earlier post about golf club manufacturer PING, who faced a similar problem,

The discount retailers were advising consumers to visit a full-service retailer to request a custom-fitting session, and then bring the specifications for custom-made clubs back to the discounter. PING could control this kind of opportunistic behavior only by dropping dealers, a very costly option.

PING wanted to set a minimum retail price (called "retail price maintenance") to address the problem.  The minimum price meant that discount retailers could not undercut full service retailers.  The antitrust laws prevented this until the Supreme Court changed the case law.

For the wedding dresses, the no-photos policy created a problem for Stephanie because she wanted to photograph her bridesmaids in each of the dresses to make sure that they choose the best dresses for the wedding. So she chose to purchase from a large retail chain, like J. Crew, BCBG, Ann Taylor, or Nordstrom’s because they had solved the free riding problem, using exclusives, where only one chain carries the style.

For an economic analysis of resale price maintenance, see the amicii brief of 24 antitrust economists (I am one of the 24.)

UPDATE:  Amazon just made free riding a lot easier.

Flood subsidies are difficult to remove

Subsidies destroy wealth by encouraging the movement of assets to lower valued uses.  Flood subsidies,, for example, encourage home owners to build where they ordinarily wouldn't build because the insurance rates are artificially low.  

But what happens when government tries to make these homeowners bear the costs of their insurance?  

... affluent beachcombers who are accustomed to artificially cheap insurance. Businesses, vacation homes and homes with "repetitive" flood losses will see rates rise 25% a year until those "rates reflect true risk," according to the Federal Emergency Management Agency (FEMA), which administers the federal insurance program. About 20% of the national insurer's 5.5 million policyholders will be affected.

Cue the caterwauling from the 1% and their elected representatives. In June the House voted 281-146 to delay premium increases for a year, a turnaround from the 406-22 vote that passed Biggert-Waters only a year ago. California Democrat Maxine Waters is protesting that she didn't know what was in the law that bears her name—which seems plausible to those who have followed her career. She'd like more Americans to build homes in flood zones and have poor Americans pick up the tab when insurance premiums don't cover losses.

REPOST: Advice for selling on eBay Motors: use lots of photos

A new economics paper has found that prices for cars sold on eBay motors rises the more photos you post on the site (about $80 extra for each photo).

Remember that adverse selection (or the "winner's curse" in auctions) is caused by the fact a seller have more information about the quality of the car than do buyers or bidders (economists call this "information asymmetry"). If buyers offer a high price, then they get a mixture of high and low quality vehicles, and pay more--on average--than the vehicle is worth. So buyers offer only low prices, correctly anticipating that only low quality vehicles will be offered for sale.

So how does a seller with a high value car convince a buyer that it is of high quality. The authors suggest that offering photos is akin to a guarantee of quality, a type of signal:

By disclosing their private information on the auction Web page in text and photos, the seller offers a contract to potential buyers to deliver the item described in the listing. If the disclosures define sufficiently detailed and enforceable contracts, the initial information asymmetry should play no role in determining the performance of the market.

I received this from a former student who verified that this theory, at least, works in practice:

My most recent eBay vehicle sale was a 102,000 mile seven year old truck, tons of bidding and sold for $11,000 sight unseen to a buyer in New York.

Text of the eBay listing is included links to all of the photos you see here:

Photos of EVERY body panel, EVERY interior angle, EVERY tire, EVERY engine bay angle, etc. Buyer was DELIGHTED upon receipt and couldn't believe I'd sent it to him with a full tank of gas.

REPOST: The Winners' curse in Yahoo Display Auctions

Preston McAfee is an unusual economist in that he has passed a market test: Yahoo is willing to pay him for his advice. His latest advice is on the design of auctions for graphical displays on web pages. Yahoo runs billions of these automated auctions every day, through their Right Media Exchange (RMX).  Advertisers can bid for certain kinds of customers, and can pay for impressions, clicks, or sales.

To choose the highest-valued bidder, Yahoo develops predictors of how many clicks and sales result from each impression. For example, if one click occurs for every ten impressions, an advertiser would have to bid more than 10 times as high for a click as for an impression in order to win the auction.

Yahoo was very proud of its predictors, but was puzzled that they systematically over-predicted the actual number of clicks or sales after the auctions closed. A well-trained economist would recognize this as an example of the winners' curse:

In a standard auction context, the winner’s curse states that the bidder who over-estimates the value of an item is more likely to win the bidding, and thus that the winner will typically be a bidder who over-estimated the value of the item, even if every bidder estimates in an unbiased fashion. The winner’s curse arises because the auction selects in a biased manner, favoring high estimates. In the advertising setting, however, it is not the bidders who are over-estimating the value. Instead, the auction will tend to favor the bidder whose click probability is overestimated, even if the click probability was estimated in an unbiased fashion.

As with the winner's curse, there is a simple fix--bid as if your estimate is the highest among all the bidders. This requires shading your predictors downwards, based on the variance of the prediction.

The paper also details two other features that Yahoo uses to make their auctions more efficient: randomized bidding, used when a less-informed bidder bids against a more-informed one; and sometimes the auction is not won by the highest bidder, due to the value of learning. When a bidder has a novel or unusual use for the display, sometimes Yahoo lets the novel user win so that Yahoo can learn more about the value of the use. If Yahoo learns that the novel use of the display is more valuable than they thought, then they can earn enough in the future to more than compensate them for giving up some revenue earlier on.

Posted by Luke Froeb at 5:11 PM 6 comments: