Set prices to reflect costs AND demand

Andy Kessler at the WSJ documents multiple instances of inappropriate use of break-even analysis.

• The USPS saw the volume of first class mail "fall from 103.7 billion letters in 2001 to 61.2 billion last year." More substitution with email and online bill pay makes demand more elastic implying margins should fall. Instead, the USPS raised prices 50% to make up for the shortfall.
• ESPN's subscribers have dropped from 100 million in 2011 to 89 million today. To 'make up the difference' it raised prices from $4.69 per sub a month to $7.21 today.
• Microsoft kept raising the price of its Windows operating system to computer manufacturers at the same time Android based computing came to dominate the market.
• Booksellers have raised effective prices on digital books "to offset the decline of physical copies."

The article documents many more examples. These examples share some commonalities. Firms had enjoyed substantial market power but now face unexpected competition. Managers feel pressure to meet investor expectations. And then they forget their marginal analysis. The lesson is:

Increasing prices attracts others to attack your market. Amazon's Jeff Bezos warns: "Your margin is my opportunity." 

Fantasy Football Draft or Auction?

Tristan H. Cockcroft at ESPN has seen the beauty in auctions.With football season just around the corner, many a fan is looking to put together the ultimate fantasy football roster. And the first step is drafting players among your league members. What is wrong with a draft?

I'm tired of the annual charade of one of my longest-standing home leagues, in which the owner who draws the dreaded 10-spot -- it's a 10-team league -- reacts as if it's some sort of death sentence.

He proposes an English auction perhaps, as our favorite textbook shows, because it is essentially equivalent to a second price auction in which the bidding strategy is simple. Simplicity is important when you are bidding on multiple players and not just buying a single item. Still, he provides lots of advice on strategy: don't fall in love with players, avoid bidding wars, don't bid for players you won't use, don't get rattled, etc.

Bargaining as a Group

Last month, FTC alumni Dan O’Brien and Jon Leibowitz along with Russell Anello, completed a study extolling the virtues of Healthcare Group Purchasing Organizations (GPOs). GPOs bring together multiple firms to buy of common products jointly rather than separately. Among the ways this lowers costs is by lowering their counter-party's disagreement value.

A healthcare provider’s bargaining strength depends in part on the size of the loss it can impose on a vendor by refusing agreement. If a vendor has little to lose from failing to reach an agreement with the provider, then the provider’s bargaining position is weak, while if the vendor has a lot to lose, then the provider’s position is strong.

Who is the world's largest automaker?

Forbes reports that during the first half of 2017, Renault-Nissan sold the most cars worldwide.

Does it matter? Not according to Nissan’s chief of investor relations, Joji Tagawa. It may bring bragging rights, but he claims it is not an important performance indicator. 

What does matter? Chairman and CEO of Renault, Carlos Ghosn promised to:

“continue to leverage our significant economies of scale and global market presence to deliver valuable synergies for our member companies this year, while maintaining a strong technology lineup and offering customers breakthrough electric models.”

Or managing scale and scope economies.

The Injustice of Corporate Welfare

The Beacon Center has produced a nice video on cities using tax abatements to lure companies. The video focuses on the unfairness to competitors of them paying taxes that subsidize their competitors.

But it also causes an inefficiency in two ways. First, the taxes represent another wedge between consumer value and producer cost that could prevent moving an asset to a higher valued use (because producer cost + tax > consumer value > producer cost). Second, the subsidy could make profitable moving an asset to a lower valued use (if producer cost  > consumer value > producer cost - subsidy).


And so we continue our slow slide into becoming a banana republic.

When is an Airport a Sunk Cost?

Fred Cyrus Roeder writes in Handelsblatt that Berlin's yet to be completed new airport is "A Textbook Example of the Sunk-Cost Fallacy." It is already seven years past its original opening date and costs are currently 150% higher than originally planned. Both numbers will undoubtedly rise. Moreover, an expansion is already needed for it to fulfill its intended purpose.

How could this have happened?

The fatal flaw was the decision by Berlin’s mayor and the governor of Brandenburg, the state surrounding the city, to ignore conventional wisdom and attempt to supervise hundreds of contractors instead of hiring one good general contractor to oversee construction. This decision transferred any liability from the private-sector contractor directly to the taxpayer.

Herr Roeder advocates scrapping the whole project and starting over.

Consumers screen out based on poor brand image ... and so do prospective employees

One might expect that bad press about a company's brand will turn away some potential customers. But a recent survey by CareerBuilder indicates that job candidates also shy away from companies experiencing negative publicity.

"In today's 24/7 news cycle and social media world, earning and maintaining a good reputation can be a challenge," said Rosemary Haefner, chief human resources officer at CareerBuilder. "It's easier than ever before for job seekers to research potential employers. Employers that value transparency and take a proactive approach to issues or complaints will have a better chance of securing trust and loyalty and maintaining a positive reputation that can strengthen their recruitment and retention strategies."

It seems that job candidates use this as an effective screen for implicit job attributes. If you consistently treat your customers poorly, you probably treat your employees poorly too.

Incentive alignment: Lincoln Electric

I show this video on the first day of class as it is a stark illustration of how difficult it is to align the incentives of individuals with the goals of a company.  At Lincoln, they do it by devoting lots of effort to measuring individual productivity.  When you have a good performance metric, it is much easier to design incentive compensation schemes that (i) give employees enough information to make good decisions; and (ii) the incentive to do so.

Declining Barriers to Entry to 'World Music'

The BBC's story on the success of the song "Despacito" (4.6 Billion streams and counting) suggested that this was emblematic of the the growing internationalism of the popular music industry.

Sir Lucian Grainge, [head of Universal Music Group] said ... "The industry has predominantly been English-speaking artists for the last 50 years [but] streaming will continue to open up music from Latin America artists globally.

This reminded me that his observation has been confirmed recently by a more systematic investigation by Fernando Ferreira and Joel Waldfogel, "Pop Internationalism: Has Half a Century of World Music Trade Displaced Local Culture?" They show that the traditional bias in overseas markets toward English language songs has declined toward more home country produced songs in the last decade or more. This is likely due to improvements in information technology: the Internet allows consumers to find new music more easily and IT lowers the burdens for musicians to produce and distribute their music.

This has implications for the how talent scouts will search for the next Luis Fonsi.

Money markets and religion

Historical explanation for the religious acceptance of for-profit borrowing and lending:

...When the Catholic Church held a monopoly in Europe, the clergy could ‘sell’ salvation at high prices – including strict prohibitions and purchased ‘indulgences’, which usurious sinners could buy in order to be absolved. But in the 1500s, during the Reformation, theologians such as Martin Luther denounced these practices. They advocated a more direct relationship with God that did not rely on priests as intermediaries, and founded new Christian movements such as Protestantism. The effect was that of a new company undercutting a monopoly. As Christian factions competed for believers, it led to a faith-based ‘race to the bottom’. And to increase their appeal, sects made fewer demands on believers – which meant weakening their stance on usury.

HT: Marginal Revolution