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.

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.

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.

Is Iran free riding on OPEC?

If OPEC and seven other oil-producing nations agree to cut back output to raise price, this will benefit Iran, the big oil-producing nation who refuses to cut back output.  Such ``free riding'' can be modeled as a pricing dilemma.  In fact, Iran's free riding seems to have caused the entire agreement to collapse:

Mr. Novak explained that the 11 OPEC states and seven outsiders present during the meeting had spent two months drafting an agreement that would cap oil production at January levels in an effort to stabilize oil prices, and it was all undone by the fact that Saudi Arabia, Qatar, UAE, and "predominantly other Gulf States" insisted that Iran be included in the deal (Iran did not attend the talks).

Power tool importer prevents free-riding with RPM

Resale Price Maintenance, or RPM, is a contractual arrangement between an upstream manufacturer (or importer) and a downstream retailer that specifies either a minimum or maximum retail price.  These contracts are illegal in most antitrust jurisdictions, and viewed skeptically in the others.  

So it was somewhat of a surprise that Australia's Competition and Consumer Commission (ACCC) allowed Tooltechnic, an importer of high end power tools, to specify a minimum resale price to prevent "free riding" by discount dealers on its high end Festool brand.  Consumers had been shopping at the high end retailers, and then buying the Festool products are lower-priced retailers who did not provide as much retail service.

Festool products are complex, with a high level of features and functions, and are aimed predominantly at professional users. Tooltechnic believed that provision of retail services such as pre-sales technical advice, product demonstrations, and “try-before-you-buy” arrangements, as well as post-sales services such as customer training and provision of consumables and accessories, would help to expand demand for the brand even if retail prices included a margin sufficient to fund those services. 

 However, retailers who provided these services were increasingly losing out to competitors who chose a simpler no-frills model, and the problem of free-riding was exacerbated by the increased accessibility of on-line sales. Tooltechnic chose RPM as a solution after judging that other approaches, such as imposing detailed contractual obligations on retailers, granting exclusive retailer territories, or restricting on-line sales permissions, would be unworkable or less effective as a means of boosting sales.

Congrats to the the ACCC for reaching a reasonable decision, and to the Economists at RBB for their role in educating a skeptical government agency.

Splitting the check? There's an app for that

Do you have to pay for other people's drinks if you didn't order any? Do you chip in for an appetizer you didn't eat? How do you split tax and tip?

So starts the CNN story about splitting the check (without losing friends). The social etiquette of group dinning may be evolving due to  the advent of smartphone payment apps like Venmo and Square Cash that allow funds transfers among friends. Moreover, apps such as Tab or Plates are specifically designed to split the check using these funds transfer apps.

It used to be that when I initiated the invitation, I expected to pick up the tab. Often, there was an expectation of later reciprocal invitations which helped facilitate the development of longer term relationships. Sometimes though, it encouraged free-riding as they ordered from the top-shelf. But if it is easy settle-up after each shared meal, both reciprocation and free-riding are reduced.

Paying only for what you ordered -- particularly down to the cent -- used to feel stingy. But the apps help reduce the pressure to round up or kick in a little extra.

California AG wants retailers to compete with manufacturers

The California Attorney General's office sued a small cosmetics company for stoppiing its own retailers from selling its products online at a discount.

Instead, prices must be set independently -- and competitively -- by distributors and retailers. Ostensibly this is supposed to help consumers, but as we know from Chapter 23 of our textbook, when two firms selling complementary products compete with one another, price is likely to rise.  Note that here the two complementary products can be thought of as the wholesale good and retail services required to sell it.

This is called the "double marginalization" or "double markup" problem, and is addressed by contracts like the one outlawed by the attorney general.  These contracts are one way to align the incentives of retailers with the goals of the manufacturer.

Another aspect of the retailer/manufacturer incentive conflict is brought up by attorney Jeffrey Zuckerman in the online discussion:

It would be hard to imagine products more in need of protection from free riding, and therefore more legitimately subject to RPM, than skin care products from a small company.  The California AG probably picked on Bioelements because they are too small to fight back.  Heck, I might have been willing to defend the company pro bono, just to keep the California AG from getting an undeserved victory.  

Can anyone on this list explain how consumers as a group have been injured because Bioelements imposed RPM on the Internet distributors of its "cosmesceuticals"? 

Here Mr. Zuckerman is referring to the promotional and retail services undertaken by brick and mortar retailers.  The manufacturer has an obvious incentive to stop internet retailers from undercutting the brick and mortar price, and "free riding" on the promotional efforts of brick and mortar retailers.

Incentive conflict between McDonalds and its Franchisees

The incentive conflict between franchisees and franchisors is well known.  Franchisors want to protect their brands, and want franchisees to invest in building a better retail experience.  However, because franchisees earn only a fraction of the returns from these brand-building investments, they are reluctant to to make them.

The conflict between McDonalds and its franchisees has come out into the open (2018 WSJ, 2019 Fortune, Twitter feed from a franchisee):

But traffic has waned in recent quarters, leading franchisees to voice concerns that the money they were being asked to invest in their stores for initiatives like remodels, self-serve kiosks, fresh beef, delivery, and all-day breakfast were not paying off.

“McDonald’s can set the direction of the brand, but you need the franchisees to buy into it,” says Senatore. “Franchisee alignment is so important to these systems.”

One way to manage this incentive conflicts is with:

1. Contracts to reward actions that are easily observable and contractible; and 
2. Vertical restraints, like exclusive territories, for actions that are not.  

Vertical restraints that restrict intra-brand competition among franchisees (e.g., with exclusive territories) give franchisees a profit stream that they are more eager to protect, i.e., with brand-building investments and higher-quality service.

Note that franchisees on freeways don't have much repeat business, so they can make more money by free riding on the brand reputation (e.g., by shirking on service or quality).  This incentive conflict is so costly to manage that McDonalds finds it easier to own and run their restaurants on the freeway.

HT:  Kaitlyn W.

The benefits of being WEIRD (Western, Educated, Industrialized, Rich, Democratic)

Reputation and trust can solve a lot of business problems, like post-investment hold-up or free riding. It turns out that WEIRDo's (about 12% of the planet) have been successful, in part, because they manage to build and maintain reputations and trust more easily than others. 

 WEIRDos are more individualistic and independent, less conformist and obedient, more likely to favor “impersonal prosociality” — the idea that one set of moral rules should govern how you treat everyone, from the most distant stranger to your nearest kin. This seems normal to them, but in a global context, WEIRD people really are extremely weird. And as modernity erodes the last vestiges of traditionalism, they are probably getting WEIRDer and weirder by the day.  

 …More specifically, Western Christianity; the number of years that one’s ancestors were exposed to the medieval Catholic Church correlates pretty nicely with things like social trust, creativity and willingness to do things like donate blood — and correlates negatively with traits such as nepotism.

The world abounds in spurious correlations, of course. But the authors of “The Church, intensive kinship, and global psychological variation” propose a very plausible mechanism: the Catholic Church’s extreme obsession with incest, which isn’t found in the Eastern Orthodox branch. The church kept banning marriages between more and more distant relations, up to sixth cousins, which smashed the tight kin-based networks common to agricultural cultures.

HT:  MarginalRevolution.com

In Los Angeles, why do equivalent land parcels sell for 35% difference?

New paper compares sales of individual parcels of land to sales of plots that are immediately assembled into bigger aggregate parcels used for building higher density buildings, like high-rise apartments. Controlling for amenities like distance to a highway and access to commuter rail, the authors find that soon-to-be-assembled parcels sell for 35-40% more than similarly situated individual parcels in the same neighborhood.

Why?

The 40% price differential means that it is not possible to turn individual parcels into soon-to-be-assembled parcels for one of two reasons:

1.  Zoning, like that in Sweden where residents can veto new development plans, makes it difficult, if not impossible, to assemble bigger individual parcels into plots of land (on which higher density apartments can be built).

2.  The hold out problem, where owners of individual parcels of land hold out in expectation of a better offer.  This is a type of "free riding," that can be analyzed as a prisoners' dilemma.

Either or both of these problems could account for the premium on land that can be assembled into larger parcels.

HT:  Marginal Revolution

REPOST: Will resale price maintenance return?

In 2007, the Supreme Court removed the blanket prohibition against retail price agreements between manufacturers and retailers. PING (the golf club manufacturer) submitted an amicus brief in the case that detailed how difficult it is to prevent discount retailers from free riding on the custom fitting services of full service retailers. 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. [For an economic analysis of resale price maintenance, see the amicii brief of 24 antitrust economists--full disclosure: I am one of the 24].

Now PING has another option, minimum resale price maintenance. The federal legality of these agreements will now be determined under a rule of reason. However, it is likely that those states more inclined towards regulation, like California and New York, will try to "repeal" the Supreme Court decision with state legislation, setting up a conflict between state and federal antitrust laws.

This just in: some manufacturers are suuing retailers who sell merchandise on eBay at a discount.

Aussies Find Cosmetics Firm Guilty of RPM

The Australian Competition and Consumer Commission (ACCC) has clamped down on so-called "resale price maintenance" (RPM) by Eternal Beauty Products. In this case, the cosmetics maker pressured online retailers to either sell goods at certain prices or risk being cut off altogether. Most countries have had some sort of anti-RPM law on the books. At first blush, it seems quite obvious that that a manufacturer requiring a retailer to set higher prices must not be in the public interest. Until, you ask a simple question, "Why would manufacturers do this?"

1. If the manufacturer was a monopolist, it might be a way of getting higher final prices. But, why not simply raise the wholesale price? Given the wholesale price, the manufacturer should want as low a retail price as possible to sell as many units as possible. Anyway, in this this case, like most, the manufacturer was one of many competitors.
2. If the industry was oligopolistic, the manufacturers may be collectively using retailers to enforce higher prices. This could be a way to reduce rivalry. But then all cosmetic firms would be party to the deal and they would have to impose price restraints on all retail channels. This appears to have been far from the case.
3. If the product was new or differentiated and the target market was poorly informed about the product's characteristics relative to competitors, the manufacturer may want to encourage point-of-sale (POS) services. Retail sales associates may be uniquely positioned to demonstrate why this product might be preferred. But this imposes costs on the retailers who perform these POS services. They may be willing to do so for a higher margin. But not if some online retailer offers the same product without the POS services at a discount. Customers will may make an initial purchase with the full service retailer and then shift orders to the cheaper online vendor. In this case, no retailer will be willing to offer the POS services and suffer the free-riding by online discounters. Without POS services, the product fails. To counter this, the manufacturer bans discounting by setting a minimum retail price that includes enough of a margin that retailers want to offer the POS services. In this theory of RPM, customers benefit from small manufacturers bringing new and innovative products to the market. Too bad the ACCC got in the way.

Group Incentives: Teacher pay

An interesting application of group incentives was examined in a new working paper by Scott A. Imberman and Michael Lovenheim called "Incentive Strength and Teacher Productivity: Evidence from a Group-Based Teacher Incentive Pay System." The incentive scheme was for groups of teachers teaching the same subject within a grade and school. One problem with group incentives is free-riding. But different teacher assignments means that the incentive can be stronger for teachers who are responsible for the outcomes of more of the students. So, as a teacher's share of students in a particular school, grade, and subject combination, the incentives get stronger. From their abstract:

We find that student achievement improves when a teacher becomes responsible for more students post program implementation: mean effects are between 0.01 and 0.02 standard deviations for a 10 percentage point increase in share for math, English and social studies, although mean science estimates are small and are not statistically significant. 

While these effects seem small, they are bigger than are found in many previous studies. So, if the incentive dissipates for larger groups, why use group incentive rather than measuring performance at the individual level? I can think of a few reasons (and maybe you can think of more):

1. Individual incentive would lead teachers to try to "cherry-pick" students. These could just be the better students if raw test average is the performance measure or those thought to be able to improve the most if change in score is the metric.
2. To better sort students into classes. Students differ in abilities as well as other characteristics (e.g. unruly versus well-mannered). Some teachers are better with one type of student than another (e.g., former drill sergeant). The group of teachers all benefit from better matching students to teachers.
3. Spillovers within a group. Teachers have heterogeneous abilities and no one likes to be 'corrected' by a colleague. But now there is a stronger incentive for the better teachers to share their methods with those who can improve.
4. Demonstration effects across teacher groups. Other groups of teachers can observe the successful groups and learn.

 So it might be worth weaker group incentives so as to address these issues.

CONTEST LOSERS: design an effective ratings agency

PROBLEM:  lousy ratings

DIAGNOSIS OF PROBLEM
1.  WHO:  Ratings companies like Moody's offer favorable ratings
2.  INFO:  Ratings agencies have access to information that would predict poor performance, although not for Black Swan type events, which are inherently unpredictable.
3.  INCENTIVES:  Ratings agencies have an incentive to offer favorable ratings regardless of risk; otherwise they won't get chosen by the issuers.

SOLUTIONS TO PROBLEM:
1.  DECISION RIGHTS:  Let someone else do the ratings, like a regulator.  The failure of regulatory agencies in preventing obvious frauds, like Madoff's Ponzi scheme, suggests that this may not be such a good solution.
2.  INFO:  How do rating agencies get access to info?  Here several "private sector" solutions suggest that disclosure of information would be in the issuer's self interest, i.e., those that did not disclose or restricted access would receive less favorable ratings.  But if this is the case, why did the problem arise in the first place?
3.  INCENTIVES:  Sever the tie between the choice of a ratings agency and the payment from the issuer.  Two types of solutions fall into this category:  (i) let consumers pay (those that buy the securities that get rated); and (ii) let the ratings agency be chosen by lottery from a qualified pool (Moody's, S&P, others).  The problem with (i) is free riding, ratings are information that is easily shared, so why should I pay for it?  The problem with (ii) is shirking, i.e., what incentives to ratings agencies have to do a good job if they are chosen regardless of their performance.  Several solutions suggested customers ratings of the ratings agencies to give them an incentive to work hard.

Interestingly, no one chose litigation as a possible solution:  give the agencies a "fiduciary responsibility" to the investors that rely on them.  This would open them up to lawsuits if they acted irresponsibly.  That no one chose it underscores the difficulty that a regulator, or a litigator, would have in gathering information and determining whether the agencies were doing a good job.

BOTTOM LINE:  everyone loses.  Come by my office and pick up a consolation mug and if you want me to sign your book, bring it by.

MY SOLUTION?: get rid of the implicit guarantees that investors will be bailed out if their investments go south.  This would give them an incentive to scrutinize investments a lot more closely than they had been doing because if they don't, the market will punish them more swiftly and surely than any regulator.

Let me defend myself against the expected ridicule by posing a simple question:
QUESTION:  How many economists does it take to screw in a lightbulb?
ANSWER:  None, the market will do it.  

Why did the Wisconsin unions blink?

In Wisconsin, spending is several billion dollars higher than revenue, and the new Republican governor submitted a budget that asks state Public Employees to pay a much bigger share of their healthcare and pension costs. It also limits the ability of the public employee union to collect the $700 dues from the public employees. It makes contributions voluntary, instead of mandatory.

The budget would have certainly passed the senate, so the Democratic state senators left the state to prevent a vote. After two days the public employees' union agreed to the higher pension and healthcare contributions, but the governor rejected their concessions.

This dispute illustrates several economic principles. First, it illustrates the "free riding" problem faced by unions. In so-called right to work states, unions can bargain on behalf of workers, but they cannot compel workers to contribute to the union. Since the workers receive the benefits of union representation regardless of whether they pay union dues, few actually choose to pay. This limits the ability of unions to collect big dues, so they lower the dues they charge, and this limits their ability to raise money to influence legislators to give them generous benefits. This is a form of the prisoners' dilemma.

The second principle illustrated by the dispute is the nature of bargaining. If we think about the dispute being resolved not by compromise, but rather by an appeal to the voters of the state, the winning strategy is to move to the center, i.e., to offer an alternative that appeals to the median voter. By offering the wage and price concessions, the union is trying to reframe its alternative as much more reasonable than the one they started out with.

What do the U.S., Switzerland, China and the U.K have in common?

Citizens more likely to sacrifice for the common good (solve the free riding dilemma):

Among students in the U.S., Switzerland, China and the U.K., those identified as freeloaders most often took their punishment as a spur to contribute more generously. But in Oman, Saudi Arabia, Turkey, Greece and Russia, the freeloaders more often struck back, retaliating against those who punished them, even against those who had given most to everyone's benefit. It was akin to rapping the knuckles of the helping hand.

Will Resale Price Maintenance Return?

Last week, the Supreme Court removed the blanket prohibition against retail price agreements between manufacturers and retailers. PING (the golf club manufacturer) submitted an amicus brief in the case that detailed how difficult it is to prevent discount retailers from free riding on the custom fitting services of full service retailers. 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. [For an economic analysis of resale price maintenance, see the amicii brief of 24 antitrust economists--full disclosure: I am one of the 24].

Now PING has another option, minimum resale price maintenance. The federal legality of these agreements will now be determined under a rule of reason. However, it is likely that those states more inclined towards regulation, like California and New York, will try to "repeal" the Supreme Court decision with state legislation, setting up a conflict between state and federal antitrust laws.

This just in: some manufacturers are suuing retailers who sell merchandise on eBay at a discount.