New York assembly candidate proposes to *really* ban zone pricing this time

Michael Giberson

From Politics on the Hudson:

Kaplowitz takes on Big Oil, says stronger ban on zone gasoline pricing could create a $1.3 billion “tax break” for New Yorkers.

At a news conference today at 12:30 at the Shell Station in Bedford on the corner of Rt. 22 and Rt. 172, State Senate candidate Mike Kaplowitz called for new laws to strengthen the state’s newly enacted but ineffective ban on zone pricing.

Statement by Mike Kaplowitz:

“Beginning in 2003, I strongly pushed for a state ban on “Zone Pricing” – the practice by big oil companies of charging different wholesale prices to retail stations for the same gasoline based on location.  Under zone pricing, price is not based on the cost of the commodity itself nor based on laws of supply and demand.  Instead, the marketplace is grossly manipulated by big oil.

In fall of 2008, we succeeded in getting the legislature to enact a law intended to end zone pricing of gasoline to wholesalers.  Unfortunately, the new law has had only limited effect, and zone pricing remains widespread in New York State.

(See related reports MidHudsonNews.com and NCNLocal.com).

It seems to be true that “the new law has had only limited effect.” At least it is the case that New York retail gasoline prices didn’t seem to change much relative to prices in New Jersey, when looking before and after the November 2008 implementation of the partial zone pricing ban. A colleague and I have examined retail price and margin data for 8,000+ stations in the two states for approximately six months before and after the law. A short summary is: no obvious change in pricing patterns due to the law.

As Kaplowitz notes in his statement, not all stations were directly affected by the ban as it applied only to wholesalers selling and distributing directly to retailers – not to vertically integrated firms owning refineries and retail stores, and not to retailers who purchased directly from refineries. It would be interesting to see whether the law has had any affect on the relative market shares of retailers buying at wholesale compared to retailers buying directly from refiners or retailers vertically integrated with refiners.

It also is true that most economists believe that zone pricing does not on average raise prices to consumers, and may allow lower prices in some areas. Zone pricing is just a form of price discrimination that relies on a geographic basis for segmenting customers. It is true that zone prices will strike some consumers as unfair, but also true – contrary to Mr. Kaplowitz’s claim – that price discrimination simply reflects the forces of supply and demand in the marketplace.

A complete ban on zone pricing may simply raise some consumers’ prices and lower other consumers’ prices.  Since zone prices likely raise prices in wealthier locales and reduce them in lower-income areas, a ban on zone pricing would tend to benefit wealthier consumers at the expense of poorer consumers.

(Which is why it is no surprise that Kaplowitz is campaigning against zone pricing in Westchester County, New York – one of the state’s wealthiest areas. The state senator who sponsored the 2008 law was from the suburbs of Rochester, another area with higher than average incomes.  Note that zone pricing is also often a political issue in Fairfield County, Connecticut, another wealthy area worried about having relatively higher gasoline prices.)

NOTE: this search will find the many previous Knowledge Problem posts on “zone pricing.”

Dynamic pricing for foodies … and for electricity?

Lynne Kiesling

If you like to cook and to eat well in Chicago, you can’t avoid chef Grant Achatz (nor should you want to!). His signature restaurant, Alinea, was recently named the best restaurant in the U.S. and one of the best restaurants in the world, and he is a creative, if controversial, innovator of “molecular gastronomy”.

Achatz, with business partner Nick Kokonas, got the foodie chatterati talking again last week when they announced their new venture, a Chicago restaurant called Next. Next has two novel features: the menu will change every few months and will channel the food and atmosphere of a particular time and place, and the pricing is prix fixe along the lines of a concert ticket. The first time-place that they will feature is Paris 1912, the tail end of the Belle Epoque (one of my favorite artistic and culinary periods!).

The pricing of the experience as a prepaid prix fixe is interesting in and of itself, and other economists have commented on that since the announcement. But the feature that is likely to be of the most interest to KP readers is outlined on the restaurant’s FAQ:

How much?
A meal at Next will represent a great value. Depending on the menu AND what day and time you are dining, food will be $40 to $75 for the entire prix fixe menu. Wine and beverage pairings will begin at a $25 supplement. Next’s goal is to serve 4-star food at 3-star prices.

Tickets?
Yes. Instead of reservations our bookings will be made more like a theater or a sporting event. Your tickets will be fully inclusive of all charges, including service. Ticket price will depend on which seating you buy – Saturday at 8 PM will be more expensive than Wednesday at 9:30 PM. This will allow us to offer an amazing experience at a very reasonable price. We will also offer an annual subscription to all four menus at a discount with preferred seating.
Two walk-in tables will be available every evening.
The tickets will be available via our website, and we are building the reservation system from scratch to ensure the best customer experience. It will be simple to use, efficient, and familiar to anyone who has booked a show or travel online.

This is a pricing system for the foodie economist! Selling tickets in advance signals popularity to the seller, gives the seller more certainty about the number of customers and the amount they will sell, and enables them to optimize their purchases of inputs. They need only procure extra for the two walk-in tables, plus a cushion for mistakes and accidents. That’s one reason why they can expect to deliver “4-star food at 3-star prices”.

But the pricing feature about which I will rhapsodize is, of course, the dynamic pricing: “Saturday at 8 PM will be more expensive than Wednesday at 9:30 PM”. This price discrimination is brilliant but not novel, although its use in restaurant pricing is. It is a decentralized mechanism that enables consumers to sort themselves according to their their willingness to pay, their preferences and their price elasticity of demand while simultaneously enabling the seller to maximize revenue. Combined with the “concert ticket” design, this pricing structure generally looks like a good setup for profit maximization. And given what has driven Achatz’s popularity and the fact that the time-place “Paris 1912″ idea is more like entertainment than any dining experience I know of other than Medieval Times, I think the price discrimination is also a valuable way to allocate dining spaces over which there will probably be excess demand.

Given this innovation in an improbable industry, here’s my challenge to those of you who work in the electricity industry, in electricity policy, or electricity regulation: if a creative innovator can create so much new value for consumers in such an improbable industry by adopting such a contractual form and such a pricing system, why do you reject it so strenuously in electricity? The parallels are striking — potential restaurant customers have a range of preferences, incomes, willingness to pay. We all need to eat. Restaurants have high fixed costs (although of course not in the proportion that we see in infrastructure industries). Customers like me relish the thought of such a choice, and look forward to its availability. Why do you make so many customers worse off relative to the potential value they could achieve from innovation if you removed the barriers to innovation, product differentiation, and competitive choice in retail electricity markets?

The Amazon-Macmillan ebook kerfuffle: an ode to price discrimination

Lynne Kiesling

[I love the word kerfuffle]

Price discrimination is the basic economics question in the current iPad-induced Amazon-Macmillan kerfuffle, even more basic than the DRM/property rights issues and the antitrust/resale price maintenance issues I discussed in my last post on the matter. Lots of people have weighed in on the subject in the past 36 hours, and I recommend some of them to your attention:

To see why this controversy is so important, let’s compare the old “wholesale pass-through” pricing model and the new “agency” model. Martin very helpfully provides that comparison in his post, so I’ll summarize here:

  • Wholesale pass-through pricing: Retailers negotiate a fixed wholesale price per unit with the publisher, and then set the retail price. In this case, Amazon has negotiated a 50% discount from full hardcover retail for their ebooks and charges $9.99 for most of them, so on any book with a hardcover retail price higher than $19.98 Amazon loses money on that sale. The publisher’s revenue on the sale is 50% of full retail.
  • Agency pricing: The publisher pays a percentage-based commission to the retailer, based on a negotiated retail price. Reports indicate that this commission is around 30% (which passes the gross margin smell test for me), so if a $29.95 hardcover sells in ebook version at $15.99, the publisher actually makes less money and the retailer makes more.

Note that under the agency pricing model, Amazon actually makes money on each ebook it sells, which at the moment it does not. The fact that it is fighting so hard to keep low ebook pricing is consistent with the hypothesis that they want to price ebooks below their marginal cost as a “loss leader to sell gadgets”.

But where the economics gets really interesting is considering the book supply portfolio and the demand for specific titles over time. That’s where the dynamic pricing flexibility of the agency model is welfare-creating — it can make Amazon, Macmillan, Macmillan’s authors, and consumers better off relative to the equilibrium with wholesale pass-through pricing, and what’s makes that possible is price discrimination.

Here’s an example: over Christmas I read Wolf Hall by Hilary Mantel (which was truly outstanding and I recommend it very highly). It was released in the US in October with a list price of $27.00. Under wholesale pass-through pricing, Macmillan receives $13.50 from Amazon for every ebook version sold at $9.99, leading to a loss per unit to Amazon of $3.51.

Under agency pricing, Macmillan could, say, commit to pricing the ebook version at $17.99 for the first week, $14.99 to the end of December, and $9.99 thereafter. Under that scenario, those Hilary Mantel fans with low price elasticity of demand would buy in the first week, those who are willing to pay $14.99 would wait a few weeks and then buy it, and those who have more price-elastic demand would wait until the price fell to $9.99, which seems to be a trigger price for a lot of current Amazon Kindle customers. This is an application of third-degree price discrimination, and in the simple static model it results in more output sold and higher profit, but generally lower consumer surplus. In a dynamic sense, though, the welfare of all parties can go up, because the price discrimination may induce the publisher to contract with more authors for more works, making all four parties better off.

Virginia Postrel mentions the price discrimination aspect in her post on the subject:

The other side of the equation is consumer response: How many more copies will people buy if the price goes down? Or, in economic lingo, what is the price elasticity of demand? Book publishers talk (and often act) as though book buyers aren’t particularly price sensitive. The Borders and Barnes & Noble coupons in my email suggest otherwise. So does what little academic research exists on the subject. In a paper looking at people buying physical books using a shopbot, economists Erik Brynjolfsson, Astrid Andrea Dick, and Michael D. Smith found very large elasticities: A 1 percent drop in price increased units sold by 7 percent to 10 percent.

Of course, people who use shopbots are likely to be more price sensitive than average. But there’s anecdotal evidence that prices matter a lot for e-books. As The New York Times reported recently, most of the books on the Kindle bestseller list are being given away for free. And comments on various discussion threads among Kindle users suggest that many are bargain hunters looking for a good, cheap read rather than a specific title.

Rather than cut prices for everyone, Macmillan hopes to be able to price discriminate, so that eager readers pay more than casual ones. It’s a reasonable strategy. But the publisher seems to envision a traditional method of dividing the market: charging more for brand-new titles and lowering prices over time. That approach works for paperbacks, which come out roughly a year after hardback editions. But paperbacks are, of course, physically inferior to hardbacks, while e-books are all the same. Discriminating by publication date works only for titles that are fashion items–you want to talk about Game Change this week, not in six months–or blockbusters with impatient fans (the latest Twilight installment). Most books fall into neither category.

That’s an interesting angle on the topic. James McQuivey from Forrester offers some evidence that may point in the same direction:

In fact, the pricing mess is only going to get messier. Our surveys have found that people are willing to pay as much as $17.81 for a new e-book, but only if the hardback costs $25. That’s the rub. People expect to pay less for digital books, compared to the price of the physical book in the market. But books don’t cost that much. Today I can buy a hardback copy of Elizabeth Gilbert’s Committed on Amazon for $12, a discount of $14.95 from the list price. And the book was just published four weeks ago. So spending $14.99 for the digital version is a bit silly.

So what’s the “new equilibrium”? Retailers and publishers will evolve and adapt as technologies and consumers do, but will it involve content as loss leader, authors contracting with Amazon and disintermediating publishers, or something else. One thing we know is that the Internet has created lots of new ways to price discriminate, and ebooks may be susceptible to that pricing model too, to the benefit of all parties.