value improv (dynamic pricing)

I wrote this post yesterday, but did not post it.  I thought: everyone knows more about pricing than an anthropologist, especially anyone with any economics  Then, I thought, well maybe there is something here.  You decide.

Pricing used to be a fluid, informal thing.  Prices in the market would fluctuate with the time of day, the clothing of the buyer, the stock of the seller or all three.  It was kind of value improv.

 
The fixed price is a relatively new thing, and someday it might a cloudy memory.  Someday, our grandchildren will interrogate their elders with questions like, "Is it true that things used to come with a ‘sticker’ and you had to pay what it said?"
 
We have the technology to "re-price on the fly."  But we have yet to put it into practice with any consistency.  Old habits die hard. And sometimes they will not die at all.  When Douglas Ivester, then the CEO of the Coca-Cola Company proposed that Coke machines might charge more in hot weather, there was a cry of outrage from all quarters. Heartless!  Unfeeling!   Coke would never exploit me in my hour of need!
 
But today [Friday], when I was boarding the train at Grand Central, I thought I glimpsed something more plausible.  In the present day, the train charges 10 bucks to get from New York to my little town in Connecticut.  Everyone pays 10 bucks.  Some of the people on my train, to judge by their clothing, watches, and briefcases, are worth great deal of money.  These are the kind of people who would happily, easily pay twice that amount.  And we might argue that Metro North, cash strapped as it is, does not fulfill its fiduciary responsibility when it does not fully capture the value it is creating for these passengers. (There are several assumptions here and throughout that I have not broken out.  If there is something of value here, I am happy to supply.)
 
Imagine a train with 10 cars, each of with has its own price point.  At the front of the train, the price is 30 bucks. At the end, the price is 10 bucks.  People array themselves according to what they are prepared to pay.  This might be a more lavishly appointed carriage.  But I suspect they would pay more merely for a seat and a little personal space.  And it will be easy to capture payment.  When the doors close, everyone’s debit card will be billed the price of the car. 
 
The train today was absolutely packed.  I mean "standing room only" packed.  And there are moments during rush hour when Metro North feels like a troop train.  Now, we can imagine two opposing tidal forces at work setting prices in the 20 minutes the train sets idling in the station.  As the "cheap" end of the train fills, people will react to passenger compression by migrating towards the "pricy" end of the train.  But the people at the pricy end by indicating their willingness to pay more for their carriage, and increase the cost of staying there.  Eventually, over 20 minutes prices should establish themselves.  Yes, even the cheapest seats will become too expensive for some people to bear and they will have to get off the train and wait for one they can afford.  At the end of the day, the trains leave the station every 30 minutes, so this is not an impossible hardship.  If someone really needs to travel, they will, up to a certain limit, pay more. 

In the longer term, I guess the train will have a digital display in each car.  It will show the price of each car in the train, and historical average for that car.  Otherwise, a trip home to Connecticut turns into a game of "musical chairs." 

 
Getting to the station, that’s another matter.  And here, as I stood on Park Avenue watching cabs rocket pass me, I thought, this is where dynamic pricing really makes sense.  I should have a card that signals how much I am willing to pay.  If my card glows red, I am prepared to pay a meter times 5.  If orange, the fare times 4, and so on.  If I merely have my hand up, well good luck.  It is easy enough to say, but this is unjust, that the rich will commandeer an even thicker share of our resources.  And this is true.  But it is also true that the taxi driver will now capture more of the value he creates, and this  seems entirely fair. 
The fact of the matter is that we have fixed pricing because variable pricing was too expensive to manage.  Now that the technology is in place, it can only be a matter of time.  Economists are much better at thinking of the effects of pricing, and how consumers react to one another’s behavior in the marketplace.  It’s the tidal thing that got my attention, and this is the kind of thing Simmel thought about, and it might here that the anthropologist can help out.  (Let’s see what jens says.) 

13 thoughts on “value improv (dynamic pricing)”

  1. I can’t speak for the US and the NY trains, but dynamic pricing is common in INdia even for things like school fees, health costs and medicine. Few families coming from more well off sectors of society ever complain at this, its ‘understood’ as a fact of life that those who have more will subsidize those who have nothing at least for basics. these schools, hospitals etc are usually run by for profits, not just charitable or NGO’s. Escorts Heart Centre is one of the best in Asia and will charge my father probably 100 times more than they would any of their ‘charitable dispensary’ patients. It is one form of CSO, imho.

    Mayhaps this scheme would not be a bad idea here as well?

  2. BC Ferries essentially has a monopoly on travel between Vancouver and Vancouver Island. They run one sailing every hour during peak periods and one every two hours otherwise. They also have a few different sized ships in the fleet that they switch between at whim.

    Tickets are sold at the gate only, the cars line up and are loaded onto the ferry in first-in-first-out order. However, you can purchase “reservations” online for specific sailing that give you precedence if you show up in time. There are also “golden tickets” that give you precedence on any sailing (but they are so expensive that most people in that bracket just take a seaplane).

    Then once you’re on the ferry, there are sections, from a lounge to staterooms, which you can pay more to enter.

  3. As an economist, I agree that your commute illustrates pricing problems. I see two different concepts in your post– price discrimination (charging higher prices to “the kind of people who would happily, easily pay twice that amount”) and peak-load pricing (charging higher prices at rush hour). Both can increase profits for the supplier, but they have different social welfare implications.

    Peak-load prices more accurately reflect the cost of using a resource at a particular time. They can help shift travel away from the most congested times. Higher rush hour prices may also attract more taxi drivers to work at those times, also reducing the shortage. Even the Metro might add cars to its trains, if prices were right. This kind of pricing can generally increase social welfare.

    Price discrimination (charging richer consumers higher prices to use the same service) depends on market power on the supplier’s part (monopoly power). A substantial portion of this kind of pricing power is merely a transfer from consumers to producers, without the same welfare-enhancing properties of peak-load pricing. Many countries have some restrictions on this kind of behavior through their antitrust laws or competition policies. (Although the regulations are not widely applied, particularly to services.)

    To some extent, there’s a trade-off when we consider fixed versus flexible pricing. Fixed prices reduce uncertainty, information-gathering costs, bargaining costs, and other transaction costs. But, as your examples show, if prices don’t respond to changing circumstances, then other problems appear.

  4. Don’t we already do this with tollroad pricing — charging more during peak-use hours? And what are need-based scholarships but differential pricing on tuition? Ditto for pro-bono legal services.
    No big deal. Only question is when supermarkets, vending machines, and the like are going to catch up.

  5. here’s to the wisdom of clouds! – so i can gladly take advantage of my right to remain silent.

    one thing though: as grant and i share a passion for the old masters, let me draw your attention to georg simmel’s “philosophy of money” – a dazzling analysis of the modern world at the turn of the 19th to the 20s century.
    http://www.amazon.com/Philosophy-Money-Georg-Simmel/dp/0415341728

    georg simmel was the son of a berlin entrepreneur who co-founded the Sarotti chocolate factory – the most famous chocolate brand in germany for a long time http://en.wikipedia.org/wiki/Sarotti (note: “Due to political correctness the moor hasn’t been carrying a tray anymore since 2004.” – …btw. a company i worked for in the 90s did the relaunch – http://www.peter-schmidt-group.de/ … so pc has finally reached germany – good to know…)

    free from financial worries little georg spent his days in berlin looking at girls and at fashion, he witnessed the pulse of the growing metropolis and carefully took note. his writings on fashion are legend – so is his “The Metropolis and Mental Life”.

    as a true son of the big city georg simmel never came up with a consistent theory. his essays dive deep into everyday observations. – “the philosophy of money” is the only exception. here he carefully draws an anatomy of modernism as a shift form a “subjective world” to an “objective” one. – extremely interesting to read today – as one could argue in simmel’s words that we are right now witnessing the pendulum swinging back (from the objective to a more subjective world).

    _
    i just found that “the philosophy of money” (in the new translation) is also available on google books. so if you have the nerve to read 500 pages online – here you go
    http://books.google.com/books?id=WpY3cCFiJHgC&dq=georg+simmel+the+philosophy+of+money&pg=PP1&ots=PPWKdglEcv&sig=xb3H6d8x2mKJ3JS-aSOMlNCylQg&prev

    enjoy!

    http://en.wikipedia.org/wiki/Georg_Simmel

  6. I have no problem with variable pricing in general, and I am sure it will become common practice in more marketplaces. In transport, most western airlines currently recalculate their prices about every 15 minutes, based on the current and anticiapted rates of bookings for particular flights. But, as with every other human activity, prices may signal, or be perceived to signal, more than simply a disparity between supply and demand. Companies ignore these perceptions at their peril.

    In Australia a couple of years ago, there was a major public uproar over the fact that retail petrol (gasoline) prices rise significantly every Anzac Day, Australia’s national holiday to honour the country’s war dead. Economists said that the reason was obvious — demand rises on public holidays because more people travel then, and thus so will prices. Non-economists said this looks like oil companies and retail outlets taking advantage of people on a day of national mourning.

    What was clear in the ensuing debate was the mutual ignorance it revealed: Economists are fond of bemoaning the lack of economic understanding that (they claim) ordinary people have. But many economists too reveal a lack of understanding — of the non-monetary aspects of life, since they could not see why people would be morally offended by such price rises.

  7. discount airlines achieve somethnig very close to this – but the determinant isn’t whereabouts-on-the-plane you sit, but when-you-book-your-ticket.

    The sophisticated systems used by easyjet have a model (start cheap for early bookers, then rise, then fall again for last minute) but the prices are adjusted on-the-fly in real time.

    I think it’s on-line sales, and the software, than enable the airlines to survive.

  8. It might be argued that there already is an element of dynamic pricing for transport, looking beyond the trains. The rich guys you think would pay more for a train ticket if prices went up might instead take a cab or drive to work.

    Taking the broader view, and the economist’s assumption that consumers are rational, commuter trains are full to bursting because other transport options are slower and/or more expensive. Raise prices and some people will abandon the trains, making commuting by road slower for everyone.

    Hypothetically we could then raise road tolls and even bus tickets until some people were actually unable to afford travel at rush hour by any method at all. Since in practice people still have to get to work (and home in time to collect their kids from school) that would probably mean manual workers, teachers, nurses and other lower-paid professions getting up early enough to commute in the small hours and miss the expensive rush. I’m not sure the benefit of more rationally priced rush-hour trains is worth the cost of inattentive buzz-saw operators and nurses too tired to reliably prescribe the correct drugs.

  9. There’s a scene in “Nobody Knows” the Japanese movie about the kids that are abandoned by their mother and live in a Tokyo apartment that caught my attention. The kids go to a convenience store on Christmas and wait outside. In front is a sidewalk sale, the price for a desired item is too much for their budget, but the kids know that if they wait, and no one buys it the price will go down. And sure enough, the sign is replaced with a lower priced sign. I asked my Japanese partner if this is normal: he said sure, it’s Christmas. The prices change all day as you get closer to closing time.

    HOT lanes are all the discussion right now around Washington where the price of tolls will adjust to the amount of traffic. We already have different price schemes for Washington’s Metro based on whether you are traveling during or outside of peak hours.

    So this is coming, but perhaps, differently than the rest of the world or at least Asia — which may be more used to these fluctuations.

  10. Chuck paints with too broad a brush in condemning the welfare consequences of price discrimination. In many, many cases the result is positive, because mutually beneficial transactions that otherwise would not occur (at a single price) can now go forward. For example, if Merck can sell a drug at lower prices in Botswana than it does in the US, more gains from trade in Botswana are possible than if it had to charge high prices in both places. (Charging low prices in both places would not be optimal for Merck.)

    Even the distributional consequences are not unambiguously bad for the egalitarians amongst us. As Grant points out, rich Stamford businessfolk have little to complain about if taxi drivers charge them higher prices than they do poorer customers. In many cases, allowing price discrimination moves gains from trade away from the most affluent customers and toward poorer customers and producers.

    As for the dire consequences Seamus raises against peak-load pricing for transit, there are three reasons not to be too concerned. First, the marginal travelers during rush hour are probably not heading to work; they are making trips that could be rescheduled, but because they put a low value on their own time, they’d just as soon travel when it’s convenient for them. I don’t have a link, but I’ve read studies of auto traffic that show that a surprisingly low percentage of trips during rush hour are actual commuters. Second, peak-load pricing makes it possible to get accurate signals of potentially profitable additions to capacity, signals which are currently suppressed and so cannot stimulate new supply. Third, over a slightly longer time frame, workers and firms can adjust their locations to reduce travel times. All three of these margins of adjustment will mitigate or eliminate the postulated harms.

  11. Grant

    I can’t but help in all the learned postings on economics that customers emotions has been missed out of the picture.

    Customers do react badly to being treated unfairly. It is one things to have generally accepted progressive taxation (providing it is not prohibitively progressive that is), or to manage demand (and thus yield) for airline seating capacity, but I sugggest it is another thing to openly price differently for products and services just because some customers are richer than others. For example, Amazon experimented with differentially priced CDs in the past with disastrous consequences.

    Customers do not like being treated unfairly and will punish others, including companies, who treat them so.

    Just a thought.

    Graham Hill

  12. Surely what you describe is the very old idea of class-based transport seating?

    The model would operate given a different level of service of product for a larger amount of money, rather than the demand-based economic model proposed by coca-cola. People have been buying first-class plane and train tickets for a long time now, and it wouldn’t be unreasonable to expect an extention of this.

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