Ethics Of Price Discrimination

Note to new readers: Do check out my other articles on versioning andprice discrimination. It would help me greatly if readers coming from Rutgers or New Jersey let me know how they found this article.

When I last visited Italy, I was walking along a street in Sienna that was lined up with stores selling  ceramic arts. It was a surprise to me see the prices vary from store to store (even two adjacent stores) for pieces that looked identical (to my untrained eye). Better yet, I saw no locals making  a purchase (makes sense) and there were some willing to haggle and for them the prices kept dropping. Different customers paid different prices. Is this price discrimination? Is this a model for a marketer to follow?

Price discrimination is charging different prices to different customers for the same product. Perfect price discrimination occurs when every customer is charged a price that is equal to their willingness to pay. Previously I talked about consumer surplus as “the size of the smile on face of customer after paying the price for the product” (definition source: Prof. Steve Tadelis). In perfect price discrimination no one leaves the store with a smile. Such a perfect pricing model does not exist except if we are willing to bend the ethics.

Pricing is about value capture – a product or service delivered creates certain value to the customer and price is the way for the marketer to get a share of the total value created. A same product will be of different value to different customers.  For example I talked about pricing for fluorescent and LED  bulbs. The value of a long lasting bulb that requires fewer replacement is higher for a customer who incurs a high changing cost vs. a home customer who has no such costs.  It is only fair that the same longer life bulb is priced differently to these customers.

The Wall Street Journal talked about rug sales and how different customers pay different prices:

Except for connoisseurs, the only thing most buyers know is what they “love.” A seller can size up a buyer and decide what he’s likely to pay. In business school, it’s called “price discrimination.” Mr. Hassankola has learned that lesson: He went to business school in Switzerland. When he finished, in 1991, he took a job in a Zurich rug warehouse.

This is not that different from the sales I saw in Sienna and other touristy places. Customers are charged different prices because of the information gap and not based on  value difference. The WSJ story later talks about a woman who dismissed the claim by the store owner that a particular rug was purchased by his grandfather, because she could tell that the rug looked newer. But most of us do not have an idea about the quality, age, workmanship or the public value of the rug we are purchasing. In other words, the prices are different not because of value difference but because of knowledge difference.

It is difficult for me to accept this practice as price discrimination. This may work in transactional situations, where a marketer makes just one sale to each customer but does not help if the marketer wants to build a long term relation with the customer. No one can succeed in a business that adds no or negative value to the customers.

As long as the price discrimination is based on economic value added it is justifiable, fair and ethical.

The Value Gap Between Buyers and Sellers

Randy Pausch and Randy Komisar – Trade Money For Time

This weekend I watched the time management lecture by Randy Pausch, (well known for his terminal condition and his book The Last Lecture). I also read a book by Randy Komisar, The Monk and The Riddle. The two Randys talked about exactly the same thing.

Their core concept is the same, simple and profound – worry about the scarcest and non-reprehensible resource. Time and not money. Both goad us to ask ourselves, ” if I only had a short time to live, would I want to do what I am doing now. Is what I am doing worth my time? What is the opportunity cost?

While Komisar is more holistic in his approach and asks ” if I am doing step-1 because it has to be done so I can get to do step-2, which I love and is really what I want to do for the rest of my life, why? Why not do what I really want to do now? Why wait? Why subscribe to ‘deferred life policy’?”

He talks about ‘drive’ which pushes you to do things you have to do while ‘passion’ pulls you towards things you would rather be doing.

While Komisar simply asked us to imagine our final days, Pausch literally had only few days to live and died recently.
Pausch gives tools and tactics to operationalize this, with specific and tionable and habit forming TODOs.

Together the two tell us to focus on our passion and how we go about achieving it.

Komisar’s book also gives brief insights into how startups and VCs work, how they think about valuation from their perspectives and some funny anecdotes on life in the valley.

Crocs Valuations Wearing Out Faster Than The Sandals

For $6, you can buy a pair of sandals that looks identical to Crocs which retails for $30. You can now buy a share of CROX stock for less than $5.

There may be differences in how these two feel, but it is  not easy to find the differences in the look. How can Crocs expect to retain its market share at such price premium? It can’t.

No one can expect to defend their price premium when close substitutions are available. Add to this, the current tough economic conditions. Crocs is not going to find it easy to convince customers that value-add from its resin technology is worth the high price.

Crocs pre-warned that it will barely break even for this quarter and the outlook isn’t positive for the rest of the year.  It reduced its earnings forecast from 43 cents to 3 to 7  cents, at almost the same revenue levels of $220 million.  Its profits are expected to drop 93% while its revenues are expected to be down only 10%.

Crocs is obviously reeling under high cost of goods sold from high oil prices and high cost of sales and marketing. But these two alone are not enough to justify such a lopsided change in operating margin. There is more hidden in its books, and this makes the stock unattractive even though it is trading close to its book value (assets less liabilities).

As I wrote last time, there are serious red flags in its accounting. It is much better off to look for other investments. In the words of Benjamin Graham, buying shares of Crocs now is not investment, it is speculation.

Follow up on two short sells I recommended

It is not difficult to make predictions in a down market. In May  I made calls on two stocks, CROCs Footwear and Ruby Tuesday Restaurants. They both had just released their Q1 earnings and I made a call by spending some time with their 10-K and their proposed strategy. While 3 months is a short time to check back, a quick view of their current market prices justify the short call.

RT is now trading at $5.8 down 21%  from $7.35
CROX is now trading at  $8.25 down 30%  from $11.81

Compared to this S&P 500 is at 1283.6 down 8.1% 1397.68.

So not all weakness in these two stocks are due to market downturn. Motley Fool’s Tim Hanson called Crox attractive at current prices. But given  the red flags in their accounting it is good to stay out longer.

Why can’t telecom providers be a house of brands?

Procter and Gamble is a house of brands. Each brand is run like a business with its own P&L. There is no attempt to bring together all the brands nor is there a need to do so. When they acquired Gillette, a company by itself, it came as another brand under P&G. There were no integration hassles or costs. What can’t a telecom company be like P&G?

When AT&T acquired Cingular Wireless, the network was completely integrated and the Cingular brand was quickly subsumed under at&t brand. When Sprint bought Nextel, they rebranded themselves as Sprint Nextel but attempted to integrate the two networks. Sprint Nextel expended considerable capital trying to integrate the two networks and is reported to be in the market to sell off Nextel, an admission that the merger did not work.

Why did Sprint try to integrate Nextel’s networks and operations when the two technologies and customer segments were completely different? Why did they not attempt to let Nextel brand stand by itself and preserve the network as is? When a telecom company acquires another why can’t they keep the separate companies as is without integrating the customers, the operations, the systems, the networks and the brand?

After all the positioning of the two companies and their customer segments have little overlap.
Sprint could have been the P&G of telecom, with multiple wireless offerings (like the Pantene and Head & Shoulders).

The answer lies in the valuation of the target at the time of acquisition and the strategic rationale. If we look at Sprint’s reasoning in 2004,

  1. Combination of Sprint Nextel will create America’s premier communications company — a leading wireless carrier augmented by a global IP network that will offer consumer business and government customers compelling new broadband wireless and integrated communications services.
  2. Expected to deliver operating cost and capital investment synergies with an estimated net present value of more than $12 billion.

The answer lies in the synergy calculation, lot of things ride on the value of the combined operation. The value of Nextel depended on the $12 billion NPV of synergy which requires the complete integration of operations. Without the integration, there is no cost savings or spillover effect and the merger itself may be questionable.

So acquiring Nextel, just to run it as its own operation would have required Sprint to value the deal by at least $12 billion below the $71 billion price tag. Nextel shareholders would not have agreed to that price.

When Sprint Nextel wrote down $20 billion in goodwill it showed that the deal was overvalued. The rumors about Nextel spin-off show that synergy is easier said than realized.

Next up, Deutsch Telecom is reported to be looking to by Sprint Nextel. Once again there are multiple technologies, DT’s T-Mobile USA uses GSM and its evolution while Sprint used CDMA and Nextel uses iDen. DT having seen the Sprint Nextel integration efforts will not attempt the same. If a deal has to happen then DT has to see Sprint Nextel by itself as a positive NPV acquisition and run Sprint Nextel brand in parallel with T-Mobile brand.

That will be an interesting experiment to watch and learn.