Quantity demanded at a negative price: Hoover’s free flight promotion

 

In Autumn 1992, the British home appliance manufacturer, Hoover, offered two free air travel tickets to every customer who purchased an appliance with a price of £100 or more. Each ticket was valid for round-trip travel to continental Europe or the United States. The market value of a pair of tickets exceeded £400.

For a £100 appliance, Hoover’s effective price was £(100  400)  £300; that is, the company was paying each customer £300 to take an appliance. As might be expected, huge numbers of consumers were willing to buy Hoover appliances on those terms. The promotion attracted over 100,000 customers.

Hoover’s management, however, had not anticipated this response. It had to establish a special 250-person task force to deal with the flight bookings and set aside £48 million to cover the cost of over 200,000 free flights. William Foust, president of Hoover Europe, and two other senior executives were dismissed for their role in the promotion.

At the time of the promotion, Hoover was owned by the American appliance manufacturer Maytag. In May 1995, Maytag sold Hoover to an Italian home appliances group for £106 million.

 

Source: “Hoover ‘Free Flights’ Scheme Costs 48 Million Pounds,” Financial Times, April 21, 1994, p. 7; “Hoover Sold after Free Flights Fiasco,” The Times, May 31, 1995.

 

 

Mobile Telephony: Pre-paid vis-à-vis Post-paid

 

Pre-paid service caters to different market segments from contract (also called “post-paid”) service. The pre-paid customer segments include people that the service provider would consider a bad risk for contract service – those without a regular high income, migrant workers, and travelers.

To the extent that it caters to customers with relatively lower income, pre-paid service is an inferior product. As incomes rise, users would upgrade from pre-paid to contract service. In this regard, the demand for pre-paid service is similar to that for paging service. Paging service is an inferior good. Worldwide, as incomes have risen, consumers have switched from paging to mobile telephone service. Consumers have also switched because the price of mobile telephone service has fallen.

 

 

How would you like your music?

 

In 1998, the value of worldwide sales of recorded music in the form of singles,

music cassettes, and CDs was $38.7 billion. In Canada, with a 30.2 million population, sales of CDs were 77.2 million units, and sales of music cassettes were 11.2 million units. On average, each Canadian bought 2.6 CDs and 0.4 music cassettes. By contrast, in Argentina, with a slightly larger population of 36.1 million, CD sales were 18.5 million and music cassette sales were 6.7 million, which translated to 0.5 CDs and 0.2 music cassettes per capita.

Canadians enjoyed higher incomes than Argentine consumers. In 1998, Canadian GDP per capita was $19,831, while that for Argentina was $9,413. The difference in incomes explains why the average Canadian bought more of both CDs and music cassettes.

Canadians also bought relatively more CDs (and relatively fewer music cassettes) than Argentine consumers. The ratio of CD to music cassette purchases was 6.5:1 in Canada, and 2.5:1 in Argentina. One explanation of this disparity is that music cassettes were a relatively inferior product compared to CDs.

Another possible explanation of the disparity is a difference in the relative prices of music cassettes and CDs. In Canada, the average price of a music cassette was $6.06, while the average price of a CD was $11.55. In Argentina, the average prices were $7.80 and $13.80. Since CDs were relatively cheaper in Argentina, differences in prices probably do not explain why Canadians bought relatively more CDs than Argentine consumers.

 

Source: The Recording Industry in Numbers, 99, International Federation of the Phonographic Industry (London, 1999).

 

 

Home football games: to broadcast or not to broadcast?

 

In the 1999 National Football League (NFL) season, the Tennessee Titans won 13 games and lost 3 to qualify for the Super Bowl XXXIV in Atlanta. In what NFL Insider Magazine described as “perhaps the most exciting Super Bowl ever played,” the Titans held down the St. Louis Rams for most of the game. However, in the final minutes, the Rams’ Isaac Bruce caught a 73-yard touchdown pass and doomed the Titans to a 16-23 defeat.

Like other NFL teams, the Titans make money from sales of tickets and food, beverage, and other concession items at live games. Increasingly, however, gate and concession income has been overshadowed by earnings from television broadcasting. In 1998, CBS won the rights to broadcast the NFL’s American Football Conference for a bid of $500 million a year, while the Fox Network won the NFL National Football Conference rights for $550 million a year. The broadcast fees are divided among the NFL teams.

What is the relationship between live broadcasting of away games and the demand to attend home games? Live broadcasting of away games entertains fans when their home team is playing away and stimulates popular support for the home team and interest in attendance at home games. Accordingly, live broadcasting of away games and attendance at home games are complements.

Live broadcasting of home games, however, may draw fans away from attending the game in person. To this extent, the two products are substitutes. On the other hand, live broadcasting of home games also stimulates popular support for the home team and hence attendance at home games. To this extent, the two products are complements.

Whether NFL team owners should allow live broadcasting of home games depends on the balance among these effects. The solution, enforced by federal law, is to allow broadcasting of home games only if they are sold out. Further, federal law requires that such broadcasts must show the entire game. This rule tends to squeeze out broadcasting of games from other cities and helps to focus the local television audience on their home team.

 

Source: Harris Molloy, Jr., NFL Insider Magazine (http://www.nfl.com/sb34/features/000130titansdefense.html)

 

 

Financing New Vehicle Purchases

 

In a study of replacement demand for vehicles it was noted how the auto industry improved demand for new vehicle by promoting leasing programs. These leasing programs provide buyers a lower cost of entry for new vehicles compared to bank loans. The promotion of leases provided a substitution for bank loans and increased the percentage of vehicle under a loan or lease agreement from 26.3% in 1992 to 34.5% in 2001. Leases became attractive to buyers; who typically could not get bank loans, by providing an opportunity to upgrade to higher priced models and who regularly replace vehicles in 2-4 year increments. Leases provided for increased demand but also caused substitution of bank loans, in 1992 8.5% of recent model vehicles were under lease, and this increased to 17.5% in 2001.

 

Source: “Vehicle purchases, leasing, and replacement demand: evidence from the Federal Reserve's Survey of Consumer Finances,” Business Economics, April, 2004 by Ana Aizcorbe, Martha Starr, James T. Hickman, April 2004

 

 

Demand for used cars

 

The American consumer’s demand for used cars grew steadily over the 1990s. In 1990, the average passenger car in use was slightly over 7.5 years old. By 2002, the average age had risen to over 8.4 years. A major reason for the increasing demand for used cars was the fast rising price of new cars. Between 1993 and 2002, the median household income rose by 35.6%, and the consumer price index rose by just 24.5%. By contrast, over the same period the average price of a new car rose by 43.8%.

The demand for used cars also grew because of the increasing quality of used cars. A further reason was that automobile manufacturers reduced the frequency with which they changed designs. Car dealer David Ash remarked that consumers “often can buy a car 2 or 3 years old that looks pretty much like the newest model.”

Historically, financial institutions charged higher interest rates on loans for used cars. Over time, however, with the improvement in automobile quality and the shift of middle-income consumers towards used cars, financial institutions began to offer more favorable rates. This gave a further lift to the demand for used cars.

 

Sources: “America’s New Darling: the Used Car,” Asian Wall Street Journal, November 2, 1994, p. 20; “Second Time Around,” Atlanta Journal and Constitution, November 15, 1996, p. S01; and National Association of Automobile Dealers.

 

 

China’s mobile carriers: Increasing sales, declining ARPU

 

China is the world’s largest mobile telephone market, with 233.6 million subscribers comprising 18.1% of the national population. The Chinese market is dominated by two carriers – China Mobile and China Unicom, with shares of 64.8% and 34.6% in their respective service areas. Both China Mobile and China Unicom have expanded their businesses primarily by recruiting new customers rather than introducing new services. Essentially, the two carriers have been selling down their demand curves.

They have done so by cutting prices and also by expanding the number of pre-paid subscribers. Generally, pre-paid subscribers spend less than contract (post-paid) subscribers. In 2003, China Mobile’s average revenue per user (ARPU) was 58 yuan per month among pre-paid subscribers compared with 171 yuan per month among contract subscribers.

Between 2001 and 2003, the proportion of China Mobile’s customers subscribing to pre-paid service increased from 48% to 64%. Over the same period, the company’s overall ARPU (from pre-paid and contract subscribers) fell from 141 to 102 yuan per month.

A secondary reason for the systematic decline in ARPU is the two carriers’ record of acquisitions. For instance, in 1997, when China Mobile was listed on international stock exchanges, it comprised businesses in China’s wealthiest areas – the major metropolitan areas such as Beijing and Shanghai and the coastal provinces. Since then, it has acquired various service providers in poorer regions. Customers in these regions spent less than those in metropolitan areas. Hence, the acquisitions further diminished China Mobile’s overall ARPU.

 

Bethel, Alaska: Cab Capital

 

Rachel D’Oro of the Associate press stated, “You won't find a luxury hotel or concert hall in Bethel, and you probably can't even get a decent bagel here. But this remote Alaska town has at least one advantage over New York City: It might be the nation's cab capital.”

 

By recent accounts Bethel has between 70 and 100 taxi cabs and 2000 United States census reports the population at 5471 residents. That roughly equals 1 cab per 64 residents compared to New York City with a hired vehicle rate (taxi, commuter van or livery car) of about 1 per for every 149 people.

 

What allows this demand to flourish?

 

Taxis become economically attractive when the cost of paying someone to drive for you is less than the costs of owning a car or walking.

 

This is the case in Bethel.

 

The substitute of owning a car (instead of taking a taxi) is quite expensive.

• Bethel is inaccessible by road. Cars must be barged up the Kuskokwim River during the summer or flown in with the lowest air freight cost at about $2,000.

• Gas costs between $5 to $7 per gallon in Bethel. With the entire winter fuel supply shipped in by river barge and stored over the winter.

 

There are additional barriers to owning a car.

• Owning a car is a significant investment but does not have a lot of cross-function since the town consists of a single 10 mile paved road.

 

The substitute of walking (instead of taking a taxi) is less than appealing.

• Bethel is on Alaska’s western delta plain. It is often not a hospitable place for walking in summer because of bugs or in winter because of the extreme cold.

 

This demand is high (at the far right of the Supply-Demand graph) because there are limited substitutes and significant perceived utility.

 

If cabbies were able to charge prices based on a free market system instead of the fixed rates the city requires one would expect that as additional supply was brought to the marketplace the cost would decrease.

 

It is worth noting that there are additional barriers keeping the supply lower than the marketplace naturally might accept including the following: steep insurance, dispatcher fees, cost of automobile repair, Bethel’s high cost of living, physical risk of driving a cab, and Bethel’s Public Safety and Transportation Commissions May 14, 2007 goals to reduce the number of Taxi Permits.

 

noted references

United States 2000 census data Retrieved February 16, 2008 from http://censtats.census.gov/data/AK/1600206520.pdf

 

D'Oro, R. (July 23, 2007 ). Taxis on the tundra. The Associated Press. Retrieved February 16, 2008 from http://dwb.adn.com/news/alaska/rural/story/9155250p-9071788c.html

 

 

Emergency Room Demand

 

By getting consumers to switch to so-called high-deductible insurance plans – in exchange for lower insurance premiums – the health care industry seeks to reduce demand for emergency room services.

Health care insurance commonly utilizes two-part pricing, charging the customer a subscription fee along with a variable usage charge, typically a percent of the charges incurred. In an effort to reduce the cost of providing medical services, the industry is trying to change consumer behavior and reduce emergency room usage, instead encouraging patients to seek out primary care and family physicians.

 

By lowering the subscription fee and increasing deductibles, the price of an additional unit of service is higher than under traditional insurance plans (until the deductible is met). The results are starting to come in, and a March 2007 study shows a 10% reduction in demand for ER services among those covered by high deductible healthcare plans.

 

It should be noted that total revenue from ER services will decrease with this type of modification. The intent is to increase demand for the substitute of primary care and increase revenue for these services, where the profit margin is expected to be higher.

 

As for the long-term impact of reduced emergency room visits, we suppose time will tell.

 

Source: Cooney, E. (2007) High-deductible plan cuts ER use, study finds. Boston.com. Retrieved on Feb 21, 2008 from

http://www.boston.com/yourlife/health/blog/2007/03/highdeductible.html

 

 

GPS market facing sliding prices and demand

By Toby Sterling, Associated Press

AMSTERDAM, Netherlands — Consumer navigation devices have gone from expensive gadgets to mainstream gear in just three years, but Europe's largest maker is struggling.

The experience of Netherlands-based TomTom NV — which saw earnings fall 83% in the first quarter — suggests the market for stand-alone global-positioning systems is at a turning point.

"What we saw for the first time is that selling prices fell, but volumes didn't improve enough to compensate," analyst Eric de Graaf of Petercam said after the results were reported Wednesday. "It's a signal the market is getting saturated."

Some analysts believe that as stand-alone versions are overtaken by cellphones and other devices with navigation technology built in, GPS devices will become low-margin commodity products, like pocket calculators. But others think a smart company could turn GPS devices into premium products the way Apple made its iPod music player stand out from a host of cheaper devices.

For now, TomTom's larger U.S. competitor, Cayman Islands-based Garmin, appears to be faring better by virtue of its greater range of products.

 

Including Taiwan's MiTAC International — owner of the Navman and Mio brands — the top three GPS makers hold around an 80% market share, giving them scale advantages over smaller players. But competition is coming from many directions, including big names like Nokia Corp., Sony Inc., Google Inc. and probably Apple.

"TomTom and Garmin are branded well," said Thilo Koslowski of Gartner Research. "But functionally there's not much difference" yet among GPS devices.

In 2007 alone, including strong holiday sales, 33.9 million units sold, almost triple the 11.9 million sold in 2006. Now, 10% of U.S. drivers and 20% of those in Europe own a navigation device. But prices for basic stand-alone devices have fallen below $200 from $500 or more.

TomTom reported a net profit of $12 million in the first quarter, which ended March 31, down from $70.3 million a year earlier. Sales revenue fell 22% to $147 million. Some analysts now fear TomTom's $4.63 billion bid to buy digital mapmaker Tele Atlas NV, also based in the Netherlands, could come undone.

MiTAC and Garmin have yet to report first quarter results. But sales figures posted on MiTAC's website show a 15% decline in the first quarter. Garmin, due to report on April 30, hasn't altered its guidance since February, when it said it expected strong sales growth in 2008 despite price declines.

Garmin benefits from offering high-end devices for aviation and marine navigation — and from reporting in dollars. Also, it plans to meet the cellphone threat with its own combination phone and navigation device later this year, and it has announced a partnership integrating AOL's MapQuest into its devices.

By 2010, Gartner estimates, 500 million cellphones capable of navigation will cell annually, compared to just 95 million pure navigation devices. Most cellphones can't yet match the easy touch interface of the devoted devices, but Apple's iPhone offers evidence that that may not be true for long.

Other competitors are getting smarter too: Both Google and Microsoft have introduced the option this spring of taking traffic conditions into account in their mapping instructions, using traffic data from vendors to calculate time to travel instead of distance. Some drivers may prefer to stick with that option, printing route maps before they set out in the car. Others buy built-in navigation systems that integrate with a car's design.

But analyst David Niederman of Pacific Crest Securities said many other drivers will still want stand-alone devices for their dashboards because they're more straightforward and easier to read.

TomTom Chief Executive Harold Goddijn said on a conference call he believed 50% of drivers will eventually own navigation devices, leaving plenty of room for growth in the coming three to five years. He predicted that prices will stabilize in the current quarter, now that retailers are done selling excess inventory.

Garmin may be broadening its offerings, but TomTom Chief Operating Officer Alexander Ribbink said his company's strategy is to focus on the in-car market, improving basic navigation and keeping the interface simple.

One upgrade TomTom recently introduced lets users share map corrections. Another embeds GPS chips in phones to collect and distribute real-time data about traffic conditions. Yet Ribbink was skeptical about the threat from phones themselves.

"Navigation on the phone is difficult for a number of reasons: it cuts into battery life and you have small screens," Ribbink said.

The large market share of Garmin, TomTom and MiTAC should help them fend off competition a while longer.

But De Graaf of Petercam said a bare-bones navigation device can now be produced for $80 to $110.

And that leaves plenty of room for more price cuts.