Saturday, November 1, 2003

Are Discount Tickets Good for Business?

STANFORD GRADUATE SCHOOL OF BUSINESS—Most Broadway plays charge a startling variety of prices for tickets. That person sitting next to you in the back of the orchestra might have paid a premium by ordering over the phone—or stood on line at a discount ticket booth and forked over half of what you did.

For Phillip Leslie, assistant professor of strategic management at the Graduate School of Business, this multi-tiered pricing practice, called price discrimination, promised to provide a fruitful way to pursue his interest in what he calls "the economics of information. "Specifically, Leslie figured that by studying the ticket sales data of one show he could investigate whether it was ultimately better for consumers, as well as businesses, if those firms charged one price or many. How would the two pricing approaches affect both "consumer welfare"—the difference between what consumers have to pay and are willing to pay—and producers' profits?

What Leslie did was to evaluate the data for all 199 performances of a play called Seven Guitars, which ran on Broadway in 1996. Using a complex series of econometric models, he was able to come to the conclusion that consumers weren't particularly hurt or helped by the practice of multiple pricing, while producers benefited slightly.  "There has been a lot of theoretical literature about whether price discrimination was good or bad in terms of consumer welfare," he says. "My study was the first to answer that based on an analysis of data."

Price discrimination is a practice used by companies that generally don't know a lot about what consumers are willing to pay. "It's something firms do when they lack good information about customers," says Leslie. In the case of Seven Guitars, producers were particularly creative in their use of multiple pricing, with a whopping 17categories based on everything from seat quality to special discounts. "I thought it was amazing that these guys had figured out how they could sell their products at so many different levels," says Leslie.

To conduct his study, Leslie figured it would be too complicated to rely on every ticket pricing category used by the play's producers. So he condensed them into five areas: low, medium and high quality seats, tickets purchased through coupons sent through the mail to consumers, and seats bought at a booth located near Times Square that sold tickets at a50 percent discount the day of a performance. Then he set about constructing mathematical models with which he could determine how sales would be affected by tickets sold at this revised multi-price approach vs. one price.

Ultimately, Leslie found that consumers were largely unaffected by price discrimination relative to uniform pricing, while producers experienced a 5 percent increase in profits. Specifically, with a uniform fee, a portion of consumers were forced to pay higher prices, while others were able to purchase tickets at lower cost than they might have otherwise. (The optimal uniform price was about $50). "But on average, it looks like it didn't make much difference to consumers whether there was price discrimination or not," says Leslie. His conclusion: "In this one example, it looks like price discrimination is a good thing," he says. "Firms make more profit without harming consumer welfare."

Through his analysis, Leslie made a number of other findings as well. One of the most significant related to the use of discount ticket booths. While they provided a significant source of revenue for the show's producers, he concluded, producers would have made more money if the reduction in price had been 30 percent as opposed to 50. The reason: With the lower discount, more consumers would be likely to buy pricier tickets over the phone rather than less expensive ones at the ticket booth, since the discount wouldn't be enough to justify the inconvenience of waiting online.

At the same time, however, even at the higher discount rate, shows were able to sell a significant number of tickets through the booth that would have otherwise gone unsold. "You're better off having a 50 percent discount than [no sales] at all," he says.

In addition, Leslie also studied why producers didn't lower prices or institute uniform pricing even in the face of fluctuating demand. About halfway through its run, for example, Seven Guitars' popularity plummeted, after it failed to win a Tony Award for best play. As a result, more tickets were sold through the discount booth after that event than before. Leslie found that if the show's producers had used uniform pricing, they would have lost a lot of money when demand slipped."[Price discrimination] helps them out when there's less demand," he says. "The firm doesn't end up losing as much money as it might otherwise. It's a safety net."

Does his study have implications for other industries? According to Leslie, implementing a wide-scale multiple pricing strategy, such as that used by the airline industry, involves installing costly computer systems. For that reason it's not applicable to most businesses. But, in some cases—like the hotel industry, where chains can spread the fixed costs over a large number of units—it might be an effective approach. Plus, says Leslie, "as computing costs continue to come down and more and more information is being collected about consumers, we may see an increasing number of firms starting to do this type of thing."

 

 

Related Information

 

Consumers Feast on Restaurant Rankings

Price Discrimination and Retail Configuration," Andrea Shepard, Journal of Political Economy, Vol. 99 (1991), pp. 30-53

Nonlinear Pricing, Robert B. Wilson, Oxford University Press,1993