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Topics for Today

Topics for Today. Benefits of dramatic new products Radically declining prices The history of lighting Digital prices revisited Radically increased assortment The Long Tail Consumer surplus in detail. Just Google It…. LED lighting .04 cents 2004. Evolution. Compact fluorescent

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Topics for Today

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  1. Topics for Today • Benefits of dramatic new products • Radically declining prices • The history of lighting • Digital prices revisited • Radically increased assortment • The Long Tail • Consumer surplus in detail

  2. Just Google It…..

  3. LED lighting .04 cents 2004 Evolution Compact fluorescent .12 cents 1992 Open fire Edison lighting 9.2 1883 .6 cents 1920 Gas lighting 5.0 cents 1875 Fat-burning lamp Sesame oil 1750 BC Kerosene lamp 4.0 cents 1855 Tallow candles 40.3 cents per 1000 L-H 1800 Milestones in the History of Light

  4. Real Price of Lighting Fuel-based: Light 1: Kerosene, Gas, & Electricity. Light 2: Light 1 early, then electricity after 1940. True price: Characteristics based. Price per 1,000 Lumens. W. Nordhaus

  5. Leads to Much Heavier Usage Spending can rise before falling, but consumption eventually grows dramatically. Measurements of growth in real wages have been biased low. Just due to lighting: 7 percent higher - $275 billion in year 1992 compared to 1800.

  6. Nordhaus says total bias in measurements is much higher: New goods make us much richer

  7. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. What about price + assortment?

  8. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Lower Prices on the Internet • Theory: • Increased competition (Bakos 1997) • Increased operational efficiency • “The average book may sit on the shelf of a store for six months or a year before it is bought. The cost of this inventory in a chain of hundreds of stores is huge. Amazon can keep just one or two copies in its warehouse — and still make the title available to the whole country — and restock as quickly as customers buy books.” (Saul Hansel in the New York Times) • Evidence: • Book and CD prices on Internet 6-16% lower than prices in physical stores (Brynjolfsson and Smith 2000)

  9. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. “The Internet is providing access for people who just can’t find the book they are looking for in a store.” Nora Rawlinson, editor Publishers Weekly, in Investors Business Daily.

  10. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Locating and Delivery Backlist Books Barnes and Noble • Total time: 59.5 minutes • Total delay: 8 days • Total expense: $37.45 BN.com • Total time: 2.5 minutes • Total delay: 3 days • Total expense: $31.99

  11. Slides with logo courtesy of Erik Brynjolfsson, M.I.T.

  12. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Product Variety Comparison Wal-Mart stocks six times as many SKUs online versus in superstore

  13. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Signals of Benefit • “The Internet is making backlist books more accessible for readers…The Internet has really stimulated sales” • Frank Urbanowski, MIT Press, noting 12% increase in backlist sales ’97 & ‘98 • Amazon advertising slogan “World’s Largest Selection” • …however no systematic measure Goal: Measure consumer value of increase product selection and convenience

  14. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Selected New Goods Literature • Hicks (1942): Compensating Variation • Hausman (1981): Closed Form Solution to Hicksian Demand • Hausman (1997a): CV for New Goods using “virtual price” • Hausman and Leonard (2001): Separate variety result (availability of new goods) and price effect (changes in prices of existing goods)

  15. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Compare Consumer Surplus from Price Drop and New Good • 16% price drop => $150 million welfare gain • Welfare from increased variety 6 times larger than from lower prices P p0 This gain can be much bigger. P p0 p1 p1 q1 q0 Q q0 q1 Qobscure

  16. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. New Goods Applications • Brynjolfsson (1995): IT Investments • Hausman (1997a): Telephone messaging services and Cellular Services • Hausman (1997b): Apple Cinnamon Cheerios • Nevo (2002): Specialty breakfast cereals • Goolsbee and Petrin (2001): Direct Broadcast Satellite • Petrin (2001): Automobiles

  17. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Model • Following Hausman Leonard (2001) • CV=e(pco,p*,u1)-e(pc1,p,u1) • Note that pco=pc1 • CV=e(pc,p*,u1)-e(pc,p,u1) • Log-Linear Demand (Brynjolfsson 1995, Hausman 1997a, Hausman 1997b, Hausman and Leonard 2001) • X(p,y)=Apayd

  18. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Model, cont. • Hicksian CS for price change from p*to p • Assume income effect = 0

  19. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Economic Estimates • Aggregate elasticity of demand • P*Q of new product • Application area: Books • Relatively “mature” Internet market • Can compare to existing research on gains from lower prices (Brynjolfsson and Smith 2000)

  20. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Wholesale Elasticity • Under A1-3, aggregate retail elasticity = wholesale elasticity. • Publishers control pricing, so can use Lerner Index: • Publishers place gross margins between 58-64% => elasticity between –1.56 and –1.72 • AAP ~ 58%, MIT Press ~ 63%, Technical Publisher ~ 64%, Trade Publisher ~ 60% • Brynjolfsson, Dick, and Smith (2002); Goolsbee and Chevalier (2002) have consistent (or lower) estimates

  21. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Revenue From Obscure Titles • What proportion of sales at Amazon.com are from obscure books? • Use rank, assume Pareto relationship between rank and sales: Q= a* Rankb

  22. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Proportion of Sales in Obscure

  23. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. How Much Consumer Surplus? • Comparing Amazon to off-line retailers (e.g. B&N Superstore): • The total increase in Consumer Surplus from access to Amazon’s greater selection was about $1.03 billion in the year 2000 • Vs. about $150 million gain from 16% lower prices • Implication: Amazon’s benefits to consumers via selection dwarf the benefits from lower prices

  24. We can simulate this.

  25. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Extensions • Time effects • Increase as more consumers gain access to Internet and comfort with ordering online. • Only one market • CDs, movies, electronics, shareware, eBay, radio programming, markets for advice, labor markets (Monster.com), dating services, … • Only one channel • Impact on sales in physical stores…?

  26. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Conclusions and Implications • The major consumer benefit of Internet retailing is access to a broader variety of new goods and services • In book market, the surplus from greater product variety is many times larger than the surplus from lower prices • Effects may be even larger in other markets: • CDs, DVDs, electronics, shareware, markets for advice, labor markets (Monster.com), dating services, eBay, online music, … • Effects are likely to grow over time • Increase in sales of obscure products => increased viability for production of additional obscure products • Improved technologies for recommendation, search and delivery

  27. Backup Slides

  28. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. pr1, qr1 Retailer 1 pw1, qw1 pr2, qr2 pw2, qw2 Retailer 2 c Publisher . . . pwN, qwN prN, qrN Retailer N Aggregate Elasticity of Demand • Ideally one would estimate this directly or through an experiment. • Difficult to get aggregate elasticity. Individual retailer estimates give upper bound on elasticity.

  29. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Proportion of Sales in Obscure: Formula

  30. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Data • Major publisher. 321 titles, 861 observations on Amazon rank and publisher sales to Amazon. 3 weeks, Summer 2001. • Weekly sales: <1 to 481 • Weekly sales rank (average) = 238 to 961,367 • ln(Q)=ln(a)+b ln(Rank)+e • a=37,274, b=-0.871 • R2=.801 • Rank=10 => 5,000 sales/week;Rank=100,000 => 1.6 sales/week

  31. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Elasticity Assumptions • (A1) Wholesale price constant across firms (pwi=pw) • Clay, Krishnan, Wolff (2001) • ABA lawsuits • (A2) Stable relationship between wholesale and retail price (pw=ki pri) • Wholesale price set from list. • Rare to make list price changes • 88.5% of 23,744 books sold at Amazon were even percentage of list • (A3) Wholesale and retail quantity equal (qr=qw) • Books sold on consignment • Returns with no penalty

  32. Slides with logo courtesy of Erik Brynjolfsson, M.I.T. Sensitivity • Our estimates with respect to industry estimates • Total Amazon sales = 99.4 million books/year vs. industry estimate of 105 million • Experiments: know initial sales/rank, order 5-6 copies in 1 hour. Get final rank. Can estimate b. • Goolsbee and Chevalier (2002): -.855 • Weingarten (2001): -.952 • Poynter (2000): -.834 • Our own experiment (2002): -.916

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