Lessons in pricing a scarce resource

By Felix Salmon
June 9, 2012

There’s a fine art to pricing any scarce resource. Ex ante, it’s impossible to do a precise calibration of supply and demand, but being able to do so is crucial to getting things right. If you’re in a business where you can make more of whatever you’re selling when demand rises, that’s one thing. But when you’re selling tickets, or Facebook shares, that’s not the case.

In a world where you have to set the price in advance, and then it can’t be changed, the calculus is simple. Set the price too high, and you end up with insufficient demand and a general feeling of failure; you don’t attract the number of people you were hoping for, and even those people are likely to end up feeling ripped off. On the other hand, set the price too low, and you create disappointment among people who wanted to give you their money and can’t, quite aside from the fact that you’re clearly leaving money on the table.

In the past couple of days, we’ve seen good examples of both. At Yankee Stadium, the price of tickets is way too high, as is evidenced by the huge number of empty seats, and by the fact that on the secondary market, two thirds of tickets are sold for less than face value. Lots of seats are being sold by people asking less than $5 a pop, and at the top of the ticket-price range, the average discount to face value is more than $90.

At the same time, sold-out $125 tickets for the Big Apple Barbecue Block Party are being hawked on Craigslist for significant premiums to face value, prompting Ryan Sutton to declare that they should be more expensive next year.

The Yankees are taking a shoot-the-messenger approach to their attendance problems, blaming the secondary market in tickets, rather than the fact that the tickets cost a fortune. That’s just silly, and it’s a no-brainer that the price of Yankees tickets should come down. Just like an IPO, you want to price season tickets so there’s a small implied “pop” in there — people with season tickets should be able to sell them on the secondary market for a little bit more than they paid. That helps keep demand for season tickets healthy, year in and year out.

What’s more, the Yankees have the same stupid pricing as the Metropolitan Opera: every game or opera costs the same amount, no matter how in-demand or run-of-the-mill the matchup. Pretty much every other baseball team has pricing variable enough that at least the big games cost more; the Yankees should take a leaf out of Broadway’s book and do the same. Broadway pretty much always sells out every show, these days, at whatever the clearing price is, and scalping is way down. That would make Yankees games much less desolate.

Pricing the barbecue tickets is trickier, but Sutton is right: when you’re raising money for charity, it’s a little heartbreaking to see tickets being flipped for profit. And the cost of setting the price too high is small: if the tickets look as though they’re not going to sell out, you just run some kind of special offer where people can buy them at a discount for a limited period of time. No harm, no foul.

And what about IPOs? With them, there’s no do-over, and the process tends to be driven very much by big investment banks with more than half an eye on their reputation in the equity capital markets. They care about making money on every deal, but they care much more about getting a healthy stream of fee income from future deals. While the barbecue can overprice its tickets without too much damage, investment banks don’t have the same luxury.

And that’s probably the real reason why there’s an IPO pop. Underpricing the IPO might mean that the issuing company is leaving money on the table — but overpricing the IPO is much worse, as Facebook and its underwriters are still discovering. So banks always err on the side of underpricing. Except, as in this case, when the issuer has too much power, and gets too greedy.

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Comments
6 comments so far

By the way, about half of Major League Baseball does dynamic pricing (a la airlines and hotels). Even many of those teams don’t sell out–for one, they never want to let people buy tickets for less than a season-ticket holder buys them for. For another, they might just make more money selling fewer tickets for more dollars.

Posted by cooperowl | Report as abusive

‘Overpriced’ is an inappropriate euphemism when FB IPO pricing is concerned.
A more descriptive adjective would be ‘fantastic’, as in ‘imaginary’ – detached from facts that constitute what we call ‘reality’.
In fact, what happened was that everyone, including analysts, journalists, financiers and investors, was mesmerized by the magical figure of 900 million FB ‘users’, and completely failed to realize that this number is pretty much meaningless in the context of social media, where anyone can (and does) create multiple, and sometimes numerous online identities for themselves called ‘users’.
In FB’s case, a person, or business are prevented from deleting old ‘users’ they’ve created, even if they wanted to do so.
FB’s IPO is not just a failure of banks and other Wall Street institutions, it is a systemic failure of the market, including the professional media, of which you, Felix are a part.
A smart, fearless journalist, or blogger such as yourself, should have smelled this rat, and exposed the bubble before it became Godzilla.

Posted by reality-again | Report as abusive

“Broadway pretty much always sells out every show, these days, at whatever the clearing price is.”

This is not true, see http://playbill.com/features/article/166 676-Broadway-Grosses-May-28—June-3. There are a small number of hit shows that do sell out consistently, and Felix is correct that they push the prices higher according to variable demand. But generally shows do not aggressively reduce prices to fill empty seats- indeed moderately successful/unsuccessful shows are more likely to give tickets away than to dramatically slash prices in search of the clearing price.

The producers of Ghost are thus acting very much like the Yankees, accepting empty seats for higher prices. It doesn’t substantively undercut your point Felix, but hey, accuracy.

Posted by RossW | Report as abusive

If the Yankees were worried about empty seats they would simply lower the ticket prices. They are more satisfied with the occupied seats paying premium prices instead.

Posted by Robocop5626 | Report as abusive

“overpricing the IPO is much worse, as Facebook and its underwriters are still discovering. ”

Why ultimately is it bad for Facebook?

Posted by byomtov | Report as abusive

I believe overpricing an ipo is bad because the market is wildly irrational and inefficient in the shortterm, so much so as to undermine longterm efficient pricing mechanisms.
Or something.

Posted by thispaceforsale | Report as abusive
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