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Psycho
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Slate had two article on this phenomenon a year ago. They were very interesting because the first one essentialy admited that economists were stumped, and couldn't explain why console makers underprice their products by hundreds or even thousands of dollars. The second article gives some more convincing explinations, but not a lot better. Here they are, sorry for the length:
http://www.slate.com/id/2132071/
Quote:
The Great Xbox Shortage of 2005
Why you can't buy the one present you really need.
By Tim Harford
Posted Thursday, Dec. 15, 2005, at 6:09 PM ET
Gaming enthusiasts camp outside electronics stores, desperate to buy the hot new game console. Corporate flacks are deployed to fend off PR calamity: "Consumer demand for the new console has exceeded our expectations, and we are doing all we can to fulfill the wish lists of people who want a new console under their tree this holiday season."
Video-gamers are clamoring for the new Xbox 360 console, but that statement didn't come from Microsoft: It came from Sony at the beginning of last year's buying frenzy for the new slim-line PlayStation 2. In 1996, parents wrestled to get hold of a Tickle Me Elmo. 1988 saw parental panic sparked by shortages of Nintendo game cartridges. And we're now celebrating the 20th anniversary of the Cabbage Patch Kid craze: They sold $600 million of those things in 1985, and that was in the days when $600 million was worth something.
These spectacular sellouts have become as much of a holiday staple as turkey and stuffing. And, of course, they have inspired conspiracy theories. Isn't it a little odd that the same story comes round year after year? Is Microsoft really running short of consoles? Yet, for economists, the Xbox 360 crisis is more alarming than a conspiracy, because these supply shortages make no economic sense whatsoever. Despite their suspicious regularity, the shortages benefit nobody.
It isn't the scarcity of supply itself that is puzzling. That is almost inevitable for some of these seasonal toys. In any given year, many toys will be unloved and oversupplied, but a few lucky ones will be in unexpectedly high demand. We shouldn't be surprised any more than we're surprised that the champion of a knockout tennis tournament won all his matches. Somebody had to.
In Microsoft's case, the Xbox 360 can be produced only gradually, but all the demand is there at once. Plentiful supply would be possible only if Microsoft made millions of consoles in advance and stored them without releasing them, or if it built vast production lines that only ran for a few weeks—both economically unwise strategies. It makes more sense to ship the consoles as they are made—and that means gradually. The steady supply can't match peak December demand.
So, supply shortages are a fact of life. The puzzle is somewhere else: Why don't companies raise prices when supply is short and demand is frenzied? Leaving aside oxygen and a few other essentials, there is no such thing as an absolute shortage of anything: There is only a shortage if the price is too low. At the moment, Microsoft is easily selling out the half-million or so Xbox 360 units (there's no official number) for prices starting at $300 for the basic package. Why doesn't Microsoft price them at $700 instead? That's the figure that the consoles are fetching on eBay. (Back in the days of the Cabbage Patch Kids, we could only speculate how much parents would have been willing to pay for guaranteed delivery. Thanks to eBay we can now put a price on customers' frustrations.)
Perhaps the sellouts are supposed to generate free publicity. By deliberately giving Xbox consoles away too cheaply today, Microsoft gets the column inches before Christmas, and that may boost demand and sell more in the long run. If you had put that theory to me last year I might have believed it, but after all the hot air over gasoline prices this fall, no longer. It's now obvious that you can get just as much publicity by raising prices as you can by selling out at low prices. But raising prices makes money, and creating lines of frustrated customers who can't get the product doesn't.
Maybe Microsoft is worried that this would be the wrong kind of publicity, because customers would dislike a price hike. That's possible, but the publicity is already bad: Many empty-handed customers seem convinced that Microsoft has a secret hangar in Roswell stuffed full of Xboxes that they've decided not to release just yet.
In any case, strange as it may seem, even if the consoles sold out at a higher price, the average Xbox aspirant wouldn't be any worse off: The increased price should be exactly balanced by the shorter lines, reduced aggravation, and greater chance of getting a console. Customers are infuriated by the shortage itself, whether that shortage is expressed in lines (as it is today) or in high prices (as it could be if Microsoft raised them). If Microsoft is going to aggravate its customers, why doesn't it at least make a buck out of it?
So, this is all something of a headache for the dismal science. Over dinner with a friendly local economics department, I challenged them to explain the puzzle of why prices stay low in the face of such shortages. They cited a number of ingenious explanations, all of them unlikely.
The economist Kenneth McLaughlin of City University, New York, has suggested that rock concerts deliberately underprice tickets because it means that a younger audience shows up—and teenagers, while they won't buy premium-price tickets, will buy merchandise and music. It's clever, but it's a stretch even for Rolling Stones concerts. (Every extra dollar on the ticket price is pure profit, after all—and how much merchandise do they really expect to sell?) For Xbox sales, it makes no sense at all to apply McLaughlin's theory, which would only work in the bizarro-world where the people willing to pay the most for the consoles were also the ones willing to spend the least on the games.
Barry Nalebuff and Adam Brandenburger, economists at, respectively, Yale School of Management and NYU's Stern School of Business, have argued that the scarcity of Nintendo game cartridges in 1988 was a deliberate attempt by the company to create a strong bargaining position in negotiations with retailers carrying the cartridges. (Retailers requested 110 million cartridges, and Nintendo produced 33 million.) Limiting supply is an age-old tactic for creating a bargaining position, of course, but the traditional thing to do with that bargaining position is to exploit it. What is the point of limiting supply if you don't raise the price?
Microsoft could certainly have made itself popular with favored retailers. If customers value the console at $700 but it retails at $300, then a retailer such as Best Buy will certainly thank Microsoft for any extra consoles, because they will attract customers into the store. Every $300 console saves a customer the extra $400 he would have had to spend on eBay to buy it (or allows that customer to buy for $300 something he can sell for $700). This is effectively a $400 handout to a few lucky customers, but Microsoft could achieve the same effect for the same price by having its representatives stand around in Best Buy handing out a limited number of $400 checks. Either way, Best Buy enjoys the crowds that result, but what has Microsoft gained?
A final explanation is that Microsoft is creating some kind of cachet by making the console scarce. But that doesn't work either because, again, it isn't the scarcity that's puzzling, it's the low price. Microsoft could create the same cachet by selling the same limited number of units at a higher price. In any case, it's not the Hope diamond, it's just a game console. How valuable can this so-called cachet be?
That leaves us with Napoleon's explanation: Never attribute to conspiracy that which can be explained by incompetence. This view of the world is antithetical to economics, because the dismal scientists tend to be suspicious of people's motives but credit them with vast intelligence.
Perhaps readers will suggest better ideas for the Xbox 360 shortage than my economist colleagues and I have done, but something happened recently to convince me that Napoleon was right: My publisher managed to sell out its rather timid print run of my book, The Undercover Economist. There was no great scheme or publicity effort attached to my book, no cachet, no hard-talking negotiation to raise the price on Amazon. The publisher just misjudged demand, and unsurprisingly so, because life is full of uncertainty.
Microsoft has got it wrong, too, but they have missed out on a far more obvious opportunity. Why didn't they sell their initial supply of Xbox consoles, packaged as a "limited edition," using online auctions? All the while they would promise $300 consoles as soon as stocks were available. Since at an auction the price is set by the buyers, not the seller, Microsoft could have made a killing, absolutely guilt-free, and created no more annoyed, empty-handed customers than they have with their current strategy.
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And the followup article:
http://www.slate.com/id/2132988/
Quote:
Xbox Economics, Part 2
More reasons Microsoft isn't charging enough for the season's hot game console.
By Tim Harford
Posted Wednesday, Dec. 21, 2005, at 1:24 PM ET
Last week I wrote that the shortage of Xbox 360 consoles seemed inexplicable, at least to me and my fellow economists. I invited readers to provide better explanations, and you did.
A reminder of the puzzle: Xbox 360s are the latest in a long line of Christmas products to suffer spectacular shortages. The shortage of supply isn't the puzzle; the low price is. Why doesn't Microsoft raise prices temporarily from the current floor of $300 for a basic console? Why doesn't the company auction them all on eBay, where consoles are currently reselling for $700 and up?
If I had a dollar for every e-mail I received on the subject, I'd be able to afford an Xbox myself. Most of the suggestions I received were wrong, but a few got me thinking, and they may get you thinking, too.
The stupidest explanation came up again and again: Microsoft is holding the price low in order to grab market share and make money on selling games. This is the "cheap razors and expensive razor blades" strategy. True, console manufacturers are widely thought to be losing money on the consoles and recouping the losses on the games. But only the most idiotic of my correspondents failed to see that one traditional part of grabbing market share is, um, producing enough consoles to supply the demand you've stoked with your low prices. If you have only 500,000 consoles, you can sell them cheaply, give them away, or even pay people to take them off your hands, but in the end there will still be only 500,000 consoles to buy games for.
Many people also claimed that the seasonal shortage creates free publicity to encourage sales later, but high prices don't create publicity. I still don't believe that: Exxon got plenty of publicity by raising gas prices after Hurricane Katrina. In any case, now, not later, is the Christmas season when people want to buy it.
One reader reminded me of the "hot IPO" phenomenon of underpricing to generate interest in new shares. Maybe Microsoft was trying something similar. But I counter that Google chose an IPO auction instead of an underpriced IPO and wasn't short of publicity.
This isn't to say that Microsoft couldn't use the buzz: The console business is very dependent on expectations. Gamers buy consoles if they expect great games. Games-publishers invest in great games if they expect the console will be popular. Confidence in a console—or lack of it—is self-fulfilling. So, yes, buzz is important. But lines aren't the only way to create a buzz: Microsoft could have secured plenty of publicity (and a lot more revenue) selling a "limited edition" at auction.
Why wouldn't Microsoft raise prices to take advantage of the seasonal demand? In my original article, I claimed that Microsoft would irritate customers equally by raising prices or by creating lines, and rightly so because the typical customer is inconvenienced either way.
But more thoughtful correspondents produced good reasons why Microsoft would steer clear of raising prices.
The first is that much of Microsoft's business is nearly monopolistic: The company has no powerful commercial rivals to its Windows software or its Office products. As a result, the company has often been targeted by regulators investigating alleged abuses of its dominant position. These businesses are huge relative to the Xbox 360. High console prices might raise government suspicions. Why take the risk of antagonizing the regulators for a relatively small financial gain?
The second reason Microsoft would avoid price hikes comes from David Friedman (whose modern classic Hidden Order will be much enjoyed by many readers). Friedman wrote to draw my attention to an essay in which he argues that there was once an evolutionary advantage for those stubborn people who insisted—contrary to what economists believe—that there is such a thing as a "just price." Imagine a person whose response to every price hike is outrage. In the one-on-one negotiations our ancestors engaged in, it's impossible to rip our man off, and most of the time he'll get his way and the price will stay low. Of course, every now and then, the price hike isn't an attempt at exploitation, but a genuine reflection of scarcity: Then the outrage means lining up in the cold for an Xbox rather than paying the price that would balance supply and demand.
A third suggestion is that Microsoft may want to raise the price, but can't. Microsoft has to agree to a retail price in advance with sellers, who in turn incorporate that price into their advertising material. It's too disruptive to change prices suddenly and for such a short period of time.
But the best idea of all is from my friend Alex Tabarrok, a professor at George Mason University who was one of those economists I originally stumped with the puzzle. Spurred on by this public humiliation, he has thought harder and he now claims to have the solution: Very few people really are willing to pay $700 for an Xbox. Contrary to what you might expect, long lines are perfectly consistent with customers who refuse to pay high prices. Imagine that the typical Xbox customer is willing to pay around $325 for a basic console but is extremely price sensitive. At $300, twice as many people want the console. At $350, hardly anybody wants it. Microsoft isn't sure exactly what the average gamer will pay and can't change the price quickly. If they priced just a little too high, all the customers would wait for Sony's next console. A little too low, and long lines form—a better result for Microsoft, but without sacrificing hundreds of dollars per console with the low prices.
Tabarrok's argument makes all the other arguments in this column more plausible: While Microsoft might not want to pass up an extra $400 per console for a few more game sales or some good publicity, if it's only $25 per console, then that's a good deal for the company.
What about those $700 consoles on eBay? If Tabarrok is right that the actual price is closer to $325, why haven't eBay prices collapsed? The answer may be that it is gamers who are acting irrationally. Very few people resell their consoles despite the high auction prices. Having grabbed a scarce console, gamers only think about using it rather than profiting from its resale. As a result, only a few consoles are up for sale and only the most desperate buyers compete for them. If more people put their consoles up for auction, the price would drop.
I leave the last and wisest word with my much-maligned publisher, whom I teased in my first article for not printing enough copies of my book. "I can't believe we didn't think of this before!" he writes. "We are raising the price of The Undercover Economist to $700."
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