...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?
Tim despairs:
Over dinner with a friendly local economics department [TC: hmm...], 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.
Surely the legal mind can do better than these economists, comments are open.
Microsoft is a very successful business, and arguably (cf. Scott McNealy, Linus Torvalds) a business that sells a notably inferior product. That means they understand group psychology very, very well -- better than all of their competitors, and certainly better than any number of armchair theorists. They know very well how to sell over the long term. So it's an excellent bet that if Microsoft thinks the best long-term strategy is to have a shortage but not raise prices, and x economists think otherwise -- then Microsoft is right and the economists need to do some more thinking.
Why does their strategy work? I don't know (and if I did, I sure wouldn't post it for free here). But here's a line of thought: MS is new in the gaming business, which is fiercely competitive, and in which having the newest, bestest technology is a major psychological force driving the acquisition of new consoles. One thing they must avoid at all costs is the idea that they are Johnny-come-lately technobozos who know nothing about making a cool console. So, given that it is a priori impossible for them to predict exactly how many consoles they'll sell this Christmas, should they choose to err on the side of too few or too many? What will be the response of the gamer if Xbox consoles are lying around unsold, versus if they are just damn impossible to get, and selling on eBay for four times the retail price? Easy call.
Secondly, after a frustrating shortage develops, which naturally makes people irritated at MS, is MS better served by jacking the price up to reduce the shortage, or better off releasing stories about how they're doing the best they can, and of course they're not profiteering, and they'll ramp up production just as fast as possible? Which course is going to make people think well of the company, and inclined to -- while they're waiting for their new Xbox -- not mind paying for the new version of Windoze to upgrade the home PC? Again, easy call.
So why MS makes these these decisions seems easily rationalizable to me. The question of why people are the way they are, so that they reward MS's strategy instead of a different strategy, that would distribute the products more "rationally", is a separate question.
I wanted to add that MS prevents retailers from raising the price as well, so the Best Buys and GameStops of the world that bought at wholesale and would like to sell for market prices (i.e. eBay prices) are prevented by MS from doing so.
Why does Microsoft keep the price low? To buy brand loyalty. Gamers are a fickle bunch and gouging them during the first few weeks of a release will earn a great deal of ill will and bad press.
The problem now is that they fouled up the production and distribution so bad they are getting bad press and making those gamers mad. Many put deposits down to reserve a place on a disrtibution list at the retailers. 50 bucks and now all they hear is that they are due to get the unit on the "next shipment" though the retailer will not show the list or say when the shipment will come or how many will be on that shipment.
Microsoft tried to balance the buzz and failed. Rushed to get the product out before the Playstation comes out in the spring they just wrote a "how not to do it" book for business.
1. They do it to create buzz. No cheaper value for your advertising dollar than the article telling you how high the demand is. If the xbox holds to other game consoles then the profits are in the games rather than the console.
2. If they raised prices now, they would have to lower them later. The message that would be sent would be that they were having to lower the price to get rid of them which would kill the market.
3. They really can't raise the price because it's only a few price sensitive customers that would pay the higher price. Others who might pay the higher price reluctantly would then feel cheated later when the price came down. Generous return policies and price match policies mean that most customers could get the lower price anyway.
4. There really is no shortage. If you want a brand-new unopened xbox at the advertised price then all you need to do is to make a few phone calls or drive a few more miles. If that fails then you can bid on ebay where it looks like the going price is about $550. The extra profits that Microsoft can capture from this transient condition (probably measured in weeks and mainly associated with the holiday) is nowhere worth the adminstrative cost of trying to devise an appropriate price discriminatory regime.
Finally, if I did want to capture some of this profit then I would contract exclusively or create a separate subsidiary with someone like xbox360.com (I made that up). Guarantee drop shipping of any orders next day and have this non-microsoft entity (or subsidiary) charge a premium for the expedited delivery. This would signal to everyone what they were paying for and allow the list price to stay the same.
/Can't wait until all price tags are RF and they can be changed to assure that there are never stockouts.
It might be argued that they could get even more consoles out there by charging the efficient price. I tend to think that the shortage problems are overblown. The shortage will last, at most, a month. Meanwhile, Microsoft undoubtedly gets wider distribution of the consoles by basically paying people to take them.
Creating false scarcity is an old marketing trick. To continue the analogy, in order to maintain a line, many clubs will not allow people in even when the club is not full because the line outside is such excellent advertising.
On a more sinister note, some of the scarcity may be due to quality control problems. There are very serious rumors that the XBOX 360 crashes several times an hour. If this is true, Microsoft risks a PR debacle as probably 99% of XBOX 360s sold so far won't be opened until Christmas morning -- and then promptly returned on December 26th.
All I'm saying is that it's not like the company can just snap its fingers and raise prices.
Since consoles are a loss-leader for games, then it makes sense to sell as many consoles as possible. So why allow/create a scarcity? I say create because MS can surely "predict", based on the past history of console releases, what the demand will be. Surely if they wanted to meet demand, they could have spent the past few years beefing up their production lines and distribution channels.
To answer my own question with insights culled from the previous posts: MS certianly knows the cost/benefit equations for both the artificial scarcity scenario and the perfect supply scenario (where they produce enough to meet demand, thus driving up the demand for games). Surely they chose the scenario that is best, so even though we don't have the numbers in front of us, we can assume that the marketing benfits of scarcity *really* outweigh the benefits of raising cost and/or production.
The other possibility is that they really couldn't raise production, but I find that hard to believe. They've been planning this release for years.
My understand of Economics I is that, while the models are sometimes described in terms of single actors making rational decisions, they don't actually *apply* to single actors making rational decisions. (Single actors are discussed in psychology. :) They apply only to the aggrigate case, the entire market. The cool part is, the models still provide *some* insight into how markets work.
Of course, as with models in Science and Engineering, you have to know when they apply and when they break down. I've always assumed that the simple supply/demand curve model (which is what I assume we're using here) is to Economics what Newton's Laws are to Physics: great to teach high-schoolers and non-specialists, but PhDs and experts know that there are much more advanced models to be used for non-layman analysis. So for Tim Harford to say that economists are discussing a real-life *marketing* campaign in a market with only 2-3 suppliers using high-school models of supply and demand... well, that's a little surprising to me. I wonder what we're missing....
I retract my previous posts in favor of an open letter to Tim Harford: "Yes, you are right. All those economists are wrong, and you are right. Microsoft has passed up the chance to make millions of dollars; even though they have a huge stake in the outcome, your arm-chair analysis has proven how truly stupid they are. If only they'd hired you into their marketing department."
Or is that too sarcastic? I can never tell. :)
Bingo. They'd give the consoles away for free, if they could.
Raising the prices increases the risk that some people will settle for Playstation or some other console, which represents a huge loss over time. So they don't want to give the impression that buying XBox is a larger investment than buying Playstation.
So not only is a higher price a disincentive for the normal reasons, but it also suggests that you may be looking at higher prices later, once you're locked in, so to speak. All that suggests that you'll get less bang for your buck down the road, and since you generally only switch consoles every few years...
At the same time, the shortage is only temporary. MS will sell a good number of systems after Christmas, but they need to make the most of their first-mover advantage to get some installed base going while they can. If people are sitting on the bench because of MS's pricing policies when Sony's offering hits the market, then MS will have a harder time convincing developers to develop exclusive games for its system (a category where Sony has a good track record, and Microsoft does not.) The long-term health of the platform is definitely decided by buy-in from other game companies, so risking that for some short-term profits is probably a bad call.
Now they're not all that cheap to make, so they have to charge something to make sure the machines end up in the hands of those more likely to buy disks in the future. Perhaps a shortage biases purchases to those willing to wait on long lines -- who have more time to play games?
-dk
That said, imperfect information, which is I think what you're suggesting, probably does play a significant role, although not the only role. More important than that is the fact that consoles haven't been sold, historically, for $500. If MS did that, the headlines would be about how amazingly expensive they were. That would stop a lot of purchases.
As ElliottG says, the big difficulty with pricing these things is that you're not just pricing them for the moment of release. You're pricing them for their first year. Even beyond that, your prices cannot be cut too much without it looking like you've lost faith in the brand. This means that it is fatal to overprice (and hence imperfect information means that you have to be cautious and assume lowball figures). It also means that you cannot charge much more than Nintendo and Sony charge for their consoles. Even if it would make sense to have 'em being $500 for the next few months, the console pricing is so inflexible that it is better to have them wrongly priced for a few months now than to have them change or be wrongly priced for many months later.
Finally, as others have noted, there isn't too much of a problem with underpricing. So long as they can shift 'em as quickly as they can build 'em, they're achieving their primary purpose, of building marketshare and creating a market for the games.
Plus when they drop the price to $250 on Feb 1. (my guess, based on various store's return policies), it will seem like a steal.
Plus, the 'games no boxes' bit. That too.
So ultimately, it's a first to market with the new technology/best product sort of thing. We'll see how this works out for MS, especially when when the PS3 comes out.
Let me point out that the the 360 is using a tiered product release to hide the true cost of the system. The Xbox 360 is $400 (the cripled "Core system" that will need to be upgraded with over $100 worth of accessories is $300). The Xbox 360 (not the cripled "Core system") at Best Buy can be found in bundle packages, all of which exceed $500 (so that you can enjoy at least one game with your new system, and variably an extra controller for 2-player, a Live subscription so you can have online play, the wireless networking adaptor costs $100, etc). If one is planning on an Xbox 360 on Christmas morning with the same level of functionality as the original Xbox you are spending at least $500 (2 games, 2 controllers, harddrive, online, headset). :-D
I think the tiered approach was engineered to give a low enough price-point to make these "360 Sold Out" stories possible (for all of the reasons mentioned in this thread, free press, after Christmas sales, and especially to increase installed base for future lock-in revenue). Every "Core system" sold is (almost) guaranteed profit from: a harddrive, as backward-compatibility and future games will require it (that's right, you can't play your old games without going for the $400 model); one or more extra controllers, so you don't have to play alone; a wireless adaptor in case you don't have ethernet near your TV; an extra PC running Windows Media Center Edition to stream movies and music; and more! If Microsoft knows anything it's that lowering the barrier to entry (OEM contracts, Xbox prices) to expand installed base (Windows, consoles) is vital to software sales (Office, their cash cow, and games/accessories/Windows MCE licenses). If they could get an Xbox 360 sold with every TV, they would. Anyway, business as usual for them.
As far as I know this is just to spite Sony and to position themselves for the post-desktop world. The Xbox business unit still isn't profitable but does give them a toe-hold in the living room.
They're pulling a "Cabbage Patch".
Or if you're younger than that, a "Tickle Me Elmo".
Shortages increase the mystique and buzz surrounding a product and can increase a product's perceived desirability. They also bring out the competitive and hunter/gatherer instincts in people.
In short, its a marketing technique or gimmick. In the right situations it can be a particularly good one.
This fits in nicely with evolutionary models of human psychology.
And also explains why the selling out of the XBox creates the "buzz" mentioned by many readers above: People have a huge craving for information about the possible scarcity of a resource.
Or is that too sarcastic? I can never tell. :)
You're talking about Slate. There's no such thing as "too sarcastic."
Consider that when MS sells an Xbox console to customer Smith, the expected value of that sale is much much more than the mere wholesale price of that console. Rather, the expected value also includes the future profits of all the Xbox videogames that Smith is going to buy over the life of that videogame console. This is probably YEARS of future videogame sales, all of which have to be licensed through MS.
On the other hand, suppose Smith had chosen a Playstation console over an Xbox console. Well now MS has lost not only the money that Smith would have paid for an Xbox. The loss is MUCH bigger than that. Consider that over the next several years, Smith will be now be buying Playstation games and not MS games. So MS has not lost merely one console sale, but rather YEARS worth of videogame sales.
Thus, the incentive for a company like MS here is to sell as many consoles as humanly possible, even if it means losing money on them. Then make up the loss later by selling the games. (Notice that MS or Sony or Nintendo, etc is going to have quasi-monopoly power on the market for its own videogames. Once you've bought their console, you're pretty much stuck buying their games for the next few years, unless they screw up so badly that you're willing to accept the console purchase price as a deadweight loss and buy one from another company).
In sum, MS has no special market power over the videogame console market (people can always just choose to buy Playstation or whatever), but TREMENDOUS market power over the Xbox game market (since an Xbox user is STUCK buying Xbox games). So we'd except the console market -- the tying product -- to be extremely competitive (since so much is at stake), and the actual game market -- the tied product -- to be much less competitive. Happens in all tying arrangements.
As a side note, I happen think a lot of good can come from tying arrangements. It's almost like a form of financing -- people can buy the main product upfront for pretty cheap, and then basically pay for it overtime through the purchase of accessories.
But I'm also no expert on tying and I'd be interested in hearing other competing arguments, both for and against tying.
I wonder if inventory taxes/cost play a part of letting the inventory to deplete? Expected econonmy downturn?
The initial XBox was released at the same price point as the Sony PS2 in part to build the confidence of the people purchasing the console that they were buying a valuable system. The Nintendo game cube has always been priced significantly below either the Xbox or the PS2. The Nintendo is intended for a younger audience (5 - 10 year olds), and even though it has roughly similar capabilities, it has a much lower perceived value due to it's supporting cast of games.
Strikingly, whenever Sony drops the PS2 price, Microsoft and Nintendo have been compelled to do the same in order to maintain their parity; it's very similar to airline discounts, where airlines will almost always follow the leader when routes are repriced.
The PS3 has been announced as coming in at a significantly higher price point than the Xbox360, although that may be gamesmanship on Sony's part. When it's released, it will almost certainly be at or slightly above whatever price the Xbox360 is at- and the next generation nintendo product will be priced 30 - 50% less.
In addition, game systems benefit enormously by network effects; multiplayer games and a rich selection of products for a gaming platform are crucial to sophisticated purchasers. If it looks like the platform will be unpopular - for any reason- gamers will refuse to get onboard, sending the platform into a spiral.
So, ultimately, Microsoft is probably losing some short term profits (on unprofitable equipment), in order to maintain brand positioning and build the perception that network effects will be working in purchaser's favor down the road. This is probably a wise strategy, as gamers are an especially fickle group, and if Microsoft appears to be gaming the system to maximize short-term profits, or appears to be failing to win new converts to the system, the gamers will sit on their wallets and wait till he PS3 comes out.
Next time you go to the drug store, take a look at those blood sugar meters that diabetics buy. Diabetics need to test their blood sugar several times per day. First they buy a meter that comes in about five brands and two or three models in each brand, that lasts essentially forever. The meters cost a few tens of dollars for the basic version and over a hundred dollars for the advanced version that gives you some electronic memory for readings. For each test they need a test strip, which costs about $0.70 each in quantities of a hundred or so. The meters are reasonably sophisticated devices that, like cellular phones, are almost certainly being sold well below cost of manufacture and distribution.
There's no need to use price to find the people most likely to buy test strips in the future. Everybody either has been diagnosed diabetic or you're not. Yeah, yeah, we have the medically uninsured in this country yada yada, but I imagine the elasticity of demand for the meters to be 0.1 or less. I do imagine that some patients test less often than they ideally should, possibly because of the cost of the strips. Therefore, the machines can be dirt cheap and the companies still do well.
Disclaimer: I am not a diabetic and I may have something wrong. For example, there may be more differences between machines' abilities than I think.
-dk
Gizmodo reports that in Norway, the launch marketing campaign aims to build hype around the console by trumpeting its "SOLD OUT!" status to would-be buyers. In addition to limiting the per-store stock of consoles and having the retailers prepare to prominently note the unit's "sold out" status, Microsoft has allegedly asked Norwegian retailers to sign an agreement that they'll sell out of the consoles on the launch date.
ebay does illustrate that the price at least is wrong, at least in a supply/demand sense. Thousands of people are paying a lot more to get one. But it's also pretty cool how much ebay, et al., facilitate greater market efficiency today vs. 10 years ago (before e-commerce)
As for the idea that consoles are loss leaders, does Microsoft make money on the games? My understanding was that others can design and sell games for consoles, just like PC games. Is there a licensing fee involved?
You are correct. Most platforms are sold at a lost. The companies recoup their losses and usually make a tidy proft through game sales.
By the way, there was a sophisticated operation scamming demo XBox360s away from retailers just after the release, with an investment made in XBOX embroidered shirts and neckties.
link
My question though is how does Microsoft recoup its losses on games it doesn't sell? For example, look at Call of Duty 2, made by Infinity Ward and published by Activision; is Activision paying a royalty to Microsoft for each unit sold?
That price can be renegotiated later for "best hits" type games too.
But every single penny of profit for the XBOX 360 and Playstation 3 will come from licensing (and online service) unless manufacturing become much much cheaper during the product cycle. And that's unlikely to happen due to the shorter lifecycle fo systems.
Playstation 2's are no longer loss leaders, but the original XBOX is STILL a loss leader and has had a very very short lifecycle.
Everything about this launch is meant to play unupsmanship with Sony. Developers are confident the PS3 will be radically more successful, but Microsoft is getting a foothold and valuable brandimage in the living room. Eventually, we won't be using desktops for internet and home office, we will be using something like a Mega Xbox, and having a solid known brand for that future household appliance is extremely valuable, particularly with Microsoft's monthly subscription service for XBOX. This sub scription idea has been MS's plan for all software for over a decade.
Sony has no such online service, but they also plan for future playstations to be living room everything systems and microsoft correctly sees them as their most serious real future competitor.
Sony, currently, has no problems with getting other game companies to produce games for its system. It took the lead away from Nintendo with the original Playstation, significantly by going to the cheaper CD-based media (cartridges are expensive!) and by charging an inexpensive licensing fee (while Nintendo's fee was quite expensive). They don't have a whole lot to worry about - assuming they don't totally drop the ball on producing the new system, their past success should ensure them a strong launch and buy-in from other game companies.
MS can't count on that. The Xbox did well compared to Nintendo's offering, but isn't anywhere near as popular as the Playstation 2. There were relatively few "hits" and many of those were released by Microsoft-owned studios. In other words, they have a vested interest in the strongest launch possible, because their track record with their last system vis a vis attracting third-party game companies to release software for that system is pretty lackluster. But if they can get a strong installed base out there, especially if Sony's launch is delayed, then they can turn that advantage into a lure for additional games... which in turn drives subsequent platform sales, and you get a positive feedback loop. Conversely, if demand for their system is soft at the time of the PS3 launch, Sony can take a commanding lead once again.
Also, MS has traditionally done very poorly in the Japanese market (they're not selling out in Japan, heh), so they're behind in attracting Japanese developers to begin with - important because a significant proportion of games and an even higher proportion of hits come out of that market. If the Xbox 2 doesn't gain an immediate foothold in the US, Sony's Japanese dominance means they can compete favorably over here as well.
Frankly, I'm appalled that someone could take this argument seriously. Does the man not understand the concept of bad PR?
I once read about an experiment that was done to see if chimpanzees could determine the intent of others. The chimps were offered juice, and given a choice of two humans to bring it to them. One human would always manage to trip or otherwise spill it by accident, while the other would dump it out deliberately. Soon, the chimps were always choosing the former, presumably hoping that he might someday succeed at delivering the treat.
I suppose Harford would be confused by this experiment, too.
Dillan is quite correct.
I work in the software industry (with some contacts in the entertainment software industry) and there's a constant battle with a small but extremely vocal group of people who consider any price too high. They scream "unfair" pricing on products and demand to be given access to the books of private corporations in order to determine the "true" price of the product (so the price they consider "fair").
This is getting worse all the time, as people (and especially the younger generation) has less and less knowledge of the way the world works, seeing only the handouts they get from their parents or the government.
Increasing prices to reduce a (possibly artificial) shortage in such an environment is detrimental, your antagonists will only scream the louder and they're the ones who get heard by the press (who in general are no more economically educated than the screamers).
Keeping the price low while working to supply the market until saturation is the best policy.
In the end you sell more units without having to increase production capacity for a shortterm burst output leading to idle factories at a later stage.
There are only ~20 games available for purchase. Half of those are sports titles. Backwards compatibility only affects about half of the titles already out there for the Xbox.
If you buy a 360 and you don't care about football or basketball, you won't have much to play.
This happened with the PS2 as well. I remember being thrilled that I *FINALLY* got my hands on one... then I went to look for a game to play on it... and I had my pick between Fantavision and Eternal Ring.
Final Fantasy X wasn't due to come out for another 6 months or so. I was playing my old playstation games on my PS2. I felt soooooo dumb trying to explain to my wife how cool I thought it was that I was playing Final Fantasy IX on my $300 system and leaving the $99 system to collect dust.
Anyway, a false shortage can get people thinking "Those people told me that I couldn't buy an XBox 360!!! WHO IN THE HELL ARE THEY TO TELL ME THAT I CAN'T BUY AN XBOX 360?!?!?" which is a lot better for eventual sales than having them tell their friends "yeah, I got one, got it home, set it up, realized that I needed a game, went to the store... and they didn't really have anything. When does Halo 3 come out?"
It used to be said by IBM that every successful product exceeded sales projections by some huge amount. Market forecasting is not easy.
First, contracts with the developers. Console vendors make their money by selling licenses to developers; the consoles are sold below cost. For the developers to be induced to pay those fees -- more than a year before the product is released, before the shortage is predictable -- the console vendor commits contractually not to sell above a fixed price. That way, the developer knows the console vendor won't double-dip and that the installed base (over time) will be high enough to merit the investment of licensing fees and development resources.
Second, retail distribution agreements (contracts between wholesellers and retailers) are put together months ahead of time. That explains why MS doesnt hike the price. The contracts also limit the prices the retailers can charge, to prevent marketing value from being converted to retailer profit.
Since both sets of contracts are put together long in advance of Christmas, when the shortage is highly unlikely (there's only one hit toy a year) the parties do not spend the transaction costs required to negotiate clauses to handle the hit-toy contingency.
I am a perrenial Microsoft supporter but I do belive Microsoft is terrified. I think they have cause to be.
The battle with Sony is not about game consoles. It is about the end of the desktop computer. Sony has every intention of turning the Playstation into the family entertainment center, game console, web browser and personal computer.
This fits in with where the world of computing is headed. In the future we will not need Microsoft Windows, or Word or even Photoshop. If we need to edit a photo or write a story, we will simply log onto the internet and head to www.word.com or say www.photoshop.com etc. Adobe is already offering pay per use for Adobe Acrobat. Google and other companies are edging this direction and I do believe it is the future. No longer will every computer need a copy of every program the user might need. FOr a fee or for the simple pain of looking at an ad, we will be able to choose and use any program that we desire.
With all of this at stake, Microsoft's NEED to crush Sony has forced them to market with an inferior product. It is a life and death battle and Gates is losing.
Mark my words... you heard it here first (maybe) ;)