Tuesday, April 12, 2016

Price Discrimination vs. DLC

YouTube user ShoddyCast is one of my favorite channels o'er yonder. For one, he is obsessively, charmingly pedantic about minor video game physics inconsistencies. For two, he cusses like a middle school boy. These are qualities I can't help but admire. But consider this recent foray into economics (featuring Richard Thaler, no less):

He gets several points absolutely correct. Game (and console) pre-orders work well for physical media, so long as the quantity demanded on or around release date is unpredictable. I recall some trouble landing a copy of Silent Hill near its release date, for example. And since I'm the sort of gamer who likes to play a few favorite franchise titles right away, this was irksome. Or maybe it was vexing. Irritating? Whatever the sensation, pre-orders purported to ease the problem. I was promised to no longer be confounded on release day. I was guaranteed a physical copy in my hot little hands. Because I'm the type of player for whom that is important.

Another point he gets right is the time value of money. Unfortunately, he gets it right for the wrong reasons. $60 today is indeed worth more to me than $60 a year from now, but that's true even without inflation. And it's even true without the explicit opportunity cost of foregone investment.

Perhaps I should pause for a moment to cover the concept of opportunity cost. Here's the superlative David Henderson on the topic. Opportunity cost is the [subjective] value of the next-most attractive alternative. In the case of the Fallout 4 season pass (at the original price), the $30 I dropped would have bought me 3 pizzas from my favorite local pizzeria (Tuesdays are buy one, get one free at Brick Pizza). For putting money into a lockbox, the alternative uses could include a couple extra shares in an ETF or an interest-bearing savings account (good luck finding one), but it doesn't have to. All that's needed to show the opportunity cost of holding cash is that you're restrained from spending it. Something might come along that you value more than that thirty bucks, but too bad, Sally. It's out of reach. Better luck next time. You might recognize this as a component to our good friend the regret condition.

He also mostly gets Thaler right. At most department stores, prices on the sale racks are still above the cost of goods sold. Therefore, the full markup price is absurdly, unreasonably high. This sales tactic relies on a cognitive illusion: you think you get a screaming deal on a pair of trousers for $20 because on another day, they might have sold for five times that price. You shake your head and pity the poor sucker too unlucky to shop on that particular day and walk off proud of your shopping acumen. But here's the curious thing: every so often, trousers are indeed sold at full retail price.

What gives? Are these spendthrifts actually behaving irrationally?

What we have here is a yes, if/no, but situation. It is indeed classically irrational to pay full price for something if the lower price is predictably available and if the opportunity cost of waiting for it is lower than the price differential.

Let me give you a quick example. One day, I was scheduled to teach an early morning Public Choice class. My favorite parking spot on campus is a seldom-used dirt and gravel lot near the football pitch on the west side of Patriot Circle. If you know the GMU campus, it's across the street from the hotel (which I think is now closed). Being a brisk early spring morning, the nearby hill that I often used as a shortcut was slick with dew. When I attempted to carefully plot my way down the hill, I lost my footing, went ass over teakettle, and completely ruined my slacks. I had a big ol' mud streak all the way up my left leg. With class starting in 20 minutes, I needed a new pair of pants, pronto. I hopped back into my car, hightailed it to a TJ Maxx, bought what I needed, and tore ass to Robinson B just in time to start my lecture on the Condorcet Paradox. In other words, I had very high opportunity costs thanks to the urgency of my shopping excursion. I was willing to pay more for convenience and speed.

So is it classically irrational to pay full price under normal situations? No, not as long as you can't adequately predict the pattern of future prices. What you're doing by pre-paying is essentially buying a call option. You put your money down now in the expectation that future prices will either rise (which is exactly what happened with Fallout 4) or that something else will change with your own subjective valuation of the good in question. Farmers do this all the time. If you've ever seen the 80s comedy classic Trading Places, you'll be at least passingly familiar with the Frozen Concentrate Orange Juice futures market. This is just a fancy, centralized method for Florida orange farmers to sell their July crop in February. This is quite a boon to farmers who are more interested in fertilizer and weeds than in the vagaries of global demand. The same idea applies with individual pre-purchases. Buying all the DLC ahead of time is a player's way of betting on expected content expansions.

But, and it's a big but, there exist incentives to gain additional information about the future state of the world. For retail department store sales, Thaler is right on the money: it's common knowledge that department stores have been taking great advantage of silly little cognitive blind spots for ages now. You are indeed a sucker to walk out of a Macy's thinking you put one over on the hapless merchant by buying off the discount rack. With low information costs like this, there's precious little excuse to pay prestige prices. But does a season pass for premium content fit this model?

Maybe. It depends on the publisher. Bethesda is notable for releasing DLC that often exceeds the quality of the base game. After the infamous horse armor incident with Oblivion, they overcompensated by giving us the massive Shivering Isles expansion, Mothership Zeta, Dawnguard, Dragonborn, Broken Steel, on and on. And the four New Vegas expansions (even though it was Obsidian rather than Bethesda) were all as good or better than the base game. Tell me you wouldn't be happy just playing Old World Blues as a stand-alone title. Point is, a long-time Bethesda customer has certain expectations about their add-on content. Incidentally, the same holds true for Borderlands publisher 2K. I felt confident enough that the net present value of all the season pass content for Borderlands 2 exceeded the opportunity cost of biding my time. As it turns out, I was right in that instance. The $30 I spent on that pass was a great deal less than the $60+ I would have had to pay on release day to get Gaige, Captain Scarlett, Mr. Torgue's Campaign of Carnage, and the splendid D&D-themed Assault on Dragon Keep. Recall that for these titles, I am the type of player to pay full price for the pleasure of playing them on or very near their release date.

And that last bit there is really the key to price discrimination. Not all shoppers are created equal. Not everyone is so enamored of fictional universes that they'll rush to get new releases on the day they drop. I'm still somewhat baffled that there can be a new Madden every year that sells extremely well, despite being pretty much identical to the previous year, but for a few roster changes. The same goes for the endless parade of FPS titles. But Fallout? You bet your ass I'm first in line to get the Bloody Mess perk and start exploding super mutants all over that wasteland.

The last component here, is of course, Steam sales. Most big titles will bundle up a Game of the Year edition complete with all the DLC a year or so after its initial release. And another year or so after that, you can usually rely on that GoY edition to go on deep discount in the Steam store during one of their periodic (and predictable!) annual sales. For players willing to wait a while, you can get some screaming deals on titles that have been out for a few years. Well over half my Steam library was acquired this way. This pattern is just as well known, just as predictable as Presidents' Day sales at department stores. However, Steam sales are also just as irrelevant to an impatient fan as Presidents' Day sales are to someone who just skidded down a muddy hill and has to teach a class. I want Far Harbor the day it drops, not a moment later. The opportunity cost of waiting exceeds my desire to play as soon as is reasonably possible.

Long story short, if you're an impatient fan, and you have a pretty good expectation that the forthcoming content will be pretty good, Season Passes can be a pretty good deal. Casual fans or folks less confident about the quality of forthcoming DLC are probably better off holding out for the Game of the Year edition round about Christmas time.

Another decent way of thinking about it is that some folks will pay full price to see a movie on opening night. Are they being irrational when they could simply wait until it gets to Netflix? Why or why not?


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Do you have suggestions on where we could find more examples of this phenomenon?