Why Is Dynamic Pricing So Rarely Used?

As technology has come available that allows performing arts organizations to adjust prices in light of demand, the question has arisen: is it appropriate for nonprofit theaters to employ dynamic pricing? See here and here for example. #

Let’s consider the issue from a different angle: why is dynamic pricing so rarely used in the for-profit sector? #

For example, at my local multiplex cinema, I will pay $5 for a weekday matinee, $7.50 for  weekday evening or weekend matinee, and $10 for a weekend evening. It doesn’t matter whether the film I see is in high demand or low, it doesn’t matter whether it is an Oscar-winner like Argo or Life of Pi, or a film whose reviews are brutal, and it doesn’t matter if I am attending during a month when cinema demand is predictably and routinely high, or low. It’s true that the cinema owner will receive different amounts for different films, as the share of receipts the cinema keeps relative to the share that goes to the distributor rises as the run of the movie extends. But as a viewer I do not see prices change. Or, to take another example, consider iTunes. For the thousands of songs they have on offer, prices are remarkably uniform. For the most part songs are either $0.99 or $1.29, regardless of the popularity of the particular tune (indeed, iTunes will even tell you the relative popularity of each song). Cinemas and music downloads come to us from commercial firms, and so have none of the qualms a nonprofit might have about whether variable prices in light of popularity are consistent with mission. They need only consider whether dynamic prices are consistent with profit. But we see remarkable uniformity in prices across offerings and over time. What could explain this? #

One possibility is that the vendor does not wish to signal to buyers that one particular movie or song is not generating demand, since that would kill demand for low-performing works even faster. Such a rationale seems persuasive to me when it comes to books. Publishers charge the same prices across their catalog for, say, works of literary fiction. Since a novel requires a lot of time on the reader’s part, and it is hard to judge a book by its cover, any discount on the price of a book that suggested it was thought by the publisher to be lower quality would put an end to any readership for that book. No one wants to spend hours with a bad novel instead of a good one to save a couple of dollars. But I don’t see how that can explain uniform prices for movies or songs. We know the songs we download, and whether we like them. We know what to expect when we attend a movie, we have seen trailers, read reviews that give a good sense of whether we will enjoy the film. Changing prices for songs and films won’t affect whether I expect they will be any good. #

Another possibility is what economists call “menu costs”: it is a lot of work for a manager to keep track of demand, adjust prices, and then post those prices. If I were running a restaurant that would certainly be a relevant consideration: I wouldn’t want to constantly have to revise and reprint my menu, and to do the work on a weekly basis to try to get the prices for every meal and drink “just right.” But this shouldn’t be such an issue for cinemas, who don’t have lengthy “menus”, and who don’t print their prices. #

What seems most persuasive to me is an explanation from behavioral economics. As consumers, we place a value on predictability, and we are guided to some degree by “loss aversion” – we are made somewhat happy when we find an item will cost us less than we expected, but we are very disappointed when we find it will cost us more, and that disappointment is of greater magnitude than the gain from finding a sale. This gives firms an incentive to keep prices stable and predictable even when demand conditions might suggest a change in prices could be profitable. If my local cinema surprises me by charging me $15 on a Saturday night to see Silver Linings Playbook when I expected to pay $10, it is in great danger of losing all my further business, because I really don’t like that kind of surprise. And giving me a discount to see a less popular movie, charging $8 instead of $10 for me to see Rust and Bone, is a nice surprise, but not one that gives me a lot of incentive to attend the movies more. Taking all that together, the cinema is best just charging $10 on Saturday nights regardless of the film, with no surprises. #

Airlines can easily use dynamic pricing: they are selling a known commodity, can easily adjust menu prices, and have a customer base without a firm expectation of what any particular flight is going to cost – when we go to book a flight we know that we don’t know what we will pay. But for cinemas it is not so easy, and we tend to see uniform prices, even when the economics would lead us to expect variable prices. #

We will return to the issue of whether dynamic pricing is consistent with nonprofit mission in later posts, but for now we should realize that even commercial firms in the arts and entertainment sector find some limitations to its use. #

Footnote: For more speculation on uniform movie prices see Tyler Cowen, or this scholarly work from Barak Orbach and Liran Einav. #

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