Saturday, December 6, 2008

Conceptual tools for allocating finite resources

I have lived and worked in Greater Los Angeles for over a year now. Since the area is one of the world's major population centers, it only makes sense that I'd come across plenty of opportunities to observe the interplay between two forces: lots of people and limited resources.

It's a common problem, but always a multifaceted one. Coming up with a solution means that planners (who could be church volunteers, business managers, or software engineers) must consider various factors. Having to stop and think about this can slow down decision making, and even when there's time to ponder and plan, thinking of a solution from scratch is more error-prone than referring to a proven set of guidelines and rules.

Consider the situation when lots of people are elbowing each other to buy concert tickets. There's no increasing the supply of these tickets since a concert hall or stadium can only hold a set amount of people without the Los Angeles Fire Department throwing a hissy fit.

Many eager economics students and libertarians automatically want to apply the law of supply and demand here: why not just raise the prices? In fact, that's what some organizations have done: Britney Spears concert tickets for Staples Center start at $150.00. (How do I know this? My girlfriend told me. Really.)

As the purveyor of tickets, you can do that when you have some idea of how much demand there will be. But what if demand shoots up while your supply stays the same? When it looks like you're about to sell all your inventory and are hours away from turning away your customers and disappointing them, you could double your prices. But then, your customers would be angry that you're gouging them. Your company would appear disreputable for "arbitrarily" changing prices on consumers.

If you're looking at it from an economist's point of view, there's no problem there: you're just changing the price to meet demand. But from a public relations vantage point, you run a very real risk of alienating your customers. It'll look like you're exploiting them, when all you're doing is ensuring availability (while making a few extra bucks).

On top of that potential PR nightmare, there's a downside that even economists must acknowledge. It's the phenomenon that economists call "sacrificing equity for the sake of efficiency." That's all fine and high-sounding, but what does that mean? It means, "It's not fair." And the customer will feel this way. Your costs haven't changed: it still costs you the same to make it, doesn't it? This gives your customers a reason not to trust you, and therefore not to come back.

Changing your prices is certainly an effective tool to curb or increase demand, but raising them is an extremely delicate matter in the age of consumers who expect posted prices to stay the same.

Waiting list: first come, first served
A common alternative to raising prices is to let people buy stuff on a first come, first served basis. The folks at Ticketmaster do this, in case the $150.00 concert tickets sell out (which they often do).

As you may recall from your economics class, this is considered more equitable, but not as efficient: the people selling tickets could make a lot more money just by raising the prices. (If you do not recall from your economics class, shame on you for not paying attention. But hey, now you know. Trust me on this one.)

As far as fairness is concerned, lower prices with waiting lists are an improvement over simply raising the price. But if you're not one of the first served, you probably won't feel like it was very fair. Maybe you had to be at work that time of day, or don't have time to wait in line.

A different spin on fairness is to let people enter a lottery to let them buy what they want at lower prices. If you were to enter such a lottery and your number got drawn, you could then buy what you're after. Typically, submissions to this lottery are accepted during a specified time window. So if you have to be at work when the lottery first opens, that's not a problem. You have just as good of a chance as the first person who entered that lottery.

This was part of Saddleback Church's approach when they hosted the Saddleback Civil Forum with Barack Obama and John McCain during the presidential campaign. Since Saddleback Church is very high-profile, it was important that a purely pricing-based model was avoided. Taking an exclusively pricing-based allocation of tickets to see the candidates would have looked too much like favoritism towards the rich, a Biblical no-no.

Then again, Saddleback Church also had to cover its costs, so it actually opted for a brilliant hybrid approach that consisted of various tiers, each with a different price. It was a multi-tiered lottery. Higher-priced tiers would likely yield a smaller pool and a higher chance of being selected. You can't please everybody, but such a creative and enlightened approach likely pleased quite a few free market die-hards while at the same time placating those who were concerned about equality. If only governments and businesses were as wise.

blog comments powered by Disqus