I think it is time for another look at that old friend of Economists and students in Econ 101, the “Demand Curve” and the slightly more complex notion of “Price Discrimination.”

To catch up, you undoubtedly recall that the demand curve essentially shows that, as prices decrease, demand will increase for a product. This is shown in the following graph:

Thus we can expect Steve Jobs is correct in saying that they did this to increase sales before the Christmas season. In fact, lowering the price should increase the sales, assuming that there is elasticity in the pricing and demand curve. Remember, elasticity is the degree to which quantity changes with a change in price. The more elastic, the greater the change (steeper the slope of the curve.)

Now, there is this other notion of “price discrimination.” Price discrimination, or “Yield Management,” is the practice of charging different customers a different price for the same product. The notion is really quite simple. As we saw in the Demand Curve, a few people are willing to pay a high price for a product. A few more would be willing to be a lower price, and so on. In the charts that follow, one can see how, by targeting different customers at different prices points, one can increase total revenue.

The first chart shows the revenue generated if one were to charge a single price. You can see that above the “box” is the revenue that is essentially lost due to customers getting a “good deal.” They would have paid more, but are most likely happy that they were able to pay less. Of course, to the right of the “box” is revenue lost because customers felt the price was not at a point where they could make a purchase.

This next chart shows, notionally, what would happen to revenue if a business were able to successfully segment the market, and provide 6 different price-points. As you can see a far greater area under the curve is colored in, showing a significantly greater amount of revenue.

By identifying these customers, and finding ways to segment the market, a business can capture more revenue by charging higher prices to those willing to pay those prices. Ideally, businesses would like to charge a different price for every customer, targeting the maximum price they are willing to pay. That level of price discrimination would ensure that every customer felt they were receiving a “fair” deal, while removing even the smallest gaps between revenue and the demand curve. This is rare, although an argument could be made that we see this in online auctions and in car sales with negotiations.

Realistically, we do see price discrimination in our daily lives. Customers can find the “same” available for different prices, simply by shopping at different stores. What makes people pay more? A sense that they are receiving something additional for the increased costs. We are perhaps most familiar with this practice in the airline industry, where yield management has gone from art to science. We pay more for a first class ticket (obvious difference in treatment, although you still arrive at the same destination.) But customers also pay a higher price for the privilege of changing travel arrangements, or for the ability to purchase tickets at the last minute. Alternatively, the airlines are able to ensure full planes by offering a select (and scientifically computed) number of seats at lower prices. Travelers must purchase these tickets within certain guidelines, but more tickets are sold (and seats filled), because they are able to capture those people who could otherwise (perhaps) not afford to travel.

If you look around, you can find other instances as well. Coffee is more expensive depending on whether a coffee shop has the right “feel.” Clothing is more expensive when purchased at “higher end” stores.

What is critical here is the ability to segment your customers, and by doing so, create barriers to transfer. This can be accomplished in many ways to include rules ( in the airline and cellphone industries), controlling information (automobile industry), perception of enhanced service (coffee shops and boutiques) and through geography (different shopping “districts.”)

So what does all this have to do with Apple?

I am glad you asked. I believe Apple made a “good call.” They sought to capture as many people in the high end of the Demand Curve as possible. The problem (if you believe that sales may have been trailing off in August) is that the demographic may have been smaller than they anticipated, or they all reacted more quickly purchasing en masse early on. This then left a potentially large amount of sales untapped. This is essentially what Steve Jobs was talking about when he kept referring to capturing the holiday sales. They want to increase sales and to do that, they must change the price point. This slides them down and to the right along the demand curve.

I suggest that Apple was trying to practice what I will call “temporal price discrimination.” They were hoping to capture the “big spenders” early, and then move down the curve, capturing sales from those who could not, or would not, spend at the higher price points. Unfortunately Steve Jobs misjudged the timing. The group that purchased the iPhones at the higher prices were not satisfied to say that 30 to 60 days of use of an iPhone was sufficient differentiation in their minds to have paid a higher price. For many, one could argue it wasn’t worth $100 to $200 per month to have a cool phone.

So, Apple failed to take the necessary steps to successfully practice price discrimination. They failed to differentiate and segment their customers in a significant and substantial way. They did try to create barriers. They were going to limit the number of people that could “switch”¹ to the lower price by putting a time window on when you could get your money back. But customers, apparently in droves, pressured Apple early and often. Jobs responded within 36 hours, offering in store credit (among other reported compensations.)

All in all, I think this has been an interesting time. I have only given a cursory look at the economics involved, and there are far more details I left out (did I forget to mention marginal costs?)  Also, I am sure there are many other factors and pressures that influenced Apple’s initial decision, and some may even include a pending shift in the demand curve itself. (If new technology makes customers feel this iPhone Gen 1 is “obsolete” then the whole demand curve might shift to the left…) Perhaps we shall revisit this topic…

¹ Ironic that, eh? Apple trying to stop people from switching?

I flew last week on American Airlines, to St Louis. As you may recall, St Louis was the hub for TWA, which was acquired by American. Despite that, I had a connecting flight out, and back, through Chicago. Every connection is an opportunity for an airline to have problems, and rise, or fall, on the opportunities to deliver customer service.

American Airlines rose.

On the outbound leg, I arrived in Chicago 20 minutes early, and the jovial command pilot asked that we bank it–so next time they run late we can “give it back.” Good humor. Ultimately I arrived on time in St Louis and when I talked to the staff about seating arrangements they were ever congenial.

The return leg was  a bit more problematic.  I arrived at the airport several hours in advance, but unfortunately the airplanes weren’t cooperative.  The flights to Chicago were being shifted back by one flgith schedule each.  My 6:30 departure had turned into a 7:45 departure with an arrival at the same time as my connecting flight.  The customer service line was quite long, but everyone in line was fairly positive.  When I got to the ticket counter the gentleman asked me what I needed.  I responded with “I need to be at [destination] by midnight.”

Guess what? He did it.  He moved me on to the earlier flight, and ensured that my connection wasn’t going to be a “miss.” He even looked, and was able to accommodate my desire to have an aisle seat.  Being 6’2″ I need the legroom.

Of course, problems tend to pile up.  I arrived at Chicago and found that not only was my final flight delayed,  but there were extended delays on the ramp.  Every step of the way the entire American Airlines team made sure that every passenger felt special, and that they knew that each passenger had requirements that they needed to meet as a service provider.  My final arrival was 1 am, later than I had hoped given a two hour drive that followed, but I arrived safely, and well cared for.

I had a choice, and I chose American.  I chose to not fly with US Airways.  I will make the same decision again.

As if you needed any more reasons to not fly US Airways, this report comes from my wife on her trip back home.

We left on different flights heading back East. She took off on time from San Francisco, but unfortunately, her flight apparently had slower engines than mine, and she arrived 30 minutes later than scheduled. This is, of course, a problem when you only have 40 minutes scheduled between flights, and your flights are in two different terminals. She talked to the flight attendant on board her first flight, and advised them of the situation. The response was actually classic US Airways: 1. You aren’t alone, there are many others who are in the same situation. 2. I am sure they know you are coming, so don’t worry about it.

Why do I call this a classic US Airways response? First, they inevitably tell you that you aren’t alone with this problem. I am not sure why they do that, but I think it is to make you feel small–like somehow you have no “real” gripe because you aren’t really unique, or special. My response has been typically “Well, if so many people are having these problems, perhaps you should be doing something to fix your airline–don’t you agree?” The second ‘typical’ response is to tell you that it will all be taken care of later, by someone else. The classic buck-passer. That’s the story I heard, time and again, from everyone I met who entered the realm of “customer service” with USAirways. Inevitably, and I do mean inevitably, the buck passer mis-spoke, mislead or just didn’t want to do something.

So that brings me back to my wife’s story. She gets off the plane, and starts hurrying through the airport. She sees one of those motorized carts, and asks for a ride, telling them what time her flight is leaving. They graciously take her to the gate (but warn her she most likely will have already missed the flight–USAirways doesn’t wait!). And sure enough, they were closing the door to the plane. “They” let her onboard, only to find out that the Gate Attendant had already given her seat assignment to someone else!

Now, why would an airline, knowing that the person they were missing was an inbound on another flight, and making a connection, do such a thing? There are two “things” that USAirways did here. First, they were going to leave a passenger who’s flight had landed, simply to make their “on time departure” metric. Second, they gave a seat away that was for a customer who was making a connecting flight. The first is an unfortunate “unintended consequence” of metrics. If you measure me on the percentage of on time take offs, and not reducing the number of stranded customers, then US Airways (and all other airlines) will continue to care more about the “push back from the gate” than having happy customers. The second “thing” is a bit more difficult to understand. I mean, giving her seat away? Perhaps one could chalk it up to the need to generate revenue (so much of what they do is meant to nickel and dime their customers) except, and here is the weird thing, they still had seats on the plane. They were able to give my wife a new seat assignment right away.

So what lessons do we learn about US Airways here?

1. Trivialize the customer’s complaint
2. Pass the buck to someone later in the process
3. When you do get “Later in the process” deny that they can do what you were promised earlier
4. Focus on metrics that don’t involve the customer
5. Focus on revenue generation to the detriment of customer service

Yup. US Airways is not a winner, at least not in my book.
2.

I had a trip out west, and unfortunately, flew on US Airways. The night before I left, I received a call telling my that my flight out would be delayed by about 2 hours, which would mean I would miss my connecting flight. I had to press hard for them to work through that, but luckily I had already built in a buffer to that schedule. My meeting was the next day at 7 am, so I would be “fine.” I had planned on meeting my wife in San Francisco and thus we had more “complications.” I needed to get her flight re-routed as well, so that she wouldn’t be waiting for 5 or 6 hours in the airport. At first, US Airways was not willing to work with us on this. “Her flight isn’t the one delayed” they kept reminding me. Finally, after a full hour on the phone, I was able to not only work out changes that had us arrive at the same time, but it put us on the same connecting flight!

All’s well that ends well? Not quite. Not by a long shot. When we got on the plane to connect to San Fran, it turned out my wife’s seat was literally double booked.¹ She, and another gentleman, had the same seat assignment.²  On an overbooked flight. Ah, but they were able to accommodate us again. We got to sit next to the bathroom.

Now here is where I feel bad. I could a nice long blog entry about how the meting went quite well. (It did.) How absolutely enjoyable (and fabulous) the “vacation” portion of it was. (It was!) I should write about how I enjoyed the seafood, and how I thought it was neat to see and hear the sealions in Monterey. (all true.) But nope. I am still too angry.

You see, I am still at the airport waiting for the final leg of my flight home. When I arrived (yesterday morning) at the airport in San Francisco, I was told that my final flight, the 50 minute connector to my hometown, was canceled (already.) And why was it canceled? Because they wouldn’t 12 hours later, have an aircrew to fly the plane. Yup–they had a “crew cancel” scheduled more than 12 hours before the flight would even take off!

The gentleman at the counter worked hard to find an alternative, but when US Airways is the only airline to the local airport, the options are limited. Ultimately, I ended up heading to the connecting airport on the East Coast, and having to stay at a (very crappy) hotel at US Airways expense. They did provide me with meal vouchers. And you know just how far that $5 goes at an airport!

I did tell them that, since they screwed up my outbound and my inbound flights that they owed me some additional compensation. Alas, so far I have only received the buck passing. More to follow, no doubt.

_{1 This is interesting, given that on April 24^th the airline’s President, and the Chairman/CEO issued a letter to customers touting that the new reservations system is in place, and that the “new software and better airport processes will allow our airport employees to focus less on keystrokes and more on getting you where you need to be, on time, with your bag. ”
² To delve further into this story, on that same flight there was another seat with two bookings. On top of that, on my final flight home (yes, I finally got one!) “they” double booked a seat on that flight. In today’s era of “Web 2.0″ and Digital Natives, how does this happen? Perhaps another post, on that…}