The Professor's Notes

I have posted this over at “Supply Chain Innovations Today” but wanted to cross-post here.

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DC Velocity has published a great article pointing out the way in which logistics (and by extension, supply chain management) comes through time and time again–and occasionally with a high profile effort. In this case, the author writes about the logistics efforts that were essential to the successful roll-out of the latest, and final, Harry Potter book.

I mention the author, Peter Bradley, focuses on the logistics necessary to deliver 12 million books in quantities large (and small) around the globe for a single, timed, opening. This of course goes beyond a simple planning and execution initiative. It required coordination, as Bradley mentions, between the publisher, and a network of transportation providers (carriers.) He writes:

Scholastic’s success was no act of magic. Rather, it was a carefully planned and executed distribution effort that required close collaboration among members of the company’s logistics team and a core group of carriers.

Planning for the rollout began in January, even before Scholastic had the finished manuscript. Internally at Scholastic, the project would require tight coordination among members of the logistics staff and their colleagues in sales, purchasing, customer service, and manufacturing. Yablin points to Ed Swart, director of operations, and Francine Colaneri, vice president of manufacturing and procurement, as key partners and team members.

The close collaboration also extended to Scholastic’s logistics partners: J.B. Hunt, Combined Express, Yellow Transportation, and ActivAir. J.B. Hunt, one of the nation’s largest truckload carriers, moved the majority of the books—all but about a million of the copies. Hunt operated in partnership with Combined Express, a Bensalem, Pa. based logistics and trucking company that specializes in publishing and retail shipping. Yellow Transportation, a major LTL carrier, handled domestic LTL shipments. ActivAir, an international forwarder that specializes in book and magazine distribution, managed international shipments to 32 destinations in 29 countries.

I would like to point out that contemporary to this initiative was the release of the much-touted iPhone. That release required a delivery between 4 and 6 pm local time, for a store opening of 6 in the evening. Another opportunity for logistics to shine.

Let’s not lose sight of the importance of collaboration across the supply chain for both of these products. In both cases, there was a line in the sand–a promised delivery date for large scale release. Satisfactorily meeting these dates required not only a close coordination of “in house” production but also coordination among all the suppliers that provide key elements to your product. In the case of the iPhone, there are many components that make up the phone, from numerous suppliers. According to their analysis (as reported in RFDesign)these suppliers include: South Korea’s Samsung (The processor core), German-based Infineon (providing the RF and broadband functions), and National Semiconductor (a single chip.) In addition, the most exciting part of the iPhone, the multi-touch screen, has many providers:

It is believed by iSuppli that the supplier for the touchscreen module in the model torn down by iSuppli was Balda, with its partner TPK Holding. It is believed by iSuppli that the iPhone LCD display itself is multi-sourced through Epson Imaging Devices, Sharp and Toshiba Matsushita Display Technology. The cost of the LCD used in the iPhone is estimated at $24.50, representing 9.8% of the 8 Gbyte version’s costs. source: RFDesign http://rfdesign.com/rfic/iphone-isuppli-components-0712/

Coordinating such a complex, and global, supply chain and ensuring pinpoint accuracy in delivery (both spatial and temporal) shows how a collaborative supply chain can truly deliver.

While I have, at times, sparred with Dean Dad over at the Community College Dean’s blog, I must say today’s blog brought back so many wonderful memories of my children when they were young.   It’s great to read about the fun a Dad and Daughter can have.

At the end, he writes that it will be a great memory for when he “won’t know anything, and she’ll greet me with a roll of the eyes and a contemptuous ‘Da-a-ad.’”

I am quite fortunate.  Perhaps I am simply blessed with great short term memory, but my kids have never truly treated me that way.  We had a great time when they were little, and while at times I am reminded I am not needed as often, they still make time for Dad, and for Mom.

Go read Dean Dad’s post.  Enjoy it.  Tell him you heard about him from here.  And go–make your own great memories with YOUR kids.

(and, if you want to learn a bit more about my relationship with my son, go check out our blog  and podcast, at the Father Son Chats.)

After writing the last post, I realized I had not tackled the big question:  How could Apple have practiced price discrimination that would have enabled the “big spenders” to still feel good about themselves, rather than feeling like they were robbed?

Thankfully, others have taken on this task.  Specifically, Seth Godin (you know, the “All Marketers are Liars” author! and blog) has identified several ways that Apple could have differentiated their product, making people “happy” to have paid 33% more for the same product.  As he puts it, “The key is to not give price protection to early buyers (that’s unsustainable as a business model) but to make them feel more exclusive, not less.”

Godin’s ideas include:

• Free exclusive ringtones, commissioned from Bob Dylan and U2, only available to the people who already had a phone. (This is my favorite because it announces to your friends–every time the phone rings–that you got in early).
• Free pass to get to the head of the line next time a new hot product comes out.
• Ability to buy a specially colored iPod, or an iPod with limited edition music that no one else can buy.

Neat–and as he points out, they wouldn’t have cost Apple $20 Million in profit.

After some thought, I have decided to write about what Apple did right, and wrong, in their decision to lower the prices on the iPhone. Essentially, I believe they recognized the opportunity to generate more revenue from a lower price point, and chose to practice price discrimination to achieve that. Alas, they made a couple significant mistakes. If you read to the end, you will see what those mistakes were.

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?

Okay, so the housing market is certainly looking like a “Buyer’s Market.”  Not bad if you want to buy a home!  Unfortunately, what is good for the buyer is not necessarily good for the seller.  Many are having to sell their homes for less than they paid for the home, and often less than they still owe.  But that’s okay–they can take the loss off their income taxes, right?

Nope.

According to the IRS Publication 523, “Loss on sale.  If the amount realized is less than the adjusted basis, the difference is a loss. A loss on the sale of your main home cannot be deducted.”

The Federal Government has given help over the past few years allowing an exemption for gains on the sale of the main home/residence.  This was intended to help ease the tax burden as the values of homes skyrocketed, and allow for the  keeping of that equity on which so many had come to rely.

Unfortunately, the same “benefit” does not extend to a tax break when we have a “loss” on a home.  Obviously, when all the housing property values were increasing we were not as concerned about the possible tax implications of a loss.  In fact, I suspect few people realized that we could not claim a loss on our homes on our income taxes.

I propose the following legislative action:

• Introduce legislation allowing for the deduction off the income taxes of a “loss” on the sale of a main home.
• Make it “emergency legislation” enacted for this tax year, and only temporary, to carry through the next two to four years of the depressed housing market.

The way I see it, this approach is consistent with the logic of not taxing the gain.  If we as a nation seek to minimize the tax impact of home ownership, and in fact encourage home ownership, then it makes sense to not tax the gain on the sale of your private, main home.  It would also then follow that one should receive a “break” on taxes if that home ownership resulted in a loss on the sale.   Removing concerns such as the concern for a profit, or a loss, frees up buyers and sellers allowing them to make decisions to sell a home without an expectation of severe negative impacts at a later date.

There are far more economic benefits to my modest proposal.  For instance, it allows someone who had to take a loss (most likely forced by pending foreclosure, or a move) to more easily move into another home.

I would encourage you to submit your own positive impacts as comments here, and if you support this idea, please write to YOUR congressperson.  You can find them at this link.