Tag: pricing

Monetising volatility

I’m catching up on old newsletters now – a combination of job and taking my email off what is now my daughter’s iPad means I have a considerable backlog – and I found this gem in Matt Levine’s newsletter from two weeks back  ($; Bloomberg).

“it comes from monetizing volatility, that great yet under-appreciated resource.”

He is talking about equity derivatives, and says that this is “not such a good explanation”. While it may not be such a good explanation when it comes to equity derivatives itself, I think it has tremendous potential outside of finance.

I’m reminded of the first time I was working in the logistics industry (back in 2007). I had what I had thought was a stellar idea, which was basically based on monetising volatility, but given that I was in a company full of logistics and technology and operations research people, and no other derivatives people, I had a hard time convincing anyone of that idea.

My way of “monetising volatility” was rather simple – charge people cancellation fees. In the part of the logistics industry I was working in back then, this was (surprisingly, to me) a particularly novel idea. So how does cancellation fees equate to monetising volatility?

Again it’s due to “unbundling”. Let’s say you purchase a train ticket using advance reservation. You are basically buying two things – the OPTION to travel on that particular day using that particular train, sitting on that particular seat, and the cost of the travel itself.

The genius of the airline industry following the deregulation in the US in the 1980s was that these two costs could be separated. The genius was that charging separately for the travel itself and the option to travel, you can offer the travel itself at a much lower price. Think of the cancellation charge as as the “option premium” for exercising the option to travel.

And you can come up with options with different strike prices, and depending upon the strike price, the value of the option itself changes. Since it is the option to travel, it is like a call option, and so higher the strike price (the price you pay for the travel itself), the lower the price of the option.

This way, you can come up with a repertoire of strike-option combinations – the more you’re willing to pay for cancellation (option premium), the lower the price of the travel itself will be. This is why, for example, the cheapest airline tickets are those that come with close to zero refund on cancellation (though I’ve argued that bringing refunds all the way to zero is not a good idea).

Since there is uncertainty in whether you can travel at all (there are zillions of reasons why you might want to “cancel tickets”), this is basically about monetising this uncertainty or (in finance terms) “monetising volatility”. Rather than the old (regulated) world where cancellation fees were low and travel charges were high (option itself was not monetised), monetising the options (which is basically a price on volatility) meant that airlines could make more money, AND customers could travel cheaper.

It’s like money was being created out of thin air. And that was because we monetised volatility.

I had the same idea for another part of the business, but unfortunately we couldn’t monetise that. My idea was simple – if you charge cancellation fees, our demand will become more predictable (since people won’t chumma book), and this means we will be able to offer a discount. And offering a discount would mean more people would buy this more predictable demand, and in the immortal jargon of Silicon Valley, “a flywheel would be set in motion”.

The idea didn’t fly. Maybe I was too junior. Maybe people were suspicious of my brief background in banking. Maybe most people around me had “too much domain knowledge”. So the idea of charging for cancellation in an industry that traditionally didn’t charge for cancellation didn’t fly at all.

Anyway all of that is history.

Now that I’m back in the industry, it remains to be seen if I can come up with such “brilliant” ideas again.

Gym pricing

In a weird sort of way, this is a blog-length expansion of a flippant thought I put out as a tweet.

Back to topic – gym memberships are a bundle. They bundle together the ability to use the gym over a long contiguous block of time. It doesn’t matter whether you want to go once a week or every day, in most gyms you have no choice but to buy the full bundle.

In some gyms (such as the one I was a member of before the lockdown started), there was more than the opportunity to use the equipment that was thrown into the bundle – the gym conducted lots of group classes every day. The option to join one of these classes (or maybe more – I never tried) was also bundled into the membership. Similarly, in an earlier gym I was a member of, the membership came bundled with the option to use squash courts, and use the gym bar.

The bundling made sense – cognitively it was easy on the members. The advantage of bundling is that marginal costs are kept at zero, which means mental accounting becomes far easier. Should I go to the gym today? I only need to think about whether I have the time and want the exercise. The decision is not complicated by money that I might have to spend. Similarly, should I join the class or just lift weights? Again depends upon mood and not on whether I need to pay anything for anything.

In any case, the pandemic and lockdown completely ruined the bundle. A lot of the options that were part of the bundle were forced to expire un-exercised since the gym was mandated to be closed (it’s unclear if they’re giving us any extensions of memberships once they restart this week).

Moreover, once the gyms restart (while they have been allowed to start on Wednesday, so far there’s been no communication from my gym on when they’re actually starting), they are likely to want to ensure some sort of social distancing. This means that the sort of bundles that they would sell earlier will be very hard to sustain.

Earlier, the bundle had both the option to attend the rather crowded 6:30 am class or the rather empty 9:30 am class. There was no differential pricing, and for good reason – mental costs were kept low. Now, in case the gym decides that the number of people per class needs to be capped (mgiht have to do that to ensure social distancing), the bundle will become unworkable.

It will be as if the members who can only attend the rather crowded 6:30 am class and no other class are part of the same chit fund, betting against each other so that they can attend their favourite class. From the gym’s point of view, this is not workable.

While gyms worldwide have for long benefited from extreme bundling (with massive discounts for long-term contracts), with the understanding that people won’t utilise a large portion of that bundle, the post-pandemic era that restricts the number of people who can attend the gym at the same time might cause this model to unravel.

It will be interesting to see how the gym pricing models evolve. I liked this model that a gym my wife briefly attended follows – which was like the mobile phone plans of olden days. For a fixed sum, you would be entitled to a certain number of classes that had to be utilised in a certain number of days (eg. 6 classes in a month). And then you would have to book online to book a class and exercise each of these options.

Then again, a lot of gyms belong to what I call the “passion economy” – people who are in business because they are passionate about something rather than because they are good at business. So I don’t know how rational they will be with their pricing.

The World After Overbooking

Why do you think you usually have to wait so much to see a doctor, even when you have an appointment? It is because doctors routinely overbook.

You can think of a doctor’s appointment as being a free option. You call up, give your patient number, and are assigned a slot when the doctor sees you. If you choose to see the doctor at that time, you get the doctor’s services, and then pay for the service. If you choose to not turn up, the doctor’s time in that slot is essentially wasted, since there is nobody else to see then. The doctor doesn’t get compensated for this as well.

In order to not waste their time, thus, doctors routinely overbook patients. If the average patient takes fifteen minutes to see, they give appointments once every ten minutes, in the hope of building up a buffer so that their time is not wasted. This way they protect their incomes, and customers pay for this in terms of long waiting hours.

Now, in the aftermath of the covid crisis, this will need to change. People won’t want to spend long hours in a closed waiting room with scores of other sick people. In an ideal world, doctors will want to not let two of their patients even see each other, since that could mean increased disease transmission.

In the inimitable words of Ravishastri, “something’s got to give”.

One way could be for doctors to simply up their fees and give out appointments at intervals that better reflect the time taken per patient. The problem with this is that there are reputation costs to upping fee per patient, and doctors simply aren’t conditioned to unexpected breaks between patients. Moreover, lower number of slots might mean appointments not being available for several days together, and higher cancellations as well, both problems that doctors want to avoid.

As someone with a background in financial derivatives, there is one obvious thing to tackle – the free option being given to patients in terms of the appointment. What if you were to charge people for making appointments?

Now, taking credit card details at the time of booking is not efficient. However, assuming that most patients a doctor sees are “repeat patients”, just keeping track of who didn’t turn up for appointments can be used to charge them extra on the next visit (this needs to have been made clear in advance, at the time of making the appointment).

My take is that even if this appointment booking cost is trivial (say 5% of the session fee), people are bound to take the appointments more seriously. And when people take their appointments more seriously, the amount of buffer built in by doctors in their schedules can be reduced. Which means they can give out appointments at more realistic intervals. Which also means their income overall is protected, while still maintaining social distancing among patients.

I remember modelling this way back when I was working in air cargo pricing. There again, free options abound. I remember building this model that showed that charging a nominal fee for the options could result in a much lower fee for charging the actual cargo. A sort of win-win for customers and airlines alike. Needless to say, I was the only ex-derivatives guy around and it proved to be a really hard sell everywhere.

However, the concept remains. When options that have hitherto been free get monetised, it will lead to a win-win situation and significantly superior experience for all parties involved. The only caveat is that the option pricing should be implemented in a manner with as little friction as possible, else transaction costs can overwhelm the efficiency gains.

More On Direct Listings

Regular long-time readers of this blog might know that I’m not a big fan of IPO pops (I’ve written about them at least four times so far: one, two, three and four). You can think of this as Number Five, though this is specifically about Direct Listings.

In case you don’t have patience to click through and read my posts, what is the big deal about direct listings? And what is the problem with traditional IPOs? To put it simply, companies looking to raise capital through IPOs are playing a one-time game (you only do an IPO once), while companies that are investing in them are playing a repeated game (they participate in pretty much every IPO that comes on the market – ok may be not WeWork).

This means that investment banks, which stand between the buyer and the seller in such cases, have an incentive to structure the deal to favour the (repeated) buyers, and they price the IPO conservatively. This means that when the company actually lists on the market, it usually does so at a price higher than the IPO price, resulting in a quick win for the IPO investors.

This is injurious for the original investors in the company (founders, VCs, employees) since they are “leaving money on the table”. A pop of 10-20% is considered fair game (a price for the uncertainty on how the market will react to the IPO), but when MakeMyTrip lists 60% higher, or Beyond Meat lists 160% up, it is a significant loss to the early shareholders.

Over the last few months (possibly after the Beyond Meat IPO), Silicon Valley has woken up to this problem of the IPO pop, and suggested that the middleman (equity capital markets divisions of investment banks) be disintermediated from the IPO process. And their vehicle of choice for disintermediation is the direct listing.

A direct listing is what it is. Rather than raising fresh capital from the market, the company picks an auspicious date and declares that on that date its stock will list on the exchanges. The opening auction in the exchange on that day sets what is effectively the IPO price, and the company is public just like that.

Spotify was among the first well-known companies in recent times to do a direct listing, when it went public in 2018. Earlier this year, Slack did a direct listing as well. Here is Benchmark Capital’s Bill Gurley (a venture capitalist) on the benefits of a direct listing.

Direct Listing is all well and good when a company doesn’t have to raise capital. The question is how do you go public while at the same time raising capital (which is what a traditional IPO does)? Slack and Spotify were able to do the direct listing because they didn’t want capital from the IPOs – they just wanted to offer liquidity to their investors.

The New York Stock Exchange thinks it can be done, and has proposed a product where companies can use the opening daily auction to price the new shares being offered. There are issues, of course, about things like supply of shares, lock-ups, price support and so on, but the NYSE thinks this can be done.

NYSE’s President Stacey Cunningham recently appeared on the a16z podcast (again run by a VC, notice!) and spoke eloquently about the benefits of direct listing.

The SEC (stock regulator in the US) isn’t very happy with the proposal, and rejected it. Traditional bankers are not happy with the NYSE’s proposal, either, and continue to find problems with it (my main source of this angst is Matt Levine, who is a former ECM Banker and who thus has solid reasons as to why ECM Bankers should exist). In any case, the NYSE has refiled its proposal.

So what is the deal with direct listings?

In a way, you can think about them as a way to simply disintermediate the market. The ECM Banker, after all, is a middleman who stands between the buyer (IPO investor) and seller (company raising capital), helping them come up with a smooth deal, for a fee. The process has been set for about 40 years now, and has become so stable that the sellers think it has become unfair to them. And so there is the backlash.

Until now, the sellers were all independent entities with their own set of investors, and so they were unable to coordinate and express their displeasure with the IPO process. The buyers, on the other hand, play the game repeatedly, and can thus coordinate among themselves and with the middlemen to give themselves a sweet deal.

The development in this decade is that the same set of VC investors invest in a large number of go-to-public companies, and so suddenly you have sellers who are present across deals, and that has changed the game in a sense. And so direct listings are on every tech or investing podcast.

Among the things I wrote in my book (which came out a bit over two years ago) is that one important role that middlemen play is to reduce uncertainty and volatility in the market.

One concern with direct listings is that there can be a wide variation in the valuations by different players in the market, and the opening auction is not an efficient enough process to resolves all these variations. The thing with the Spotify and Slack listings was that there was a broad consensus on the valuation of these companies (more in line with public company valuations), a set of investors who wanted to get in and a set of investors who wanted to get out. And so it all went smoothly.

But what do you do with something like WeWork? The problem with private market valuations is that with players like SoftBank, they can be well divorced from market realities. In WeWork’s case, the range of IPO valuations that came up differed by an order of magnitude. And that kind of difference is not usually reconcilable in one normal opening auction (imagine a bid of 8 billion and an ask of 69 billion, and other numbers somewhere in between) without massive volatility going forward. In that sense, the attempted traditional IPO did a good job of understanding demand and supply and just declaring “no deal”. “No deal” is usually not an option when you do a direct listing.

OK I’ve written a lot I know (this is already 2X the length of my usual blog posts), so what do I really think about IPOs? I think all this talk about direct listings will shift the market ever so slightly in favour of the sellers. Companies will follow a mixed strategy – well known companies (consumer brands, mostly) with stable valuations will go for direct listings. Less well known companies, or those with unstable valuations will go for IPOs.

And in the latter case, I predict that we will move closer to a Dutch auction (like what Google did) among the investors rather than the manual allocation process that ECM bankers indulge in nowadays. It will have the benefit of large blocks being traded at time zero, at a price considered fair by everyone, and hopefully low volatility.

British retail strategy

Right under where I currently live, there’s a Waitrose. Next door, there’s a Tesco Express. And a little down the road, there’s a Sainsbury Local. The day I got here, a week ago, I drove myself nuts trying to figure out which of these stores is the cheapest.

And after one week of random primary research, I think I have the classic economist’s answer – it depends. On what I’m looking to buy that is.

Each of these chains has built a reputation of sourcing excellent products and selling them to customers at a cheap price. The only thing is that each of them does it on a different kind of products. So there is a set of products that Tesco is easily the cheapest at, but the chain compensates for this by selling other products for a higher rate. It is similar with the other chains.

Some research I read a year or two back showed that while Amazon was easily the cheapest retailer in the US for big-ticket purchases, their prices for other less price-sensitive items was not as competitive. In other words, Amazon let go of the margin on high-publicity goods, and made up for it on goods where customers didn’t notice as much.

It’s the same with British retailers – each of their claims of being the cheapest is true, but that applies only to a section of the products. And by sacrificing the margin on these products, they manage to attract a sufficient number of customers to their stores, who also buy other stuff that is not as competitively priced!

Now, it is possible for an intelligent customer to conduct deep research and figure out the cheapest shop for each stock keeping unit. The lack of quick patterns of who is cheap for what, however, means that the cost of such research and visiting multiple shops usually far exceeds the benefits of buying everything from the cheapest source.

I must mention that this approach may not apply in online retail where at the point of browsing a customer is not “stuck” to any particular shop (unlike in offline where a customer is at a physical store location while browsing).

Variable pricing need not be boring at all!

Who do you subsidise?

One basic rule of pricing is that it is impossible for all buyers to have the same consumer surplus (the difference between what a buyer values the item at and what he paid). This is because each buyer values the item differently, and is thus willing to pay a different price for it. People who value the item more end up having a higher consumer surplus than those who value it less (and are still able to afford it).

Dynamic pricing systems (such as what we commonly see for air travel and hotels) try to price such that such a surplus is the same for all consumers, and equal to zero, but they never reach this ideal. While the variation in consumer surplus under such systems is lower, it is impossible for it to come to zero for all, or even a reasonable share of, customers.

So what effectively happens is that customers with a lower consumer surplus end up subsidising those with a higher consumer surplus. If the former customers didn’t exist, for example, the clearing price would’ve been higher, resulting in a lower consumer surplus for those who currently have a higher consumer surplus.

Sometimes the high surplus customer and the low surplus customer need not be different people – it could be the same person at different times. When I’m pressed for time, for example, my willingness to pay for a taxi is really high, and I’m highly likely to gain a significant consumer surplus by taking a standard taxi or ride-hailing marketplace ride then. At a more leisurely time, travelling on a route with plenty of bus service, I’d be willing to pay less, resulting in a lower consumer surplus. It is important to note, however, that my low surplus journey resulted in a further subsidy to my higher surplus journey.

When it comes to markets with network effects (whether direct, such as telecommunications, or indirect, like any two-sided marketplace), this surplus transfer effect is further exacerbated – not only do low-surplus customers subsidise high-surplus customers by keeping clearing price low, but network effects mean that by becoming customers they also add direct value to the high surplus customers.

So when you are pleasantly surprised to find that Uber is priced low, the low price is partly because of other customers who are paying close to their willingness to pay for the service. When you pay an amount close to the value you place on the service, you are in turn subsidising another customer whose willingness to pay is much higher.

This transfer of consumer surplus can be seen as an instance of bundling, but from the seller’s side. Since a seller cannot discriminate effectively among customers (even with dynamic pricing algorithms such as Uber’s surge pricing), the high-surplus customers come bundled with the low-surplus customers. And from the seller’s perspective, this bundling is optimal (see this post by Chris Dixon on why bundling works, and invert it).

So the reason I thought up this post is that there has been some uncertainty about ride-hailing marketplaces in Bangalore recently. First, drivers went on strike alleging that they weren’t being paid fairly by the marketplaces. Then, a regulator decided to take the rulebook too literally and banned pooled rides. As i write this, a bunch of young women I know are having a party, and it’s likely that they’ll need these ride-hailing services for getting home.

Given late night transport options in Bangalore, and the fact that the city sleeps early, their willingness to pay for a safe ride home will be high. If markets work normally, they’re guaranteed a high consumer surplus. And this will be made possible by someone, somewhere else, who stretched their budget to be able to afford an Uber ride.

Think about it!

Cross-posted at RQ

InMails and the LinkedIn backfire

A few months back I cleaned up my connections list on LinkedIn. Basically I removed people who I don’t “know”. I defined “know” as knowing someone well enough to connect them to someone else on my network (the trigger for a cleanup was when someone asked me to connect them to someone else on my network who I hardly knew).

The interesting thing about the cleanup was that a lot of the spurious connections I had on LinkedIn were headhunters. Thinking back at how they got in touch with me, in most cases it was with respect to a specific opportunity for which they were finding candidates. Once the specific opportunity had been discussed there was no value of us being connected on LinkedIn, and were effectively deadweight on each other’s networks.

Over the last couple of days, ever since I wrote this piece for Mint on valuation of startup ratchets, I’ve got several connection requests, all from people I don’t know. Normally I wouldn’t accept these invitations, but what is different is that most requests have come with non-standard messages attached. Most have mentioned that they liked my Mint piece and so want to either connect or discuss it.

When you want to simply exchange messages with someone, there is no need to really add them as a “friend”. Except that LinkedIn’s pricing policy makes this kind of behaviour rational.

LinkedIn offers a small number of “InMails” which you can send to people who you aren’t directly connected to. Beyond this number, each InMail costs you money. So if you want to have a discussion with someone you’re not connected with, there’s an element on friction.

There’s a loophole, however. You can send messages for free as long as they go along with a connection request. And if that request is accepted, then you can have a “free” conversation with that person.

So given the current price structure, if you want to have a conversation with someone, you simply send your initial message as part of a friend request. If the person wants to continue the conversation, the request will get accepted. If not you haven’t lost anything!

Then again, there are mitigating features – an InMail won’t get charged unless there is a reply, and LinkedIn’s UI is so bad that it takes effort to read messages attached to connection requests. So this method is not foolproof.

Still, it appears that LinkedIn’s pricing practice (of charging for InMails) is destroying the quality of the network by including spurious links. I guess they’ve done a cost-benefit analysis and believe that the cost of spurious connections is far lower than the revenue they make from InMails!

 

Water, IPL and the ease of doing business

The latest controversy surrounding the just-about-to-start ninth edition of the IPL (a court case challenging its staging in Maharashtra while farmers are dying in Vidarbha) is a clear illustration of why the ease of doing business in India doesn’t look like it will improve.

At the bottom of it, the IPL is a business, with the IPL and teams having invested heavily in team building and marketing and infrastructure. They have made these investments so far hoping to recover them through the tournament, by way of television rights, gate receipts, etc.

Now if the courts were to suddenly decide that the IPL should not take place in Maharashtra, it will mean that alternate arrangements will have to be found in terms of venues and logistics, teams which have prepared grounds in Nagpur, Pune and Mumbai will have to recalibrate strategies, and most importantly, the people of these cities who have bought tickets (they clearly believe that the value of these tickets is higher than the price) will also end up losing.

Farmers dying for lack of water is a real, and emotive, issue. Yet, to go after a high-profile event such as the IPL while not taking other simpler measures to curb fresh water wastage is a knee-jerk reaction which will at best have optical effects, while curbing the ability of businesspersons to conduct legitimate business.

There has been much talk about how policy measures such as the retrospective taxation on Vodafone or Cairn have been detrimental to investor sentiment and curbed fresh investments in India. This court case against the IPL days before it began is no different, and a strong signal that India’s policy uncertainty is not going away quickly.

Unless the political class manages to fix this, and provide businesses more stable environments to operate in, it is unlikely we’ll see significant increase in investments into India.

The problem with premium ad-free television

I watched snippets of the just-concluded ICC WorldT20 final using an illegal streaming service, which streamed content drawn from SkySports2.  The horrible quality of the streaming aside (the server seemed to have terrible bandwidth issues), the interesting thing to note was that it was completely devoid of advertisements.

With the quality of cricket coverage in India currently being abysmal due to the frequent cutting for advertisements (I remember getting thoroughly pissed off with the cuts for advertisements before the replay of a wicket was shown during the India-Australia series earlier this year), it made me think about the economics of a separate premium service that is ad-free.

The infrastructure for delivery is in place, given that internet-based legal streaming services are fairly common now (the likes of HotStar). Internet-based delivery also makes it easy to charge pay per view, so payment is also not a problem. This raises the question of whether it is a good idea for channels to monetise the demand for ad-free cricket by providing the service through online streaming, leaving the mainstream broadcast to be monetised via advertisements.

While in theory this appears like a good idea, the problem is with the kind of people who will migrate to the new service – they will be people who have the ability and willingness to pay for a higher quality broadcast. Such people are likely to belong to two overlapping categories – loyal fans of the game and people who can afford to pay a premium.

It is unlikely that the union of these two sets will comprise of too high a proportion of the overall viewership of the game, but the point is that these are the two groups who are likely to be most lucrative to advertisers – the loyal fans watch regularly and the people who are able to pay have more disposable income.

Moving such customers to an ad-free online channel might reduce the supply of advertisements which can be used to reach them, and this might not make advertisers happy. And given that television channels have cosy relationships with advertisers (or at least media buyers), they are unlikely to piss them off by moving the most lucrative customers to a premium platform.

Of course if this segmentation (between ad-free and free broadcasts) is implemented, it will also impact the price of advertisements in the free broadcast. That will need to be taken as an input while setting prices for the ad-free service. In other words, pricing is going to be a challenge!

If some television channel wants to work on this, I’m available for hire as a consultant. I’ve done a fair amount of prior work on pricing and dynamic pricing, am pretty good at quantitative methods and am in the course of writing a popular economics book.

Pricing season tickets

One observation about the crowd when I attended my first game at the Camp Nou (in October 2014, against Ajax in the 2014-15 Champions League) was how people around me all seemed to know each other. There were friendly nods and handshakes, and it was evident that these men and women were familiar with each other. They all arrived and departed independently, though, and there wasn’t much conversation during the game, suggesting they were acquaintances rather than friends.

On my second visit to the Camp Nou (ten days ago, for the 2015-16 Champions League game against Arsenal), I noticed hordes of empty seats. I was in a stand two tiers higher than where I had sat for the Ajax game, and despite that stand being priced at a princely €150, there were plenty of empty seats (my wife sat next to me for the duration of the game despite her assigned seat being one rank and a few files away). It was a cold and rainy day, but not so rainy that €150 be treated as “sunk cost”!

The common feature that explains both these phenomena is the “season ticket”. As the official club website explains,

The complete season ticket gives members the right to attend, always from the same seat, games played at the Camp Nou in official competitions: Spanish League, Champions League, Copa de Rey and UEFA Cup (emphasis added)

The reason people seated around me at the Ajax game were acquainted with each other was because they were season ticket holders, and would watch every game seated in close proximity to one another. And the empty seats for the Arsenal game were a result of season ticket holders, for whom the marginal cost of not attending the game was far less than €150, not attending the game (there is a “free seat” program that lets season ticket holders sell their ticket through official channels, but considering that the decision to not go would have been made in the last minute (given the rain) many season ticket holders may not have exercised this option.

Football clubs (and other performance venues) sell season tickets in order to create a “base load” of demand for their tickets. While these season tickets are sold at a deep discount (relative to what it costs to buy a ticket for each game), the fact that they are sold at once and at the beginning of the season means that the club can be sure of a certain amount of revenue from ticket sales, and can be assured to fill a certain proportion of seats at the stadium in every round.

Season tickets are also important because they help create a sense of loyalty among the fans, and the same fans sitting in the same spaces week after week can bond and help create a better viewing atmosphere at the club. In other words, season tickets seems like a no-brainer. Except that Hull City, which plays in the English Championship, has decided to do away with season tickets starting next season.

The official statements related to this move seem like sanitised PR (refer link above), but the linked article gives away an important piece of information that suggests why this new ticket scheme might have been brought into play:

The club said the Upper Stand would be closed, meaning 1,800 fans must be relocated, but would be opened for high-profile matches

While the club doesn’t want to admit it, the reason it is doing away with season tickets is that attendance at the KC Stadium has been falling, and it appears that there have been lots of empty seats in the stadium.

As I had noted in my earlier piece on pricing Liverpool FC tickets, there are network effects to watching a football game in the stadium. You gain value not only from what happens on the pitch, but also from the atmosphere that fans at the stadium (including you) build up. And while there are many ways in which fans can affect the watching experience of co-fans, it shouldn’t be hard to understand that empty seats do not add to the stadium atmosphere in any way.

The problem with season tickets is that even with programs such as “free seat” (where the season ticket holder can get paid for giving up their seat), the cost for a season ticket holder to not attend a game is extremely low. And when several season ticket holders decide to not attend certain games, it can lead to rather low attendances, and diminished stadium experience for the fans who do end up attending.

This network effect – of fans helping shape experience of fellow fans – makes the sale of football season tickets different from that of long term cargo contracts, for example. You not only seek to assure yourself of revenues by selling season tickets, but also seek to fill a certain portion of the seats for every game through such a program, and help create the experience.

And when your fans are being delinquent (by purchasing season tickets but not attending), your first action would be to increase the price of such season tickets so that only “serious fans” will buy it and the (sunk) cost of not attending a game is higher. It seems Hull City has already gone through one such exercise, and raised its season ticket prices, which hasn’t helped drive overall attendances.

Hence, the club has decided to do away with season tickets altogether. With the new rolling monthly ticket program, fans will purchase if and only if they are confident of attending a certain number of games. On the one hand, this pushes up the cost of not going for a game, and on the other, allows the club to manage its revenues on a larger portion of the tickets.

From a revenue point of view, this is a risky strategy, as the club foregoes assured revenues from season tickets in favour of more volatile monthly ticket revenues, and greater tickets to sell in the open market before every game. However, considering the network effects of watching football in a stadium, what the club is banking on is that this measure will help them fill up their stadium more than before, and that the improved atmosphere that comes out of that can be monetised in the long run.

It’s a bold move by Hull City to improve football attendances. If it works out, it offers a way out for other clubs that are currently unable to fill their stadiums. But you must remember that optimisation here takes place on two axes – revenues and crowds!