TCS Daily


The Elusive Xbox Price-Point

By Josh Hendrickson - January 26, 2006 12:00 AM

I want an Xbox 360. Unfortunately there is a shortage of the game console and it can currently only be found on eBay for well above its retail price. Meanwhile Microsoft is selling the console below cost in hopes of future reductions in hardware costs as well as increased revenue from licensing fees and games. This makes me wonder why Microsoft does not sell the console for a higher retail price.

Recently, "The Undercover Economist" Tim Harford wondered why the retail prices on Xbox 360 game consoles were so low. He determined, in part, that Microsoft might shy away from raising its price due to its continued battle with regulators. Nevertheless, there could be a solution that benefits the buyer and the seller.

Economists study the allocation of scarce resources. Xbox 360 is scarce today. And they study auctions because auctions are an efficient and accurate instrument used to determine prices for scarce resources.

The company should be able to use price discrimination to sell its game consoles. What this means is that Microsoft should be able to charge the maximum price that each individual is willing to pay. Therefore someone may pay the retail price of $399, while someone else may pay the $700 the console has sold for on eBay.

Now, it is unlikely the employees at Best Buy, or any other electronics retailer for that matter, would be able to determine the maximum amount its customers were willing to pay for the game console. Given that the Xbox has been selling on eBay for prices much higher than its retail price, Microsoft could simply cut out the middleman and have an auction of its own. Rather than shipping the new game consoles to electronics retailers nationwide, Microsoft could list individual auctions for the initial release of the Xbox 360 on its website. By doing so, Microsoft would be able to attract all individuals willing to purchase the new Xbox (even those like me who are unwilling to wait in long, cold lines). They would have many different options for the auction.

One option for Microsoft would be an auction that lasted seven days and featured bidding similar to that of eBay where each person enters their maximum bid, but the bid increases only by increments. After seeing the results of the auctions on eBay there is reason to believe that the vast majority of game consoles would likely be sold well above the retail price. Also each console would likely have a small deviation from the mean selling price because each bidder would continually bid on the lowest priced console thus lifting the price of the lot.

A modified option would be for Microsoft to register potential buyers and restrict them to betting on any one in a small group of consoles rather than the entire lot. In this case I would expect to see some game consoles selling for prices upwards of $700 while others sold below the retail price because ultimately there would be groups that are willing to purchase the Xbox at any cost and others that would be more frugal.

Alternatively the company could have a Dutch auction where prices begin high and are then dropped until a bidder accepts the going price. Although I would expect this type of auction to be successful, it may be hard to administer this type of auction given that there would be hundreds of thousands of Xboxes on which to bid. A Dutch auction works best when there is only one item. Nevertheless, if Microsoft used this format I would expect the consoles to sell above the retail price because once a larger number of individuals accepted the going price -- a domino effect would lead to the sale of many others due to the fear that they would end up without the new console.

Even though Microsoft would in theory see a larger profit using an auction, there is still no guarantee that they would adopt such a technique. The company may fear that by selling their product directly to consumers they would alienate electronics retailers. Additionally, the distribution costs of shipping individual game consoles to each consumer rather than hundreds or thousands to distribution centers would be substantially higher. Microsoft executives may also believe that the status quo is somehow less risky.

However, the situation with the Xbox 360 is unique. Unlike the Tickle Me Elmo and the Cabbage Patch dolls, consumer goods that experienced major shortages, game consoles require the user purchase games in order to use them. Therefore retailers should not feel alienated because considerable revenue is generated not just from the consoles themselves, but from the games. Also, since the Xbox 360 is being sold at a loss, Microsoft should be more willing to incur higher distribution costs given the chance of making a profit.

Microsoft would have little to lose by attempting an auction. Preliminary estimates suggest the retail price of the Xbox 360 is twenty to forty percent lower than the cost. Additionally, there would be little fear about alienating retailers because they can still increase revenue from game sales. Auctions are not infallible and there can be mistakes, but in this case the reward appears to outweigh the risk. Besides, then I might not have to wait out in the cold to get one.

Josh Hendrickson maintains a blog entitled "The Everyday Economist" (http://everydayecon.com).
Categories:

2 Comments

what it show is
There is a big difference between reality and Economists view of reality. It's easy to stand on the sides lines and say how you could do it better but in the end their doing and your theorising.

Microsoft strategy
Microsoft has a very clear strategy here. The only problem they have is with production (shortage).

They are selling the consoles at a loss to grab market share prior to the PlayStation 3 launch. This is smart because the real money to be made on these systems is games. More market share = more profit per game = more games written for the Xbox.

They could care less that people are profiting from buying XBoxes and reselling them on EBay... in fact the hype around it is probably helping them. This is a pure play for market share prior to the launch of a superior competing product (PS3).

TCS Daily Archives