Co-Opetition - Adam M. Brandenburger [112]
On Wall Street, some people make their livelihood from creating complexity. They take a simple financial instrument, such as a mortgage, and split it up into half a dozen or so esoteric components that can trade separately. By turning one market into half a dozen, the market makers greatly increase the scope for trading. Because each component trades independently, it’s easy for prices to get out of line. If the components are collectively underpriced, traders can buy up all the parts, put them back together to re-create the original instrument, and sell that at a profit.21 Yale School of Management finance professor Steve Ross has a pithy way of explaining why traders value complexity: “Not everyone realizes that pulp, seeds, peel, and juice can be combined to form an orange.”
Creating Complexity
Complex pricing schemes create a fog that obscures the true price. From the seller’s perspective, that’s sometimes just as well. The Nintendo Entertainment System premiered at a price of $100. That sounds cheap enough. But parents soon found themselves in for a penny, in for a pound. Buying the machine was only the beginning. After that came the game cartridges. On average, families bought eight or nine cartridges for the machine, at $50–$60 each. The lifetime cost? Around $550. Had parents been more aware of this number at the outset, perhaps they might have better resisted their kids’ pleadings for a Nintendo.
Microsoft Windows 95 debuted at $85. A true bargain? Yes, but not quite as good as it looks. People soon discovered that there were several hidden costs. To run Windows 95 effectively, they had to buy more memory ($360), a bigger hard disk ($200), and a faster microprocessor ($300). The cost of the software was the proverbial tip of the iceberg; 90 percent of the costs were hidden.
People get particularly upset if sellers hike prices in response to a spike in demand. That’s why sellers sometimes try to hide price rises in a fog. In college towns, there’s always a shortage of hotel rooms on graduation weekend. Instead of raising price, some hotels sell only four-day packages. Parents coming into town to see their son or daughter graduate might want a room for one night, but they have to buy three extra nights. The net effect is no different from a 300 percent increase in room rates, but people apparently don’t perceive it this way, perhaps because they get the option of staying the extra nights. In Geneva, participants in the Telecom ’95 conference saw this practice taken to a new extreme. Responding to a flood of requests for accommodations, an ideally located establishment—we’ll call it Hotel Noah—offered rooms at the apparently reasonable rate of $350 per night. Minimum stay: forty nights. Unbelievable! One skillful negotiator reported: “I managed to negotiate the terms down to a minimum of twenty-six nights.”22 Not bad, but the conference lasted only ten days.
You might imagine that hotels don’t create much fog with these tactics. After all, they’re not much more than thinly disguised price increases. Still, creating even a little fog can be much better than acting in a way that’s plain for all to see. Following the destruction caused by Hurricane Andrew in 1992, Georgia-Pacific jacked up its lumber prices in Florida. Georgia-Pacific appeared to be profiting from others’ misfortune. As a result, the company found itself at the center of a storm of its own making. There was immense public criticism, even an investigation by the Florida Attorney General’s Office. Georgia-Pacific would have done better had it raised price only a small amount and, as a quid pro quo, gotten long-term contracts