Tuesday, 26 September 2017

Tesla, damaged goods and price discrimination

I'm a bit late to this story, as reported in TechCrunch:
Tesla has pushed an over-the-air update to some of its vehicles in Florida that lets those cars go just a liiiittle bit farther, thus helping their owners get that much farther away from the devastation of Hurricane Irma.
Wondering how that’s even possible?
Up until a few months ago, Tesla sold a 60kWh version of its Model S and Model X vehicles — but the battery in those cars was actually rated at 75kWh. The thinking: Tesla could offer a more affordable 60kWh version to those who didn’t need the full range of the 75kWh battery — but to keep things simple, they’d just use the same 75kWh battery and lock it on the software side. If 60kWh buyers found they needed more range and wanted to upgrade later, they could… or if Tesla wanted to suddenly bestow owners with some extra range in case of an emergency, they could.
And that’s what’s happening here.
Price discrimination occurs when different consumers (or groups of consumers) are charged different prices for the same good or service, and where the difference in price does not arise because of a difference in cost. This is clearly price discrimination, since the same battery was selling for different prices to different customers (even though the customers didn't know this!). The excellent Jodi Beggs also covered the story at Economists Do It With Models:
First, I guess I should point out that this [the update that increased battery capacity for Tesla owners in Florida] is a nice thing to do. But…you mean to tell me this whole time you were just sandbagging some of the batteries???? That’s…bold, among other things. I hope the warm fuzzies you get for this gesture outweigh whatever customer fury may be heading in your direction…(personally, I can’t decide whether I would be more irritated if I had or hadn’t paid for the better battery)...
People typically aren’t thrilled when they hear the phrase “price discrimination,” since they seem to assume it’s just another fun way for a company to rip them off. Not all of these customers are wrong- it’s entirely possible that some customers pay higher prices than they would otherwise if a company decides to price discriminate. That said, it’s almost always the case that price discrimination results in lower prices for some customers, and it’s even possible that price discrimination results in lower prices for some customers without subjecting any customers to higher prices.
The interesting thing about the story is that Tesla was effectively selling the same product to both groups of customers, but purposely degrading the performance of the battery for the cheaper version of the cars. Alex Tabarrok on Marginal Revolution notes:
But why would Tesla damage its own vehicles?
The answer to the second question is price discrimination! Tesla knows that some of its customers are willing to pay more for a Tesla than others. But Tesla can’t just ask its customers their willingness to pay and price accordingly. High willing-to-pay customers would simply lie to get a lower price. Thus, Tesla must find some characteristic of buyers that is correlated with high willingness-to-pay and charge more to customers with that characteristic...
The classic paper in this literature is Damaged Goods by Deneckere and McAfee who write:
"Manufacturers may intentionally damage a portion of their goods in order to price discriminate. Many instances of this phenomenon are observed. It may result in a Pareto improvement." 
Note the last sentence–damaging goods can be beneficial to everyone!
It makes sense for firms to damage their own goods, if that allows them to effectively price discriminate - to charge high prices to those who are willing to pay a high price (or who have relatively inelastic demand) for the undamaged good, and charge low prices to those who are not willing to pay a high price (or who have relatively elastic demand) for the undamaged good. But this will only work if those with high willingness-to-pay (or relatively inelastic demand) would not be attracted by the lower-priced damaged goods. Which it appears was the case for Tesla. It remains to be seen what post-Irma fallout, if any, Tesla will face.

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