CS99I Meeting 12 Notes: Dynamic Pricing and Auctions, Stock Valuation
Started by Gio Wiederhold, 27 February 2001,
updated Feb 21, 25 2002.
Dynamic Pricing
The rapid interaction feasible on the web allows new ways of charging for goods. Auctions have been a traditional way for adjusting prices rapidly.
An
assumption is that broad dissemination of knowledge will make all customers
(that use the web) equally powerful.
See Meet06Notes.html for Paying
Auctions
In the
past, mainly used for unique, valuable (non-fungible) items, where common
distribution mechanisms fail. The auctioneer provides links, marketing, escrow
services etc., and lives of a cut of the sales price (3-10%?) Most auctions are
local (for goods of modestly high value, that are unlikely to be shipped far,
unless purchased by dealers). There are some large auction houses (Christie's
etc) that have specialized in very valuable items, and provide services
(telephone) for remote bidders. All are entering the on-line market. One
(Butterfield's) has been acquired by eBay.
Various
models, but generally the highest bid at closing time gets the goods for that
price. In eBay, when lots of identical are auctioned, all pay the same price,
which is the lowest of the winning prices. eBay does not provide escrow -- the
seller and buyer must contact each other to arrange pay and delivery, but bad
(and good) experiences with sellers (and buyers?) are posted and easily
available, providing some degree of protection.
The
on-line model has been attractive to a much broader range of customers than
traditional auctions. It has allowed auctioning of relatively small value items
(Pez-=dispensers initiated eBay). It is also used by vendors of fungible items,
who gain broad exposure. For about $100 a vendor can place him/herself on a
weekly? list of `hot' auctions and gain yet more visibility.
The
popularity of eBay is in part due that it provides a rapid and broad means for
comparison shopping. Although the selling model differs, having an item of
interest available on eBay and seeing the bidding provides a base indication of
the market, and can be used as a base for conventional shopping expectations as
well. It has been noted [] that purchase prices at auctions do not indicate
low, or rational prices, since the final price is the highest one, and may well
be affected by the excitement of the game or similar emotional factors.
Other
auction models include
Dutch
Auctions: Going down in price until goods are purchased
Dynamic
Pricing: Payment amount varies with demand, for goods in limited supply, e.g.,
Easyjet.com Price for flights starts
at about50%, increases when 30, 60, 80% of seats are sold to full price. Requires payment commitment—just like
any auction.
Internet Stock Valuations (expanded from notes from Bill Burnham presentation 2001)
Why do
investors view Internet companies as being different from brick and mortar (BnM)
companies?
positive: Low cost of capital, leads to higher return
on investment (ROIC). Ability to reach economically world-wide (except for shipping
costs).
negative: The customer base is volatile. Low capital cost invites excessive competition (Internet bubble, see slides on Web Growth )
For a
new enterprise that does not yet sell much (revenue) but spends much to get established
(costs are: people, rent, equipment, software, advertising), and hence has a
negative cashflow (revenue -cost) it is difficult to assess the value.
Similarly,
for an old enterprise that is threatened by new enterprises, historical valuations
will be overly optimistic (say paper-based information services).
In
rational analysis one must look at
1.
market segment
-- is it suitable for the Internet (seller's expertise and knowledge can be demonstrated,
exploited over the net, the goods are fungible items, economical to ship, few
expected returns, ... )
2.
uniqueness: is
there a hold on the market segment (natural monopoly, irreplaceable expertise, exclusive
contracts with suppliers or delivery systems) which will provide stability
3.
number of
customers: many customers increases the total market size, but invites more
competition, gives local BnM sites advantage (say groceries). Metcalf's law:
Network size has a squared advantage -- applies to information interchange.
4.
growth: Stock valuations
that are significantly higher than expected from profits are based on expected
growth of market in terms of quantities sold. Expectations based on extremely
high profit ratio are risky, since that invites competition unless truly unique.
(example: AOL growth in customers,
in 2000, days to add 1M customers: 12 to13M took= 133 days, 13-14 = 77, 14-15 =48,
15-16= 41 days.
Valuation
is volatile when it is based mainly on expectation of growth rather than on
current positive cashflows are way out.
For stability consider for Customer-oriented businesses (C2B) what services do they provide
- Content players: get income live from ads, sponsorship, rarely fees (micropayments are hard). Are threatened by low switching costs {Yahoo, Marketwatch , }. Customer loyalty is based on service quality and relevance.
- Transaction players : Transaction revenue, but commodity business: {Amazon, ETrade, Citibank, BankOne}. Customer loyalty is based on price?
Content provides may loose customers if they are viewed as being biased. Some consolidators (Priceline?) show all prices, but the default is that their sponsors appear first. Transaction linkage is more commonly done by smaller content providers.
Content players can go into partnership with transaction-oriented B2C, B2B firms, lessening the direct impact of potential bias -- equivalent to having ads in the newspaper. They could also acquire some, or integrate them as new services. Example NY Times links to Barnes and Noble. See BuyNow.com. [Bill Burnham, general partner, Softbank Capital Partners, LLC]
Since Information has value, businesses may want to protect it. However, proprietary control is being destroyed by technology, by consolidators. Examples are {Yodlee.com MaxMiles.com, VerticalOne.com} Companies are trying to fight this trend, for instance FirstUnion is trying to stop Paytrust from getting to its customer credit-worthiness records. The suit cites nominally privacy, but really addresses proprietary concerns. Keeping information that is published for sale private is a losing battle [Bill Burnham].
·
A reasonable ratio
for the ratio of profit versus the stock price is 10% -- i.e., without growth it
would take 10 years of steady profits to repay the original sum. Since there is
a risk in stocks, it should be better than investing funds in something stable.
·
If the company
does not make a profit then the expectation must be based on future profit and revenue,
and revenue growth becomes a big factor. One then applies a high, but reasonable
profit margin to time periods in the future. When something is novel, the profits
will be high, but since high profits invite competition, they must eventually
be scaled down.
·
If a startup
company does not yet sell anything - i.e., has no revenue, then it is really a
bet on the people and the value of their intellectual property (IP), their
ideas and their capabilities to make it work. One measure could be: how much
would an established company pay for the startup if it the concept is proven. That
would be based in turns on the benefits such a company would gain from the people
(who are actually quite volatile) and the IP.
Companies
that start up will not have stock on the open market, so their value is not
judged by many people, only by themselves, their initial investors, and the
venture funders they attract. The
venture funders, since they typically aggregate funds from investors, must justify
their stock valuation based on future expectations, namely that the stock will
be more valuable once it reaches the open market after an IPO (Initial Public
Offering )
High stock
valuations are due to high expectations. Some expectations are valid -- the world is changing.
But it is unclear on who will win in the future world?. Some due to investment
bankers pressures. Portofolio managers have to buy some risky company stocks to
justify their pay, because otherwise they perform less than others, and they
get no bonuses. But losses don't affect them as much. In 2000 60% all new
capital was flowing into technology, more than made good sense, which led to a devaluation
of underwriting standards. Frustrating for conservative CEOs.
IPOs can
rapidly become an orphan stock, ie., lose all value, even if the company continues:
example TheGlow. But without having valuable stock it is hard to obtain more money
from investors. "A shakeout will come "( written in 2000).
Third
circle companies that support the Internet infrastructure were considered good
bets in 2000, since they support a broad range of Internet services (Telecom, CISCO). However, they also suffered greatly, since
so many of their customers disappeared. Since this group had to invest more capital
in hardware, they had larger debts, reducing their ability to scale down.
Marketshare
E2B is
hard (CommerceOne convinced GM) (but only one deal for GM) Vertical net is a
mile wide, one inch deep, good selling, and no can acquire stuff. Also done by
CISCO, acquires companies started by its engineers that have quit. `Dream has
become a belief'
International
presence differs. Softbank supports incubators all over, using it to replicate
US ideas. QXL knocked of EBay that way in Great Britain. Internationalizing
180-flowers was hard due to local gift preferences, perishable. Requires more corporate
work, not only local partnership. [Bill Burnham].
How will the market split up [Burnham]
Unclear is the trend of broad-based (YaHoo, AltaVista) versus focused, In-Context (iVillage, DiabetesWebSite.org) access points. InContext commerce has many benefits, in that there is less irelevant material. In-context commerce makes it possible to monetize a customer base with other commerce and content. If a domain aggregator gets 5 million loyal affinity customers, it is powerful. (similar to a specialized magazine).
To survive, sites need Barriers to Exit, as deals, community spirit, etc. Now AOL earns 70% of income from subscriptions. But when access can be free, what happens? (Can AOL become just an infrastructure provider?)
A simple customer incentive is free Internet access. But what comes then? See All-Advantage, since May 1999, now 2 M customers, 400 employees. Profitable in Sept 1999. Business model pay users 50c per hour. Also make money when referring people `multi-level business model', discourages exit.
Now unstable equilibrium. [Bill Burnham].
Notes
See BRittania Website [Computerworld July 2000] article.