Diamonds as durable goods; are they forever?

First, a quick overview of the diamond market.  Diamonds are a multi billion dollar business (Diamond Jewelry business valued at $74.2 Billion).  Diamonds are durable goods, meaning they last for several time periods.  Operating under a value chain framework (company value adding through multiple mediums), the diamond business is segmented into Miners and Producers, Cutters and polishers, Jewelry Manufacturers, and retailers.  About 133 million carats of rough diamonds are produced each year, and in fact four control about 65 percent of the market (De Beers controls about 35% of the market).  Diamond Giant De Beers in a 2004 interview with Fox Business warned that diamond prices could rise in the coming years as the gemstones become rarer.  No matter how big the mine is, one still has to move rocks to get a very small number of diamonds.

But, are diamonds really that rare?  Companies such as De Beers face criticism for the belief that large scale mining projects across the world invest billions of dollars every year to produce and control the supply chain, and in the end knowing the demand for diamonds will not be reduced by the end consumer.  Their is criticism that De Beers has created a monopoly trading industry, where the supply is controlled.  Coase’s conjecture states that “a durable goods monopoly that sells its product has less market power… when compared to a monopoly that rents the durable good”.  The paradox is, when selling a durable good, more market power leads to less market power.  Basically, the theory that there is no difference in outcome between renting and selling if consumers are convinced that the monopoly will continue with its pricing policy in the future does not hold based on De Beer’s current market moves.  The company is now trying to solve the problem of consumer expectations.  For a durable goods monopoly; you are trying to rent instead of sell, convince consumers that future production will be limited, produce less durable goods as a monopoly, and get a reputation for never lowering prices  De Beers cartel relies on controlling quantity to artificially increase price as part of their anticompetitive tactics.  If prices fall, De Beers reduces supply.  If new suppliers emerge, De Beers will flood market and sell below market prices.  Essentially, these tactics have allowed De Beers to have arguably the largest and longest lasting monopoly of all time.  Yet, their realization of current consumer trends and furthering incentives to lower prices has forced them to shift their focus to marketing and brand name.  It be kind of disheartening to spend thousands of dollars on a ‘rare” diamond jewelry and then realizing that the price is artificially controlled.

Sources Consulted

https://are.berkeley.edu/~sberto/DeBeers2008.pdf

http://www.wakingtimes.com/2016/02/13/when-ignorance-isnt-bliss-the-truth-about-the-diamond-industry/

http://www.cnbc.com/2016/06/16/blame-millennials-diamond-jewelry-business-in-a-rough-spot.html

Movie Theaters: how do they make their money? What does that imply about movie distributor contracts with theaters?

On the contrary to popular conception, the movie theaters themselves rarely make any money of the tickets of the movies that they are showing inside the theater.  So how do theaters make their money?  Concession Margins.  Most of the theaters’ money comes from concessions.  Theaters can stay in business because the profit margins on drinks and food is so high.  Fountain drinks cost pennies to make, including the cup/lid/straw, so profit ratio is massive.  Popcorn is likewise really cheap, and they also charge a huge markup for it.  Their fixed costs with employees also leads to zero marginal costs for movie theaters in regards to selling concessions.  As Time magazine puts it in 2009, “Movie Theaters make 85% profit at concession stands”.

Looking at the price discrimination graph below, Movie theaters markups in their concessions are reflective of second degree price discrimination, meaning that the theaters charge a different price for different quantities.  This applies for movie ticket sales/food quantity.  Price discrimination is the action of selling the same product at different prices to different buyers, in order to maximize sales and profits.   The tickets are a form of price discrimination as well for their are different ticket prices for certain age demographics.

In the case above, the seller charges a higher per-unit price for fewer units sold and a lower per-unit price for larger quantities purchased (hence why theaters still implement family deals to attract customer initiatives.  The seller is attempting to extract some of the consumer’s surplus value as profits with residual surplus remaining with the consumer over and above the actual price paid.  Thus, high margins under a movie theater framework.

In movie distributor contracts with theaters, the movie studios leases a movie to the the local theater for a set period of time.  Movie distributors make deals with the theaters in regards to tickets, and there are several terms that are agreed to: Set figure negotiated by the theater to cover basic expenses each week, percentage split for next box office is set (amount of box office left after the deduction of house allowance), percentage split for gross box office is set, length of engagement set.

For example, I pay $10 to go see La La Land at my local theater in their opening week, in which the the first week or two of the showing the theatre itself gets to keep only 20-25% of that $10 per unit.  As the theater moves into the third and fourth weeks of release, the percentage starts to swing anywhere from 45%-55% that the theater gets to keep.  Usually towards the end of the movies lease, the audience number starts to really decrease and the higher percentage allocation towards theater at that time means really little.  More often than not, the theaters itself are willing to lose money in the first week or two of a popular movie opening (giving distributors higher percentages) so they can generate higher volume in  people going to the concession stands, where the margins are high and they keep 100% of the profits.

Different films make different deals with theaters, so the exact percentage is different from film to film, but it always involves theaters agreeing to a small cut at the start and an ever growing percentage over time.  Ultimately, the real money for theaters comes from their concession stands, despite their actions to generate revenue from ticket sales.  For movie studios, they are more concerned with revenue maximizing rather than profit maximizing based on the structure of the studio/theater arrangement.

 

Sources Consulted:

Movie Theaters Make 85% Profit at Concession Stands

http://www.themovieblog.com/2007/10/economics-of-the-movie-theater-where-the-money-goes-and-why-it-costs-us-so-much/

http://entertainment.howstuffworks.com/movie-distribution2.htm

Nokia and its Current Success in China

The cell phone market is one of the strongest and most stabilized markets in the industry today.  Nokia is a Finnish company that has been around for more than a century, and was once the largest vendor of mobile phones in the world.  Unfortunately, their move into the smartphone industry was ill fated as they quickly became overshadowed by tough competitors in Apple and Samsung.  Their mobile phone business has since been bought by Microsoft in a deal totaling $7.17 Billion, and has led to a creation of a new entity called HMD Global in 2016 (which still operates under the “Nokia” brand name).  Though many see the smartphone business has being almost completely saturated by the sheer market dominance of Apple and Samsung, the Nokia 6 Android smartphone seems to be doing rather well currently.  That statement’s foundation is built on the idea that America is not the only market for different smartphone players to thrive.  In this case, Nokia has done quite well in China and has a brand appeal to the country’s consumers.  Basically, does China offer another playground for products that would not normally thrive elsewhere?  If so, does a specific business model drive it?

Formally announced on January 8 of 2017, the Nokia 6 has already gathered 1.4 million registrations before a second flash sale in China.  The phone had garnered 2.5 million registrations just 24 hours after they opened on JD.com.  What is more absurd, is that the first flash sale for the Nokia 6 saw the phone going out of stock within 60 seconds.  Flash sales are the sales of goods at greatly reduced prices, lasting for only a short period of time.  This business model seems to be very effective in China with its consumers, as Chinese companies such as JD.com and Vipshop thrive on this model.  It seems as if the Nokia brand recognizes that they have appeal to the Chinese consumer, and have directly tailored this phone exclusive to China.  But, the management levels of Nokia’s smartphone division see the crucial importance of working with established flash sales vendor such as JD.com.  Nestor Xu, vice president of Greater China, HDM Global, announces his verdict on the Nokia 6:

“China is the largest and most competitive smartphone market in the world, it is no coincidence that we have chosen to bring our first Android device to China with a long-term partner.  Jd.com is known for its upward mobile customer base and it has for many years believed in the Nokia brand and sold millions of our products to Chinese customers.  Launching our first smartphone device, in such a strategically important market, with JD.com a trusted online retailer marks a signal of intent” (Investopedia).

Even though most Americans see the cell phone market as primarily dominated by either Apple or Samsung, this is not the case in China where multiple players exist.  Hence, the main question asked is what does it take to succeed with the average Chinese consumer.  Is the current success of Nokia 6 in China only possible through the company’s collaboration with flash sale vendors?  Can it thrive without this business model in other countries?  Data shows that mobile phone companies such as China’s Le-Eco are succeeding well in countries such as India.  The flash sale model is again implemented, and the company launched their Le Eco’s smartphone in a series of three flash sales.  The first sale resulted in sales of 70,000 units in 2 seconds.  The second sale paved way for the sale of 95,000 units in about 20 seconds, and the third one sold about 55,000 in 9 seconds.  Is the flash sale model that critical to success in China?

 

Sources Consulted:

http://www.investopedia.com/news/nokia-6-sells-out-china-within-minute/

http://indianexpress.com/article/technology/mobile-tabs/nokia-6-reaches-1-4-million-registrations-days-before-second-flash-sale-in-china-4491422/