business model analysis kamal jain (ebay research labs) in collaboration with melika...

Business Model Analysis

Kamal Jain(eBay research labs)

in collaboration with Melika Abolhassani(Maryland), Nikhil Devanur(Microsoft), Darrell Hoy (Northwestern), Sven Seuken(EPFL), Harry Shum(Microsoft), Di Wang

(Berkeley), Chris Wilkens (Yahoo), …

Innovation Pyramid

A business model is a revenue plan of a company. A good businessmodel is sustainable, provides advantage over competitors, and helpspierce through the advantages of the competitors.

Business ModelUser

Experience

Technology

Operations

Businesses fail ultimately due to the failure of their business models. A not-so-good business model can cause a lot of pain.– Play-for-sure.

A good business model aligns with the user experience.– Search ads.

Variety of business models

Smart-phones, Sensors, and Internet technology allow multitude of new business models, which were not possible before.

Challenge: It is hard to make an educated guess if a business model will succeed.– Lack of data.– Lack of mathematical tools.

Business Models in this talk

• eBay – Commission.• Google – Cost per click.• Bestbuy – Mark up.• Costco – Membership fee.• Groupon – Discounts for commitment. • iTunes – uniform pricing.• Premium Roads – Tolls.• Web – Display advertising. https://www.facebook.com/kamaljain

A model of Intermediary

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Goods

Sellers competing with each other.Single Buyer.(Buyers are not competing.So not modeling eBay auctions.)

A model of Intermediary

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Goods

Advertisers competing with each other.Single Buyer.Buyers are not competing.

A model of Intermediary

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Goods

Suppliers competing with each other.Single Buyer.(Buyers are not competing.)

Matching

The intermediary facilitates a matching between a buyer and sellers.

Positions

The intermediary has a shelf for displaying the products. The shelf has various positions. The buyer may pay different attention to these positions.

Mostly ignored.

Most visible.

A model of Intermediary

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Goods

A model of Intermediary

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Goods

A model of Intermediary

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Goods

Simplification - Single shelf

We assume there is a single shelf. Whatever product is placed here, the buyer will inspect it. May or may not buy it, depending upon the price and the utility.

Comparing various business models

In the short-run a business can optimize its revenue by fine tuning some knobs.1. Ebay can change its short-term revenue by changing its

percentage commission from 10% to 5% or to 15%.2. Even, Google can change its reserve price, or the number

of ads per search page etc.

So we compare two business models A and B, by assuming two hypothetical companies which only differ in the business models, and desire to operate at the same net revenue in the short-term.

Cost-per-click vs Commission

Theorem 1: A risk neutral seller will offer lower prices, when the intermediary uses cost-per-click business model than in commission model.

Theorem 2: Seller surplus will be higher, buyer surplus will be higher, and the intermediary can make higher revenue in the cost-per-click business model than in commission model.

Buyer’s Demand Curve

At sale price of s, the probability of buying an item i, is probi(s).

Price = s

probi(s)

Seller’s maximum surplus

s

probi(s)

ci

Seller’s Profit

Sellers are assumed to be short-term focused. They are focusing on maximizing the expected profit from this buyer.

Buyer’s surplus

Sellers benefit, if buyers benefit

s

probi(s)

ci

Seller’s Profit

Assuming no cheating:

A buyer and a seller benefit only when a transaction happens.

Buyer’s surplus

A Page Viewpay-per-transaction

This is when the seller pays.

What if ebay adds an option to pay when a user views the page itself

(pay-per-click)

Proof:

s

probi(s)

ci

s

Seller’s ProfitBuyer’s surplus

eBay’s commission

Per click model commission model

Working example

• Samsung Galaxy S4 – mobile phone.• Procurement cost: $450 per phone.• Demand curve is linear:

– $1000, probability of purchase is 0%.– $0, probability of purchase is 100%.

s

probi(s)

10% ebay commission

Optimal price:$750.

1. 25% of the interested buyers purchase it.2. eBay made $75 per transaction.– Click -> purchase is 25%, hence ebay made $18.75

per click.

3. Seller made $225 per transaction.– i.e., $56.25 per click.

If eBay charges $18.75/click

Optimal price:$750 $725.

1. 25% 27.5% of the buyers purchase it.2. eBay made $18.75 per click.3. Seller made $56.25 $56.875 per click.

The biggest difference is made to the buyers, price falls by $25 per phone!

eBay Price

November 18, 2012

Seller’s website price

November 18, 2012

Amazon Price

December 2, 2012

Seller’s website price

December 2, 2012

Data Evidence

Implications of the theorems

• Advantages of Cost-per-click – Better consumer pricing.– Higher relevance.– No disintermediation.– Full Reward for higher performing sellers.– Higher revenue margin for the intermediary.

• Advantages of commission model– Small sellers who are typically risk averse find it

appealing.

An intermediary should offer both!

Commission vs Mark up

Theorem: A supplier collects lower whole-sale-price from the intermediary in commission business model than in mark up business model.

Conjecture: The net consumer price is lower in the commission model than in mark up.

Membership model vs Mark up

Theorem: As per Nash bargaining, the intermediary will have higher bargaining power in negotiating with its suppliers, in the membership model than in the mark up model.

Discount Coupons

Imagine a user who may want to use a service. The service is offered at time T only.

A: Price of coupon offered at time 0. Service is free with the coupon.

P: Price of service at time T, if no coupon is presented.

Ut: Perceived utility of the service at time t.

Question: When should a rational user buy the coupon?

Model of Ut.

Ut: We model Ut as log-normal distribution with known volatility (standard deviation).

Theorem

C: The price of an European call-option, on a stock with the current value of U0 and the strike price of P.

Theorem: The user should buy the coupon if U0 > A + C.

Open Problem

Assume that the service is offered anytime between time 0 and T. How would a rational user makes a decision of buying the coupon?

Wrong Answer: American call option.

iTunes

Recently in a dispute with Hachette, Amazon published:

1. People want to buy ebooks at standardized pricing of $9.99. People are 74% more likely to buy an ebook at $9.99 than at $14.99.

2. Amazon says that ebooks compete against mobile games, television, movies etc.

Jain-Vazirani (2010)

• People have ordinal preference of songs, movies, etc.

• People have cardinal preference between different categories of digital content, e.g., how many songs you want depends upon your commute time.

• Business model evolves to uniform pricing within a content category.

Theorem

There is a market-equilibrium in Arrow-Debreu sense even when you allow digital goods.

The market-equilibrium is consistent with both the fundamental welfare theorems in economics of conventional goods.

Premium Road

• Example: Washington Highway 167.• Pay-for-consumption business model allows incorrect

choices, which causes regret and inefficient use of roads.

• With all the sensors on the roads, it is trivial to estimate the performance, i.e., time saved by a driver.

• A driver pays in proportion to the time saved by using the premium road!

Devanur-Jain-Sven (2009)

Theorem: The ex-post social welfare is higher when the road tolls are billed according to the time saved.

Proof: It is trivial for a driver to make a quick and correct decision.

Display Ads

• Non-pareto optimal social welfare.

• A display ad wastes more valuable time of the users than the revenue it raises for the publisher.– It value users time at 13 cents an hour (study in

2010).

Why?

• The transaction is between an advertiser and a web-publisher.

• User has no seat at the bargaining table.

Implication

• Over 20% users use ad-blockers.• These users do not contribute to the web-

economy but get a better experience!

I block over 1,000 ads a day!

Solution?

Open Problem: Suggests a solution to correct the economics.

Our Solution (preliminary version with Harry Shum 2009): Route the money from the advertisers to the publishers through the users. Use machine learning so that a typical user does not have to actively manage the experience.

What does this research suggest?

1. Make $20 when a pair of jeans is sold?2. Make $1 from the manufacturer when a pair of jeans is tried by a potential buyer?

• The act is registered electronically.

Thanks

A lot of this content is available on my facebook wall.

https://www.facebook.com/kamaljain