Dolce Gabbana, Apple and Nike — the Economics of Discrimination

Italian fashion brand Dolce & Gabbana apologized this month to Hongkongers following an incident outside its store in the busy shopping street Canton Road. The Tsim Sha Tsui store had become the target of protests following reports that a security guard there tried to stop Hongkongers from taking photos of its shop windows, saying only foreigners and mainlanders were allowed to do so.

 

This touched a raw nerve in Hong Kong. The episode was video-taped by a reporter and quickly distributed over the internet. Crowds have since gathered outside the shop to denounce the firm, deliberately take pictures, and demand an apology. Angry comments have been posted on the company’s website and Facebook page.

The belated apology did not impress some shoppers because it came too late to be convincing. Some felt the company was just worried that the protests would hurt its business if they continued. Others accused the company of apologizing only because the Equal Opportunities Commission indicated it would conduct investigations into an alleged violation of anti-discrimination laws.

 

High-end fashion stores have for years, if not decades, stopped individuals from photographing their stores ostensibly to protect the intellectual property rights of their designs. Whether there is a legal and business case for so doing and whether it has been effective in protecting their business interests are not important to us here. What is intriguing is whether there has in fact been discrimination and whether the use of discrimination is inherent to and necessary for the sale of branded products.

 

Fascination with Brand Names

 

Consider two interesting recent examples: Apple’s iPhone 4s launch in Beijing and Nike’s release of a retro-model of the popular Air Jordan basketball shoes across the US. Both events led to public disorder as customers fought to buy the limited stock of products. The incidents happened in two vastly different societies, therefore explanations for such behavior based on national and cultural reasons cannot be convincing.

 

In early January, hundreds of customers including migrant workers hired by scalpers in teams of 20 to 30 waited overnight in freezing weather at Apple Inc.’s flagship store in Beijing’s Sanlitun district to purchase the iPhone 4S at China’s first launch. Concern over the size of the crowd that had gathered led Apple to cancel sales that morning to protect the safety of customers and employees. The crowd erupted; angry customers and gangs of scalpers threw eggs and shouted at employees through the windows.

 

The incident highlighted Apple’s huge popularity in China and the role of middlemen who buy up limited supplies of the product or smuggle them from abroad for resale to Chinese gadget fans at a big markup. A migrant laborer who queued up outside the Beijing store was reported to have been paid 100 yuan to wait in line overnight.

 

This was not the first incident of its kind. Apple’s China stores are routinely mobbed when new products are released. Last May, the Sanlitun store was also closed for several hours after a scuffle between an employee and a customer during the release of the iPhone 4, the previous model in the series.

 

The US has seen a similar frenzy over a popular product. Last December, scuffles broke out and police were brought in to quell unrest that nearly turned into riots across the US following the release of Nike’s Air Jordan basketball shoes. The mayhem stretched from west to east, coast to coast. Police used pepper spray on about 20 customers who started fighting in Seattle, while a man waiting in line was stabbed in Jersey City, New Jersey. Like the iPhone 4S, this frenzy over Air Jordans is not new. Some people were mugged or even killed over early versions of the shoe, which was created by Nike Inc. in 1984.

 

Why the fuss? One reason is that the shoes, which retail for about $180 a pair, are selling for prices above $500 online. However, one guy was reported to be licking the bottom of the Air Jordan — evidently a fan who wanted the limited edition for himself.

 

Creating Monopolies

 

To best understand the intense desire these products inspire, we need to begin with the simple economics of pricing a product for sale in a competitive market. Simple economics says that the price should be set at a level that equals marginal cost. This would be the equilibrium level where demand equals supply. As a result there should be no queues of unsatisfied customers unable to buy the product. The market would clear.

 

In a competitive market the vendor does not care who buys the products as long as the purchaser pays the market price. If the vendor is concerned about the identity of the purchaser to the extent that he would charge a premium to those customers he does not like and give a discount to those he likes, then he is discriminating among customers. Chicago economist Gary Becker in The Economics of Discrimination (1957) showed that vendors who discriminate will not survive in competition against those that do not discriminate. The market punishes firms that discriminate.

 

But this is not what happens in a market where supply is deliberately limited by the vendor, which is typically the situation for high-end branded products. Supply is limited by fixing the total amount that is supplied, and by replacing existing models or designs with newer ones that are differentiated from earlier ones. The idea that each new model and design will in time be replaced by ever newer ones reinforces the perception that supply is limited.

 

Branding promotes the idea that the product has only poor substitutes. The perception of supply scarcity (or uniqueness) is communicated indirectly in two ways. First, by differentiating a product from other competing products to emphasize its uniqueness. Second, by differentiating the newer model or design against older ones to indirectly relay again the message of uniqueness. The point is to create actual and perceived limitedness of supply.

 

Two implications emerge when such products are put on the market. First, products whose supply is limited confer upon the vendor a certain monopoly power in the sales of those products. The limit on supplies ensures that the monopoly power would be necessarily transient.

 

However, that limit alone is not sufficient to have transient monopoly power. The product in question also has to be sufficiently unique and have no close substitutes that can successfully compete with it. For example, Apple’s iPhone 4S and Nike’s Air Jordan shoes are not without substitutes, but customers do not perceive these to be acceptable substitutes. This perception is important for conferring monopoly power.

 

It is worth pointing out that the transient monopoly power is product specific and not company specific. A company may supply many products with limited lifetimes, but possess monopoly powers in only a few. Therefore it is not appropriate to identify such a company as a simple direct monopolist in a general textbook sense.

 

Scalpers and Parallel Importers

 

The second implication is that a vendor with transient monopoly power in a product has pricing power to capture monopoly profits. Economists call these profits short-term monopoly rents caused by limited supply. The limit on supply for such products is often particularly acute in the short-run and when the product is newly launched. It is therefore quite common to see a huge excess demand, such as long lines, at the first launch or re-issue of a product.

 

There are many sound business reasons why companies do not raise prices on these products to clear the short-run excess demand. Such opportunistic behavior is bad for business and damages customer relations. The extent of excess demand may vary from city to city and clearing markets in every city may well result in different prices in different cities. This would precipitate arbitrage across cities by employees of the company and authorized resellers, thus disrupting and harming the firm’s business.

 

For this reason, companies set a single price across all cities; and sometimes even for the entire duration of the lifetime of the product. They know there will be arbitrage by scalpers and smugglers, but because these occur outside the bounds of the company and authorized resellers, they can be tolerated; and perhaps even condoned or encouraged. 

 

Arbitrage by scalpers and smugglers is a necessary mechanism to clear markets with excess demand. In addition, these middlemen perform an important service that companies and their authorized resellers do not or are unwilling to do — to search out the customer who is willing to pay the most for the product to restore the balance between demand and supply in the short-run.

 

Actually the company has a deep interest in seeing the product end up in the hands of the customer who is willing to pay the most. These are their “best” customers in the sense that they value the product most. Meeting their demand and keeping them satisfied is good for business. Letting scalpers and smugglers pocket the difference between what the customer is willing to pay and what the company charges is still good business practice. The company in effect is allowing these middlemen to perform the price discrimination function.

 

In economics, a monopolist can price their product in two ways. First, by setting a single price (that is higher than the competitive price) for all customers. Second, by setting a different price for each customer depending on their willingness to pay. We call the first type a simple monopolist and the latter type a perfectly discriminating monopolist.

 

A necessary condition for a monopolist to engage in some form of price discrimination is to be able to identify those who are willing to pay different amounts for the same product. While it may be difficult to know every potential customer’s willingness to pay, it is not impossible to identify some groups that are more willing to pay than others. That is why we often observe discounts for certain groups or types of customers, such as children, the elderly, frequent buyers, and even by gender, race, religion, etc. Such price discrimination is efficient because it gets the product to those who want it most.

 

For high-end fashion stores, selling the product to a customer cannot be just about whether the person is willing to pay the listed price. It is about getting the product into the hands of those customers who would value it much more than just the listed price and who would be willing to pay a lot more for it; someone who loves the product like the Nike fan who went to the extreme of licking the bottom of Air Jordan shoes. How could you not let such a customer have his pair of shoes? It would be bad for business and horrible customer relations management. And making sure those who are willing to pay more get priority access is good for business. Discrimination is the name of the game.

 

Discrimination and Sensitivity

 

Fifteen years ago a friend of mine wanted a Birkin bag, but realized there was a one-year wait. She asked me to try asking for it on a trip that took me to Paris. Upon showing up at the Parisian store I was informed that it was not available, they would not even consider putting me on the waiting list, and invited me to drop in next time when I was in town to try my luck. I was not infuriated. These guys knew their business. They took one look at me and realized I could not be a worthy customer. And I appreciated their meticulous politeness. Dolce & Gabanna should raise the pay for their security guards; as the saying goes, if you pay peanuts, you get monkeys. Their business is to discriminate with style.

 

The sensitivity of Hongkongers in recent years at being discriminated against involves a number of different perceptions. First, the perception of dwindling opportunities and a feeling of being squeezed; second, the perception that their opportunities have often been taken away by competition from mainlanders; third, the perception that the lack of a level playing field is the cause of the loss of opportunities; fourth, the perception that this is unfair; fifth, the perception that this unfairness may be exacerbated, if not caused, by the so-called “hegemonic power” of certain businesses working with institutions of authority; sixth, the growing perception that failure to resolve existing divisions over the political development of Hong Kong is taking a toll on the Special Administrative Region’s economic and social development; and seventh, the perception that neglect has allowed this impasse to become polarized into an antagonism between “one country” and “two systems”.

 

Tension Under One Country Two Systems

 

Defenders of the “two systems” in Hong Kong, instead of applauding the rise of China and its new found wealth, perceive it as a new form of threatening hegemonic oppression. They have increasingly clung onto Hong Kong’s “core values” as their last moral stand. It is a sad sight to see a once confident community that can now only find comfort in chanting slogans of their so-called “core values”. What is clearly lacking is an articulated vision that would give purpose to the community and its role today in its own development and that of the nation under “one-country two-systems”. 

 

Advocates of “one country” have done no better. They too have failed to articulate what it means to be part of “one-country”, why the people of Hong Kong should embrace it, and what are the honorable means of so-doing under “one-country two-systems”. If the participation of the community in the nation’s development is perceived by all to be mere handouts for seven million people then it will surely backfire. The alms giver will feel hurt by the ungrateful biting mouth it seeks to feed. The alms receiver, if she were privately grateful, would have confirmed that she is no better than a harlot.

 

And until this gap is bridged the alms receiver will continue to seek a higher moral reason for their existence. And the alms giver will continue to blunder and dismiss the alms receiver as ungrateful victims of colonial legacy stubbornly chanting empty slogans about “core values”.  Professor Kung Qingdong of Beida has sadly confirmed this by his shrill outburst labeling Hong Kong people “running dogs”. What a pity to have this happening in Chinese New Year!