Saturday, February 27, 2010

Six Percent and the Secrets of Real Estate

Several years back, Alex Tabarrok pointed out the mystery of real estate commission. No matter where you go, or what's being sold, real estate agents take 6% of the home's selling price (typically, 3% goes to them and 3% goes to the the agency they work for). This is bizarre: why would agents in Montana be charged the same percent as agents in California, where homes are much more expensive? Is the increase in work to sell a home really so perfectly proportional to its price? Seems unlikely.

I ran into a real estate agent on the train while traveling to New Haven, CT on Thursday and asked her about it. She insists it's not true. Even before the crash, commission's negotiable: she's done 4% or 5% for some buys and she's charged 7% for major sales (such as if selling the home requires that she rents a helicopter and takes aerial photographs). If she's selling a home and finds a buyer willing to be represented by her, she takes a smaller commission on each (though she gets more overall; 4% twice is more than 6% once). "Everything's negotiable," she says. That's reassuring.

While she's been in the business since the mid 1990s, this is just one data point. Still, with so much freedom of entry and variation across real estate markets, I'm more likely to believe that this 6% level is more urban legend than industry practice.

Thursday, February 11, 2010

Pictures From Snowmageddon

I normally don't do personal stuff here but the pictures from the twin blizzards are pretty interesting (and should be convincing to those knowledgeable of Midwestern winters that if I complain about the snow, it's not because I've gone soft).

The first shots are from the first blizzard. In this shot, I've already dug out the back area (which took about an hour). Yes, I actually had to do some digging to confirm the car was mine (the snow was originally hiding the plate and my IHS bumper sticker).

There is, of course, some economics in this post. For one, I note a similar mystery that Bryan Caplan pointed out. For example, here's the milk section at the local supermarket I visited today (note the soy milk, way at the end, is pretty well stocked).

Bryan thinks it's strange that the brand name stuff is grabbed more than the off brand. As staple products, if people like them five times as much, why isn't there five times as many of it? Several days into the storms, I still found other strange juxtapositions.

Some of this might have been due to constant restocking but based on Caplan's observations (and others that went out right before the storm concur), it's equally possible that this is not the case.

It also highlights the problem of inflexible prices, especially during a crisis. It's probably due to price-gouging laws, which exist is most, if not all, states. Luckily when I went today, I was able to get everything I needed (but only because the nearby Wal-Mart just restocked its milk).

Friday, February 05, 2010

Ryanair: Cheap, Reliable, and Safe

Ryanair ranks in the bottom 10 of 581 companies on ethics (based on social responsibility, environmental awareness, etc), compiled by Geneva-based Covalence. Henry at Crooked Timber notes that Ryanair is unique among its low ranked brethren: it seems to covet its slimly image.
The company prides itself not only on being perceived as having no social conscience, but as having a reputation for screwing its customers as systematically and mercilessly as possible. Which other airline’s CEO would announce that he wanted to charge passengers to use the toilet as a publicity stunt? Clearly, Ryanair thinks that this reputation is a money spinner for them (it is quite deliberately cultivated), and they have indeed made quite a lot of money. But why (if they are right) would a reputation for shafting your customers be a commercial asset for a consumer-oriented business in a relatively competitive sector? The standard economic account doesn’t seem to provide much insight. Help me out here.
There are many sloppy explanations, but three good ones stand out.
Ryanair is trying to attract well-informed consumers who will see the add-on charges beforehand and adjust for it; they end up with a very cheap airfare (it's apparently an inexpensive way to travel) and no surprises. Ill-informed consumers end up footing the bill. This is a nifty argument but I don't see it holding in equilibrium, especially when you're issuing press releases about charging for using the bathroom. Something like that is likely to get out to even the poorly informed consumer.

Ryanair is signalling safety. Since they are inexpensive, the company is showing where they get revenue from thus customers aren't afraid that they got a deal because the firm skimped on safety checks. But it seems that the safety regulations which govern air travel would put customers' mind at ease. At the same time, you could argue the fear is that they cut corners in other ways, such as paying their flight attendants very little which would result in rude service.

Ryanair is signally honesty and reliability. When you travel, there's a lot of stress so when you discover some small fee it seems like a much bigger problem than it is. By outlining all their add-on costs before you pack your bags, they're cutting out uncertainty (and the fear of uncertainty). Yeah, you have to pay to use the bathroom, but since you knew about it ahead of time, it doesn't seem as bad as if you discovered it after drinking six glasses of water. Since everyone knows companies spin the truth in commercials, blatantly not spinning it sends a strong signal that "this is all you will have to deal with."

What I like about this last argument is that it bears a striking resemblance to Domino's "sorry we had horrible pizza but now it's good" campaign. Some commentators laugh at it, replaying old commercials touting the flavor of Domino's "cardboard." But no one really cares; every pizza chain says their pizza is great. But Domino's admitting a lot of people didn't like and now we're fixing it speaks volumes. Down right honesty is often an under appreciated business practice.

Thursday, February 04, 2010

The Myth of Magic Medicare

Insurance companies are greedy. Everything its CEOs work for is to make as much profit as possible. They are hesitant to do anything that increases their revenues, and anxious to adopt anything which decreases their costs. Until today, I didn't think anyone would disagree with this until tonight, when Congressman Anthony Weiner went on The Daily Show.

Congressman Weiner argues that Medicare should be expanded to all citizens, citing its very low administration costs (about 3% of its total payouts) as a way to save money. Insurance companies, by contrast, have about 12% overhead.

What magic has Medicare mastered to keep its overhead so low, magic that continues to allude our greedy insurance companies? It's not economies of scale. Medicare has about 45 million customers, while AIG covers 74 million. Even if you adjust for the fact that AIG covers people worldwide while Medicare only works within the US, such a massive difference in overhead is hard to explain with just economies of scale. After you measure your customers in the millions, those efficiency gains from volume tend to disappear. Otherwise we'd have far fewer insurance companies (I counted 31 health insurance companies in the US from this Wikipedia list with 27 confirmed as currently active). It's hard to think of another argument which could possibly justify this vast difference in overhead between the public and private sectors. I wonder how Rep. Weiner explains it; perhaps insurance companies don't care as much about profits as we thought. Or government is far more cut throat than anyone possibly imagined. Or maybe the folks at Medicare has some sort of genie/manager.

Now you could argue that Medicare doesn't have to worry about paying for advertisers nor state taxes. That's a lot better but 9 percentage points for TV commercials and taxes is hard to believe. There are two other explanations which justify this difference and neither of them help Weiner's argument.

First, Medicare covers only those over 65. Since the elderly, on average, need more medical assistance than the rest of us, the payouts in relation to administration costs drastically increase. It's not that Medicare has some secret which keeps overhead low; its payouts are just biased upward.

Second, Medicare spends very little money investigating the claims it accepts. And medical insurance fraud is a big problem. Just because you're spending less money, doesn't mean it's actually saving money.

Monday, February 01, 2010

How the Middleman Can Save You Money

Tonight's Daily Show featured Austan Goolsbee of the Council of Economic Advisers to the President. He argued in favor of the government taking over lending to students and cutting the middleman (various financial intermediaries) to save money. Cutting the middleman is a time-honored way to try to boost efficiency but it doesn't always work. Middlemen exist for a reason. In this case, they provide specialized knowledge and an incentive for efficiency since they keep the profits and suffer the losses (most of the time anyway).

This isn't simply a matter of buying your mattress directly from the factory (though, even there the middleman probably has better customer relations). Lending money is hard because because you have to avoid the twin pitfalls of those who can't pay you back and those who won't pay you back (aka adverse selection and moral hazard). People still default on loans despite various inventive mechanisms banks developed over the years to avoid these pitfalls; mistakes are easy to commit.

But it's even easier when you're not fighting for your life. No matter how well trained a government employee is, they are much less likely to get fired for approving a lot of loans which later default than for an employee at a for-profit company.

It still might be cheaper for the government to provide this service directly (though I'm skeptical). But it's not simply a matter of pocketing the middleman's cut.