Robert Litan: An Economist Walks Into a Bar at TEDxKC (Transcript)

Robert Litan

Here is the full transcript of economist Robert Litan’s TEDx Talk: An Economist Walks Into a Bar at TEDxKC conference.

Listen to the MP3 Audio here: an-economist-walks-into-a-bar-by-robert-litan-at-tedxkc

TRANSCRIPT: 

So, there are these two guys that walk into a bar “Damn, not going to go there.” It could be the beginning of a joke. But I really want it to be the introduction to the notion of artificial scarcity. And you’ll see why in a minute.

So let’s go back to the bar. First guy, he approaches the first woman that he sees, offers her a drink. She turns him down. He, then, decides to walk his way down the bar. And, of course, all the women watching this, they see what he’s up to. And they all turn him down.

Now, our guy, I’m going to call him the anti-hero. He hasn’t learned from this experience, in the real world. So he decides to go to the virtual world. He goes to the Internet and joins Cupid.com and he tries the same technique, and sure enough, with the same result. They all turn him down.

So our anti-hero is in trouble. But you know what? Cupid.com is in trouble too. And the reason they are, is that the women who have joined Cupid.com are being inundated with offers for men for dates. They get turned off, they quit. And if they quit, men quit. Cupid is in trouble. Who are you going call, to solve this problem. Know the answer is more obvious than ghost busters. You call an economist. Don’t laugh, you call economists. In fact, you call two of them.

This is Muriel Niederle of Stanford, and Dan Ariely of Duke. And they spend a lot of time, studying the problem of artificial scarcity and abundance, in the online dating context, which is a reason Cupid call them up. And they wanted to know how to fix their problem and the two economists said they had an idea, that was as simple as it was profound. Just put a sharp limit on the number of date offers that men could make to women each month. This is the notion of artificial scarcity. Taking what looks like an abundant resource, which is date offers, and artificially constraining them.

And the economists said to Cupid that if you do this, the men will take their offer seriously. They’ll look at more than just the women’s pictures and they’ll actually look at their profiles. And the women will know this, and they’ll be more likely to accept date-proposals. Artificial scarcity helped save Cupid.com, and other dating sites that copied the technique.

Today, online dating is a $2 billion industry in North America alone. Now, I want to talk about a lot more than online dating and artificial scarcity. Much bigger topic. I want to try to show to you, how economists and their ideas have contributed to the rise of the entire Internet economy, and to some of the iconic companies within it.

I’m sure that many of you are familiar with the notion of “name your price travel“. That was invented by Priceline. Well, “name your price travel” was really not the key to their success. Because, if you could name your price, what price would you bid? Zero, right? Or one or two. And obviously the airlines or the hotel chains would not accept the offer.

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The key to Priceline was not their great advertising. It wasn’t the fact that you could do searches online. Know the real key to Priceline success, by the way it’s a $60 billion company, market cap today. The real key is they make you this proposition. They say that if you bid a particular price for a hotel room or a flight, and Priceline decides to accept it, you’re bound to pay it. This is called the conditional price offer. And basically, what it does, it induces you, as the traveler, to take your offer seriously, in the same way that the artificial restrictions on the dating proposals at Cupid.com did for men.

So who is the brilliant guy behind the conditional price offer? He’s a smart guy, but Captain Kirk was not the inventor of the idea. He was the pitch man. And it still is for Priceline. Know the real genius behind Priceline was this guy. Jay Walker. Jay studied economics as an undergraduate at Cornell. And he actually listened and thought two steps beyond what his lecturers told him at Cornell and came up with the idea of a conditional price offer, which led to Priceline and revolutionized the entire travel industry in the United States.

I have another example. So one that you’re also very familiar with. The search page at Google. It could be at any other search engine, and what I want you to pay attention to is that right hand side, the ads over there. Google collects about $50 billion a year, from advertisers, large and small, seeking placement on that right hand side. They auction off the site. But that’s not how the system started, because when Google was launched, online advertising was in its infancy, and Google, believe it or not, went door to door, advertiser to advertiser, trying to get them to place for an ad next to a search term. Highly laborious, you quickly can see that this is not going to scale, as the number of searches explodes on Google.

And so the founder of Google asked two young engineers, Eric Veach and Salar Kamangar, to come up with an automatic system, that would solve this problem. Well, they were instinctively attracted to auctions. But they were thinking about another problem. That is if they auction off the sites, they fear that the advertisers would bid a very low price, and then incrementally raise their prices just a little bit, and keep the auctions going on forever. And if this happened, and a lot of searches were also going on at the same time, the whole site would crash.

So, as an engineering solution, they came up with this idea. That the winning auction, or the winning placement will be the price, the second highest price that was bid plus one penny. This will cut off the auctions, greatly simplify the process, and in the process also solve another problem called “the winner’s curse“. I’m sure that many of you that have participated in auctions may have regretted winning because you felt like you’ve paid too much. Pretty obvious point.

But the CEO of Google at the time, Eric Schmidt still wasn’t sold on the second price auction as the way to go, until he ran into this man. Totally by accident at a party This is Hal Varian. At the time, he was Dean of the Information Science School in Berkeley and a world leading expert on auctions and also the Internet. Schmidt asked Varian: “Does this second price auction make any sense? Why not the first price?” And Varian pondered the question, and came back to Schmidt, and said “You know, those two engineers, they have reinvented what this guy came up with.” This is William Vickrey, he was an economist at Colombia, who proved mathematically, that the second price auction was the ideal solution to the winner’s curse. And you know what, that won him the Nobel Prize in Economics in 1996.

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Well, now if you’re Eric Schmidt, you’ll think “Well, economists, they may be able to help Google.” So he persuades Hal Varian to leave his tenure position at Berkeley, and join Google as its first chief economist. Varian then goes on, to hire an army of statisticians and economists, who helped refine the online ad auction process, and also developed other services for the Mountain View giant. You know they say that imitation is the best form of flattery. Well, guess who is watching, Microsoft from up north, their chief competitor or would-be competitor of Microsoft. They wanted their own Hal Varian. And they got her. This is Susan Athey. Susan is a rock star economist at Stanford, world leading expert in auction theory, and she splits her time teaching, with also working as an economist at Microsoft.

I have a third example, it’s bigger than the first two. It’s the entire business of web retailing. It’s a $300 billion industry in the United States alone. And you all know the poster child of web retailing, it’s Amazon.com. Now many of you may think that Amazon’s success is due to its fantastic system of warehousing and inventory control. It’s able to basically send out all that stuff that you order online. But you know, Amazon or other web retailers would not be as successful as they are, without a highly flexible transportation system that actually would deliver all that stuff. And guess who helped bring that system to reality. Economists.

Because back in 1980s, when Jeff Bezos was just a teenager, the airline and the trucking industry were heavily regulated. Every fare and every route that they charged or they flew or they drove, had to be approved by the government. In fact, there was a rule that set to an airline, that owned a trucking outfit, that it couldn’t deliver merchandise more than 20 miles away, from the airport, at which the merchandise landed. This rule was obviously in place to protect other truckers from competition, which of course was the whole point of airline and trucking regulations in the first place. That’s why economists long opposed it. But they also opposed it for another reason.

There are lots of airline and trucking firms, they’re not natural monopolies in the same way that a local utility is, that needs regulation, in order to prevent price gauging. No! Airlines and trucks should have never been regulated. And three of the economists who were most insistent about this are in this picture: Michael Levin, Alfred Kahn and Darius Gaskins and trust me, there were many more, who have been writing for decades in order to get rid of this crazy system.

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Well, there were two politicians, craziest politicians who finally listened to these guys and women, and persuaded Congress in 1978, and 1980 respectively, to dismantle the system of airlines and trucking regulations, against the stiff opposition of course of those industries. And you may not recall, but prices fell after deregulation.

But more importantly for my story is that deregulation unleashed vigorous competition, between the two giants of the transportation industry: UPS and FedEx, they went on to develop a highly flexible and efficient transportation system, that was ideal for the Internet economy. So that 20 years later when Jeff Bezos and other web retailers came along, they were able tap into and used this system. In fact, Jeff Bezos, if you’re watching this, you should send a thank you note, to three of the economists that I’ve showed before and many of the others, who made your fortune possible.

I want to conclude with one final example, has nothing to do with the Internet, unless you want to count the 32 million people, who play some form of online fantasy sports. I mention sports because I’m a sports nut, and I want to talk to you about Moneyball. I’m sure many of you have seen the movie. It’s based on a book, yes, go ahead and applaud, fantastic book, and movie, and it is written by this man, Michael Lewis, who by the way, I think he’s probably one of the best non-fiction writers in America, or the world for that matter.

And Moneyball, as you know, was about Billy Beane, the general manager of the Oakland As, who built a great baseball team, on a shoestring budget. But Moneyball really wasn’t a traditional baseball movie in the same way that Bull Durham or Field of Dreams was Know the real hero of Moneyball was this guy. Now many of you may not recognize him, but I submit to you: he had as biggest influence on baseball as Hank Aaron or Babe Ruth. Because he applied economics and statistics to showing how it’s possible to produce winning baseball. He invented a field called Sabermetrics, that was used by Billy Beane and other baseball teams to build their rosters. In fact, it is used throughout professional baseball, not just there. Sabermetrics is used by professional basketball teams, football teams or even hockey teams as people like Bill James on their staff.

Economic thinking has revolutionized sports. You know, in the course of my career, I’ve had a good fortune to meet many many people in the business world. But unfortunately, from my perspective, too many of them have no respect for economists. They say we would never make a payroll, we meaning the economists. What, what do they know? Well, economists help build the Internet economy. Economists help make it possible for Amazon, and other web retailers to deliver all that stuff that you order to your door step efficiently and promptly 24/7.

Economists shape the system of online advertising, especially online auctions. Economists made it possible for you to get five-star hotels at three-star prices. Economists may even have made it possible for you to have a date, and conceivably for you to have met your spouse. I think economists deserve some respect. That answers it, don’t you?

Thank you very much.

 

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