The Power of Opaque Selling

secret1Some friends and I recently organized a trip to Las Vegas. We were able to find great hotel rates for Friday night, but published Saturday night rates were crazy expensive. So we turned to Priceline, and within minutes we had a 5-star hotel for Saturday, on the Strip, for a fraction of the lowest listed price.

Priceline, Hotwire and vacation packages from offline and online travel agencies can offer prices that are dramatically lower than published rates without cannibalizing revenue because they are opaque selling channels. Opaque selling makes some part of a purchase non-transparent to the consumer (such as which hotel, what time the flight will leave, what products you are buying) so that the probability of revenue cannibalization is dramatically reduced. While opaque selling creates incremental revenue for airlines, hotels and car rental companies, can it work in other industries?

Fukubukuro — “Lucky Bag”

Fukubukuro, a Japanese New Year’s Day tradition, puts opaque selling to work in shops across the country each year with retailers packaging an unknown collection of things into “lucky bags” and offering them at various prices. The idea is that the retail value of the bag is much greater than the price, but the catch is that you don’t know if you want what’s in it.

Just about every retailer in Japan participates in this tradition. While it started as a way to clear out last year’s inventory, it’s now as much about promoting retail shops as it is about opaque selling. Japanese friends of mine describe Fukubukuro much in the same way eBay fanatics describe bidding for an item — as a game-like addiction.

When Apple opened its Union Square retail store in San Francisco in 2004, it offered lucky bags for $250 with the chance to win the then-new iPod mini. The bags were said to contain 7-8 items with a retail value of $600-$1,000.

Why Opaque Selling Works

While the seller of a product or service would ideally like to charge the maximum price a buyer is willing to pay — the goal of price discrimination — the seller doesn’t actually know what that maximum is. And the buyer has no incentive to tell, as anyone who has haggled with a car salesman well knows.

So sellers create segmented offerings as a way to get at least some customers to pay more. For example, airlines offer first-class seats at a dramatically higher price per unit of space consumed — the buyer gets more space and the prestige of flying in first class and the airline gets an order of magnitude higher revenue per customer for the same flight — often 10x more.

Other techniques include charging a high starting price and then lowering price through age-based discounts (movie tickets for kids and senior citizens), channel-based discounts (online vs. offline), volume discounts (frequent flyer programs) and geography-based pricing differences (enterprise software).

Even with all of these techniques, the market clearing price for products often leaves a seller with excess inventory — open seats on a flight, for example. The marginal cost of that inventory is often so low that it is usually possible to sell it for a profit, but doing so means that people who would have bought the product at a higher price will now pay less and aggregate revenue will decrease. By selling a hotel room through a bundled vacation package a seller dramatically decreases the likelihood that she is cannibalizing her revenue — especially in fragmented markets.

The Opportunity

At the end of each day, many shops toss perishable items. Why not offer lucky bags?  At the end of a season, many clothing retailers push their inventory to outlet stores under the assumption that forcing consumers to drive out of the way will prevent the cannibalization of sales, even though such outlets are increasingly located near major metropolitan areas. Why not find an opaque channel instead?  The same thing goes for consumer electronics, video games, and so on. The Amazon.com Gold Box has daily deals — why not turn the Gold Box into the Amazon.com “lucky” box?  It would offer consumers killer deals, it would be fun, and it would offer Amazon and its suppliers an opaque selling channel.

Fukubukuro aside, would opaque selling work outside of travel? I believe that it can. After all, the fundamental economic drivers of opaque selling in travel exist in many other industries. Less transparency isn’t always such a bad thing.

Mike Speiser is a Managing Director at Sutter Hill Ventures. His thoughts on technology, economics and entrepreneurship will appear at this time every week.

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