Lucky by Design | Judd Kessler

How Do Hidden Markets Work?

Dan Loney: When you score an unexpected win, is it by luck or by design, or is it a combination of the two? Our guest today believes that it is actually how we navigate some of the hidden markets out there. Pleasure to be joined here in studio by Judd Kessler, professor in the Business, Economics, and Public Policy Department here at the Wharton School. He is author of the new book Lucky by Design: The Hidden Economics You Need to Get More Of What You Want.

Judd, great title, because luck and design are two things that are very far apart, but you say that there is a connection here?

Judd Kessler: The premise of the book is that there are all these hidden markets that allocate things that we value, that we want. The markets are not necessarily visible to us. We don't always know that we're in one. But if we see that they exist, we learn their rules, and then we play the right strategies, we can do much better in these markets than we might think. And that's what I call getting lucky by design. Figuring out how you can essentially make your own luck in these markets to get what you want.

Loney: It’s a recognition that these hidden markets are there, and there are dynamics that can benefit the person as they move forward in some of these areas?

Kessler: It's a recognition that the world is not as random as we think, and that sometimes the reason that we don't end up with what we want isn't just luck. I mean, luck often enters in. Don't get me wrong, there are allocations that you know are based on lottery and are supposed to have a big luck component. But even in those markets, and I argue in lots of markets, the strategy that we play can improve our chances and make us happier with what we get, and also give us a little bit more sense of agency, make us less stressed in these environments, because there's something that we can do to improve our chances.

Loney: When you say hidden market, you mean what exactly?

Kessler: I define hidden markets as markets that allocate things without relying exclusively on prices. I'm an economist. Economists love prices, right? We really are into prices. What we think normally happens in markets where there are more people who want something than we have available to serve them all, is that prices will rise. If you ever heard an economist say supply equals demand, they’re making an assertion that a price will change such that, at some point, there's not so many people who want something, and you can give the scarce resource to all of them who are willing to pay that price.

Those markets I call visible markets. Those markets are the ones we see. Those are the ones we're used to interacting with. You go to the store, you decide if something is worth the price, you buy it or not. But that's not how many, many markets operate. Many markets don't allow the price to rise until the market clears. It could be because the seller doesn't want to. Taylor Swift could charge massively higher prices for tickets to her tours than she chooses to do so. There's some other set of rules that decide who gets access to those seats. And it's going to be rules set by Ticketmaster, who's doing the allocation.

If you want a reservation at a hot restaurant, the restaurant could raise its prices until there isn't a long line of people standing outside the door, but they don't. They keep their prices low. In some markets, like markets that the government controls, we don't have prices at all. Your public elementary school, there is no kind of price. Everybody gets a spot for free. I do a bunch of research on organs and life-saving organ transplants. We decide we don't want to give organs to the people who are willing to pay the most. In these markets that don't have explicit prices, you need some other set of rules to decide who gets what.

Loney: Obviously, these markets are different, because you're talking about different dynamics here. But are there characteristics of these markets that are similar that if somebody recognizes this market, then they naturally can see the next one coming down the road?

Kessler: This is why I say you have to see that these markets exist and learn their rules, and a lot of the rules are familiar. When you're rushing to click before everybody else for a reservation or a ticket — or in my case, for an after-school program to get my daughter into the classes she wants — I know it's a race. I've experienced that before. There's lots of markets that have that feature where you have to be the first one there, you have to click immediately, or you're out of luck.

You can identify that a market is like that and develop the strategies to play in markets that have that structure that are first-come-first-serve races. But then there's other markets, like first-come-first-served lines, where you have to decide, “I know that there's going to be a line around the block. I have to decide when to join that line or not to participate at all.”

I'm have an example in the book about going to see the Sistine Chapel, which was the first kind of cultural thing I did when I left the country. You have to decide, “All right, I'm going to have to wait online to get into this great cultural institution. What time should I join the line to make my experience in Rome as enjoyable as possible?” And there are markets where they're lottery based or centralized clearing houses, right? Like, each set of markets has their own rules. Once you identify them, you figure out, what's the strategy to play?

Loney: You were saying Sistine Chapel. All I can think about is going to Disney and trying to get there at the right time and get in the right lines so that you can have the best experience.

Kessler: Exactly. One of the things I talk about in the book, which happens at Disney as well, is when these markets arise, there are strategies you can play. Sometimes money comes back in. At Disney, you can pay extra to get advantages on certain lines. That comes up a lot, and you have to decide as a market participant, is that something that I want to do for this experience or not, or as part of the enjoyment, given the cost to stand in line and just enjoy being in the park.

Loney: That opens the door to my next question, because there's an element of this for some companies, Is it a conscious decision to go this route, because it is the greatest benefit for the bottom line of the company?

Kessler: When I talk about, why do firms choose not to raise the price just to clear the market? What the economists say is kind of the optimal thing to do. Sometimes it doesn't make sense to do it because of what you're selling. If it's admission to an elite college or university like Wharton or University of Pennsylvania, we don't just raise tuition until we fill a class with the people willing to pay the most, because that's not the point of the institution. The experience of being here is, we want to admit only the best and brightest and have them get to interact with each other, and we think our teaching will be most effective for that group. So, we are very selective in that market for picking the group that is right for us.

That same thing is true on the labor market, which is another of these hidden markets where you don't just lower your offered salary until you get one person to apply. You have to work through the applicants that you get and pick the right one.

But some of the firms, when they do this strategy, it's not just about finding the right people. It might be about bolstering future demand. Maybe the restaurant likes the line around the block, because then it builds demand for the next night when people walk by and say, “Oh, my God, how do I get into that restaurant? It looks so good.”

I think this is true of a lot of fad crazes. This summer, it was Labubus. They’re these little stuffed animals, and they remind me of Beanie Babies or Cabbage Patch dolls, where like everybody wants one this summer, and they're impossible to get. I don't think it's just that they have trouble producing them. I think they want there to be a mania around them so that people will get excited by buying it, and that creates these hidden markets that might not otherwise exist.

How Common Are Hidden Markets?

Loney: How common are hidden markets?

Kessler: They're definitely more common than we think. When I started talking about hidden markets and thinking about all the ways that they crop up, I was also surprised how often that they pop up. They pop up in these environments that are particularly important. Dating and labor markets, right? Those are the two of the most important decisions that you make in your life potentially, and they are dictated by these hidden market rules, rather than just I decide I want something so I pay for it.

Loney: But once somebody understands that they have benefited from a hidden market, I'm going to assume they have to start thinking that and looking for some of these other avenues where they may be able to benefit from it down the road?

Kessler: The nice thing about thinking through the strategy of how to play in these hidden markets, some of them, I will admit, are unique to the market. If you're playing in a first-come-first-serve race, there's a lot of advice that's like, know that the race exists, be there, ready to click as fast as possible, and be on high-speed internet. That’s advice that's specific to first-come-first-serve races.

That same advice is useful for any first-come-first-serve race you play, whether it's kids afterschool program, restaurant reservation, getting housing. When I was applying for housing for graduate school, it was like an online interface that had same market rules. But then there's other strategies where, when you figure out how to play them in one market, they apply in lots of different markets with very different rules.

One of the ones I talk about in the book is what I call settling for silver, as in silver medal in the Olympics. Our temptation is to try to get the thing that we want the most and that we always approach a situation, I think our default instinct is, this is what I want. I'm going to go for it. And I call that going for gold. That is often the right thing to do. It turns out, though, in some markets, it might be that when you go for gold, you're facing a lot of competition for something that a lot of other people also want.

If I'm trying to get my wife a reservation for a birthday dinner at the French Laundry, this fancy, expensive, but very notoriously hard to get a reservation for because they only have 60 seats in the whole restaurant, going for gold would be trying to get her a Saturday night reservation at 7:30 p.m. But everybody wants that time, and that's what they're going for. Settling for silver might be going for something little bit less desirable, acting like it was my first choice, like 4:30 p.m. reservation, 5 p.m. reservation. It might not actually be when she wants to eat, but while everybody else is racing to get the 7:30 reservation, if I quickly, you know, click on the 5 p.m. or 4:30 p.m. reservation, I might end up getting to eat there, while everybody else does not.

That kind of strategy of pretending that something that's not your real first choice is your first choice, ends up coming up a lot. There are students who will soon be applying to colleges, and this is a case where there is early decision, where you can apply to one school, and if you get in, you're committing to go. It might be that the optimal strategy for you is not to apply to your dream school that you'd love to get into. It could be that that school is not going to admit you whether you apply early or not.

It might be the case that, since you only really get one bite at the apple for an early decision application, maybe you should apply to your second or third choice school that might not admit you if you apply regular, but would admit you if you applied early, because they reward early applicants. It might be that playing that strategy will allow you to get into your second favorite school, but you might not if you go for gold and try to get into the dream school that's probably not going to take you.

Loney: These are the conversations I had with my older daughter just a few months ago, trying to get off-campus housing at the school that she's going to right now. Just the process of getting there is just so crazed to get what you want.

Kessler: It’s another example of a hidden market that comes up that we don't think about. Oh, it's just a housing market. We know how housing markets work. But sometimes there are many more people who want the available housing stock. In places where the price rises, it's a visible market, but in places where it doesn't, a hidden market comes up.

Loney: I would think that for some of these hidden markets, is there an element where it is created by the company, the value that gets it to be more viral?

Kessler: I think that that is absolutely the case that companies that want to get people excited about their products will often create fake scarcity to generate it and generate a hidden market just for the attention of it. But I think a lot of times hidden markets just come up naturally. No one thought carefully about how to do the allocation. We’ve always done first-come-first-serve for tickets to some concert. And maybe that made sense before the internet and credit cards, where you got online. If you wanted a ticket for a live event, you could signal that you cared more about the performers by standing in line earlier. And if you were there overnight, you clearly were dedicated, and we want to give you the best seats because you are a fan.

Then there's credit cards. People can start calling in over the phone, so the race becomes who can call in the fastest. Then maybe having a boiler room set up with more callers is going to be the way that you get tickets. Now, all of a sudden, instead of diehard fans, it's speculators who are hiring these people to call. Now it's online, and a lot of the tickets that are getting bought to these venues are being bought by bots, by programmed computers that can click way faster than me, even if I am the most excited about this artist. Of course, those speculators are only buying the tickets so that they can resell them to me at higher prices. Then that seems like a market gone haywire.

Loney: What do you hope then is the takeaway for people that read the book? I guess part of it is just understanding that these markets are out there in the first place.

Kessler: Yeah, I want them to know the markets are out there, to see them, start to understand their rules, develop some strategy for how to play in them. Whether they get what they want or not, knowing that you did everything you could reassures you that you have agency in these environments, and I think makes us feel better about being market participants. And there's another part of me that wants people thinking critically about these markets. Should it be the case that we use first-come-first-serve races to get tickets when those races are always going to be won by bots that are programmed to be faster than any human can? Another angle is thinking about, how could we improve the hidden markets that we participate in?

A third thing is that there are hidden markets that we control. It's not just firms deciding their pricing. It's not just governments deciding the rules to get into elementary school. We control the markets for our time and attention. We decide which emails to respond to, which meetings to put on our calendar. We decide how household chores are done by ourselves and our spouse and our kids, and those are hidden markets where, again, your time and attention is a valuable, scarce resource that you do not sell to the highest bidder. You have to decide what is going to get your valuable attention and your valuable time, and you can set up rules that make it better for the people who are trying to get in touch with you and better for yourself to be spending that time efficiently.