The story provides a perspective on the economics of prostitution as a business model, and also engages with the social implications that the business has on those involved in sex work.
Consider Honoria ‘the Horny’, a streetwalker in Bayswater, Chelsea, who has a robust market share of the Soccer ‘Yobs’ who come to Stamford Bridge to watch Chelsea play home ties in the Premier League. Honoria charges £100 for the basic act. The ‘Yobs’ are used to this, and expect that till the Chancellor announces the budget for the next Fiscal, the 10% price hike will not come. Now, suddenly, the market becomes aware of the arrival of Magdaleena, ‘the Mouth’, from Ukraine. It is reported that Magdaleena charges £40 for her favours. Knowing how price elastic the market is, Honoria fears that her market share would soon disappear in a wisp of smoke. Her economic advisor, Patrick ‘the pimp’, advises her to cut her rate drastically to, say, £50. They argue a lot about whether the 40:60 revenue sharing model between streetwalker and pimp should be modified, since Honoria feels that at the new rates and the given volume of customers, her take-home would put her below basic minimum wages. Patrick, however, boasts of two years at the Houndslow Poly. He remembers the general drift of demand elasticity. His argument is that with a fall in prices, quantity demanded would go up enormously, and the gross revenue before protection money, bribes and taxes (PBT) would be higher than now. Much shouting, cursing, tears and hair-pulling punctuates this process of collective bargain, and ultimately they decide to let the ratio of sharing remain as it is.
So, we have a new market in Chelsea with Magdaleena ‘the Mouth’ charging £40 and Honoria the ‘Horny’, charging £50. The market faces its first test on Saturday after the London derby, when Tottenham Hotspurs visit Chelsea and defeat the local team by a solitary goal from a hotly contested penalty. The locals are not pleased. Crowding the Butcher’s Hoo – a pub where the Chelsea Football Club was founded in 1905 – many expletives are bandied about the parentage of the referee. Amidst a sickly fume of Yorkshire Bitters and B&H cigarettes, the hapless Paul Gascoine (Gazza) is pilloried for pretending to be tripped in the Chelsea penalty box resulting in the penalty kick being awarded.
Then, in walks Patrick ‘the pimp’, making a commercial announcement that the going basic rate charged by Honoria ‘the Horny’ has been slashed by £50. There were a few weak cheers, following which Patrick leaves the pub, his good deed for promoting trade and commerce done. After the match has been discussed threadbare, one of the ‘Yobs’ raises the issue of Honoria halving her going rate. The conversation veers to this new topic, with all manners of explanations being exchanged. The terrible consensus is that she must have been told that she has the Pox. After closing hours, the Yobs stumble in a group towards the Metro station, singing, and chance upon Honoria. Each one feigns some prior engagement, some saying that they had to ‘take the Missus to the local fish and chippy’. Honoria, to her shock and surprise, finds no takers.
By the following week, the rumour is rife that the Stamford Road beat has only lemons to offer; Magdaleena, being Ukranian, is by default declared a lemon, and Honoria, by cutting her prices to Magdalena’s level is also tarred by the same brush. In fact, to rub salt into her wounds, the local Yobs, popularise a new song, where ‘Honoria’ in the second line rhymes with ‘gonorrhea’ in the fourth. Her Chelsea market is totally destroyed, forcing Honoria to repackage herself as Tiffany (the Tart) and relocate her base to Earl’s Court.
Fiona had a question about how one could avoid the effects of such asymmetric information. In the second-hand cars market, the innovations of product warranties and performance guarantees had the effect of assuaging the worst fears of would-be second hand buyers. Since the time George Ackerlof wrote his seminal article, the American car industry had put together databases of every registered car in such publications as Craig’s list and Kelley’s Blue Book, where the history of the car, its ownership record, accident history, and major mechanical malfunctions were listed, significantly reducing the moral hazard problem.
I guess Honoria and her colleagues also need such ‘signalling devices’. Most of the streetwalkers have to undergo mandatory health check-ups annually. One way to signal that you were not a lemon could be to make this check-up far voluntarily more frequent, say, once a quarter, and to get the NHS to issue a certificate. A photocopy of the certificate put up in the notice board of pubs, for instance, could have the same effect as a product warranty. Nor would the display of such a certificate on the notice board be construed as ‘soliciting’ under the Sexual Offences Act, 1985.
Apart from the pure economics of it, Fiona informed me that the presence of Ukranians had also affected the drugs trade, which used to move in tandem with prostitution. In addition to that, the ex-Soviet immigrants had also brought in trade in sophisticated weapons, usually stolen from the arsenals of the erstwhile Soviet Armed Forces. The quantum of money being generated by such clandestine trade was a multiple of what the typical London gang boss used to earn. Moreover, the Ukranians had a reputation for violence and cruelty that scared off even the most hardened British criminals. Fiona’s take was that it would be impossible to prevent entry at the lower spectrum of the trade. In effect, the best course of action was for the Magdaleenas and Honorias to collaborate and fix reasonable ‘pooled rates’ rather than fight over entry deterrence and market share.
Fiona felt that the high end of the market was different. Even though ownership of the franchises would pass into Ukranian hands, it would take close to five years before a Ukranian hooker could have the attributes to challenge this segment. She saw a lucrative alternate market in acting as a mentor-um-manageress to the new entrants.
In her own niche, what Fiona feared most were part-timers, like University students, moonlighting on the side, who were increasing. She mentioned the case of a talented medical intern from St Bartholomew’s, who paid off her entire student’s loan of £100,000 in three short weekends spent consorting with some royals from Brunei. She had the good sense to quit thereafter, but her singular success had rattled the likes of Fiona. Even though the advent of the internet was some years away, Fiona could visualise the markets being far more conducive to entry of part-time amateurs like bored housewives from Suburbiton or secretaries in the city. Sure enough, the internet boom saw a proliferation of B2C (business-to-consumer) models that changed the ground rules of doing business. It proved to be extremely efficacious in breaching the high end of the flesh trade.
Fiona was interested in how she could fend off competition for the present. It is useful to see Fiona’s position in the market. In the top end of the flesh trade, Fiona is perhaps an oligopolist. What is her menu of responses if some newbie, Catriona, made a determined bid to enter the exclusive club?
The first factor that Fiona had to realise is that setting up entry barriers can be costly. In what followed, we used game theory in scenario-building to see how a typical Industrial firm would fight entry, and which of these tactics could be used by Fiona to maintain her position in the market.
An important aspect in deterring entry is the reputation of the incumbent. Will she fight tooth and nail to stave off entry? Is her threat credible? Does entry deterrence entail huge investment costs by the incumbent to suitably shut off entry by a potential entrant?
Catriona, the would be entrant, has to decide what, if she enters, her potential gains and losses would be in case Fiona decides to fight back. Fiona, on the other hand, must have some idea of what she gains by fighting in case Catriona enters, and what she gains/loses if she doesn’t fight back.
So, Fiona must think of some irrecoverable sunk or commitment cost (=c) that must act as a deterrence against Catriona’s entry, and also generate a reward (=d). Let us see how this has to work out in case Catriona has to be deterred. We will discuss what the nature of the commitment cost (c) will be after we have sweated out the math.
It will be apparent that Fiona’s commitment to fight will arise only if :
Her payoff from fighting is greater than her payoff from concession;
1+d ≥ 4 – c
Or c ≥ – 1 –d +4
So, c ≥ 3 – d (1)
But the payment will only be made if the payoff in the game without commitment (4) is greater than
– c ≥ 4
c ≥ 4 -8
or c ≤ 4 (2)
Combining (1) and (2), Fiona will invest in a commitment expense/strategy and entry will be deterred only if:
4 ≥ c ≥ 3 –d (3)
This condition is met if d =2 and c= 3
What does all this imply for Fiona? She and a few of the top entrenched escort girls (the oligopoly) have to make some costly investments that make psychological entry barriers credible, but costs (c) cannot be too high, and gains (d) need to be sufficiently large to: first, ensure that payoff from deterring entry with the investment cost (8-d) is more than the payoffs without incurring the commitment (4); second, ensure that the increase in payoff with commitment (d) is large enough so that fighting is optimal.
What kind of additional investments can Fiona think of to deter entry? One option is to bundle services. If she has access to first grade Columbian cocaine, she could bundle a few hundred grams of this with her regular output for such customers who sniff the stuff. Or, using her contacts and money, she could always ensure seats in prime plays and restaurants as part of the entire sales effort. These would be costly initially but would pay off in the long run.
The most effective instance of bundling is the way Microsoft ‘bundled’ its MS Office Software with every IBM compatible computer running on Windows before the advent of Windows 95.
A user had a choice of a spreadsheet software like Visicalc, Quatro and Lotus 123. With MS Office bundled and given “free” with every Desktop, the need to invest in Lotus 123 fell drastically, even though it was a better software than MS Excel.
We had virtually completed Fiona’s basic course in Microeconomics and Easter was first approaching. The remaining two or three sessions were taken up with concepts like cost-plus pricing, discriminating monopolists and such like. On her part, Fiona regaled me with interesting tidbits on ‘how harlotry had contributed to common English usage including nursery rhymes.’ After all, who would have thought that the innocuous Jack and Jill went originally thus:
Jack and Jill went up the Hill
Jill came down with half a crown
But..it wasn’t for fetching water.
Note: This story is purely a work of fiction. Though some of the personae peripheral to the story (such as Professors Desai and Goodhart exist), the main protagonists are fictional. Any resemblance to known figures is purely coincidental.
This is the fifth part of the short story The Adventures of Fanny Hill at the London School of Economics.
Boz is the nom de plume of a retired IAS Officer with experience in Finance. He was at the IMF and possesses a PhD in Economics from the London School of Economics.