Part 2 (1/2)

So here's ain, don't try to find a cheap store Try to shop cheaply Similar products are, very of-ten, priced si trip is the result of carelessly choosing products with a highinto a store with ”bad value,” because price-targeting accounts for much more of the difference between prices than any difference in value between one store and another

Mix it up!

Another very co We're all so used to seeing a storewide sale with hundreds of items reduced in price that we don't pause and ask ourselves why on earth stores do this When you think hard about it, it beco prices The effect of a sale is to lower the average price a store charges But why knock 30 percent off many of your prices twice a year, when you could knock 5 percent off year-round? Varying prices is a lot of hassle for stores because they need to change their labels and their advertising, so why does it s up?

One explanation is that sales are an effective forood deal and soh prices to pry cash from the loyal (or lazy) custoain hunters Middle-of-the-road prices are no good: not high enough to exploit loyal custoain-hunters But that's not the end of the story, because if prices were stable, then surely even the et particular goods cheaply So rather than stick to either high or low prices, shops jump between the two extremes

One co for the same customers As we've discussed, it's hard for one to be syste a lot of business, so they will charge sie, but both will also ain hunters fro to pick up ingredients for a cookbook recipe they are ain-hunters will pick up whatever is on sale andof it The dinner-party shoppers come to the supermarket to buy specific products and will be less sensitive to prices The price-targeting strategy only works because the supermarkets always vary the patterns of their special offers, and because it is too o to both stores If shoppers could reliably predict as to be discounted, they could choose recipes ahead of time, and even choose the appropriate superredients wherever they're least expensive

In fact, it is just as accurate, and , to turn the ”sale” on its head and view prices as preular price The random pattern of sales is also a random pattern of price increases-companies find it more profitable to increase prices (above the sale price) by a larger amount on an unpredictable basis than by a small amount in a predictable way Customers find it troublesome to avoid unpredictable price increases-and oods-but easy to avoid predictable ones

Try to spot other odd mix-ups next time you're in the supere ten tie as for loose fresh chilies? That's because the typical customer buys such small quan-tities that he doesn't think to check whether they cost four cents or forty Randoetable is a favorite trick: custo-etable that week; custo price rise

I once spotted a particularly inspired trick while on a search for potato chips My favorite brand was available on the top shelf in salt and pepper flavor and on the bottom shelf, just a few feet away, in other flavors, all the same size The top-shelf potato chips cost 25 percent more, and customers who reached for the top shelf demonstrated that they hadn't made a price-comparison between two near-identical products in near-identical locations They were

Admittedly, for some people the difference in flavors is iher price for salt and pepper flavor and, irritated, pay anyway Others will prefer the different flavors and count themselves lucky that they have inexpensive tastes

But this is an example of a universal truth about supermarkets: they are full of close (or not so close) substitutes, so rando The random element is there so that only shoppers who are careful to notice, reains If you want to outwit the supermarkets, simple obser-vation is your best weapon And if you can't be bothered to do that, you really don't need to save money

Reality check number one: Does the company really have scarcity power?

It's ti coet carried aith notions of how they are infinitely powerful and we are infinitely gullible Not true

Remember that no company has power unless it has scarcity, and often that scarcity is so is stopping us fro fro us frolancing around for two seconds when buying potato chips

Every store has a tiny amount of scarcity power, if only because it's an effort to walk out and go next door But some haveabout when estiies

For instance, what is the answer to the question we posed in the previous chapter: why does popcorn cost so much at movie theaters? Is it for the same reason that wine is expensive in res-taurants? We know that the first-glance answer in both cases is, ”Because once they get you in the door they can charge whatever they want” We also know that this first answer is probably not true Customers may be dued a lot for wine in restaurants and for pop-corn and candy in movie theaters before they walk in the door

Noe have a better answer: it's likely to be a price-targeting strategy Moviegoers who are sensitive to price will bring their own snacks froo without People who are not sen-sitive to price-perhaps because they're on a date and don't want to look stingy-will simply pay for the overpriced popcorn Very clever

This is a much better explanation, since in many towns there is only one movie theater, and even in toiththe filives a theater a lot of scarcity power, and if the er is smart he'll want to exploit that power to the full

Yet the sa true for pricey wine at restau-rants The typical restaurant has less scarcity power than a movie theater because in most towns there will be a variety of alterna-tives Whenever there is little scarcity power, prices need to re-flect costs Yet even the e a lot for wine A better explanation is that one of the big costs in a restaurant business is table space Restaurateurs would there-fore like to charge custo, but because they can-not do that, they charge higher prices for products that tend to be consuer meals: not just wine but also appetizers and desserts

We go to a movie theater to see a movie and to a restaurant to eat, so is the truth also that ays get gouged on ”options”? Not at all One option available in both movie theaters and in restaurants is the option to use the restrooe Tap water is also free in restau-rants It is not the option that invites the gouging, it's the lack of price sensitivity that allows a business with scarcity power to prac-tice price-targeting

Reality check nu leaks?

Perhaps you are a colee as you read this, planning to deploy a range of clever price-targeting strategies in your own business Before you get too ex-cited, you'll need to deal with the leaks in your price-targeting systereat holes in an otherwise brilliantscheme If you don't deal with them, your plans will be in ruins

The first problem is that supposedly price-insensitive custoame It's not hard to persuade price-sensitive customers to steer clear of an expensive product, but sometimes it is more difficult to prevent the price-insensitive custo the cheaper one This is not a problem in the case of set some customers to pay a e in relative ter a bag of potato chips up onto the top shelf When it co decisions it is not always so easy

Some of the most extre first class by train or air isthe coach-class seats, but since the fundaet people fro ers In order to price-target effectively, firerate the differences between the best service and the worst There is really no reason at all why coach-class train cars shouldn't have tables, as they typically don't in the UK, for instance, except that potential custoht decide to buy a cheaper ticket when they see how coers have to suffer

There is a famous example from the early days of the trains in France: It is not because of the few thousand francs which would have to be spent to put a roof over the third-class carriage or to upholster the third-class seats that soes ooden benchesWhat the coers who can pay the second-class fare fro third class; it hits the poor, not because it wants to hurt theain for the sa proved alers andwith first-class custoive the rich what is superfluous

The shoddy quality of most airport departure areas across the world is surely part of the same phenomenon If the free departure areas becaer be able to sell business-class tickets on the strength of their ”ex-ecutive” lounges And it would also explain why flight atten-dants so off the plane before the passengers from first and busi-ness class This is a ”service” ai on in pity and disgust fro for your expensive seats, or next tiht attendant

In the supermarkets, we see the saed for the express purpose of conveying awful qual-ity Supere, displaying crude designs that don't vary whether the product is lemonade, bread, or baked beans It wouldn't cost os But that would defeat the object: the packaging is carefully designed to put off custo to payto pay five tiain product unless the supere them So, like the lack of tables in coach-class trains and the unco of ”value” products is designed to et price increases on the examples of all come from the world of computers For instance, IBM's ”LaserWriter E,” a low-end la-ser printer, turned out to be exactly the sah-end ”LaserWriter”-except that there was an addi-tional chip in the cheaper version to slow it down The et their printers was to design and le printer, then sell it at two prices But of course to get anyone to buy the expensive printer they had to slon the cheap one It seems wasteful, but presun and manufacture two completely different printers Intel, the chiptwo very si chips at different prices In this case, the inferior chip was actuallythe superior chip and doing extra work to disable one of its features

Software packages often have two or more versions: one has full functionality (the ”professional” package), and the other sells to the mass market at a considerably reduced price What some people don't realize is that the professional version is typically designed first, and certain features are disabled for the h price of the professional ver-sion, it's the cheaper version that actually has an extra up-front cost for the developer, and of course both versions are sold on CDs, which cost the same to manufacture Coe cost structure because of intensive research and develop costs At the height of the Internet bubble, giddy gurus were clai-but, as we've seen, the basic rules ofmoney in the hi-tech business are not so different from the rules for train operators or coffee bars

The first ”leak” in a price-targeting strategy, then, is that rich customers may buy cheap products, unless the products are de-liberately sabotaged The second ”leak” is a particularly difficult one for co: their products roup to another The risk is that the custo offered a discount buy the product and then resell it at a profit to the custoher price Up until noe'veser-vices that can't be resold (like a bus trip or a visit to Disney World) or products that are probably too much hassle to resell (such as a sandwich or a cup of coffee) That's not coincidence Services and convenience products are the ies, because they don't leak The really great pricing tricks take place on airlines, in restaurants and cocktail bars (not many bookstores have a ”happy hour”), in supermar-kets, and at tourist attractions

In contrast, some products are inherently leaky: they're expen-sive, easy to transport, and nonperishable The obvious exaital media (CDs, DVDs, and software) and phar leaks, which in an age where Internet shopping allows us to order products froly difficult to pre-vent For instance, the DVD industry agreed on a systeht in the United States would not work in Europe But that syste circumvented by an alliance of custoly equip machines to read a DVD fro like mine, it all seems like a pretty shabby trick But the sa to sell their products at different prices in differentphars to poor countries at discounted prices Confusingly, our es

Maybe the story is as simple as this: when it's an important product like a treatet it to the poor; when it's as trivial as a DVD, our irritation at being ripped off is the dominant emotion But that doesn't quite add up: DVDs make it to very poor areas, and surely we should be at least soet to watchworld? Or, conversely, shouldn't we be even ing for crucial treatments in the developed world? An economist cannot solve these ethical conundrums, but economics can unwrap them so that at least the ethical question beco Here is a thought experiine a hypothetical pharmaceutical company called PillCorp, which has developed a uniquely powerful new treate in any price-targeting and charges the salo-bal price so that the gain in sales froin from a price cut For exains by half Unless they doubled sales this would reduce profits They could raise prices and double their ins, but if sales dropped by more than half that would also reduce profits PillCorp willat the point where either a price cut or a price increase would slightly dah, because people in rich countries will pay a lot for an effective treat custo thousands of dollars in an effort to pick up custo pennies

That looks like bad news PillCorp is using its scarcity power to charge a high price for a life-saving drug As a result, people in poor countries don't get the drug People are dying because of PillCorp's greed

Actually, it's only half bad news People are also living because of PillCorp's greed PillCorp developed the life-saving treated to do so by the hope of a lucrative patent Pharmaceuticals are very expensive to research and de-velop, and somebody has to pay the bill The current system is that public and private insurers pay, and since the United States is easily the largest ely paid for there

Although PillCorp is lobal price, they could be doing better and so could everybody else Econo-your-shoulders-life's-like-that-sothe world better

Say that a year's supply of drugs for one customer costs 10 for PillCorp to produce, and retails at 1,000 For rich custo to pay-or who have insurance that will pay-that's not really a proble with AIDS to those who produced the treat to pay only 50 a year for treatas for his taxi Because of PillCorp's global price policy, the taxi driver loses out on the treatment, and PillCorp loses out on the chance to make some profit But if PillCorp were able to make a one-time discount to the taxi driver and sell him the treatment for any price between 10 and 50-say 30-everybody would be better off The taxi driver gets treat to pay 50 PillCorp receives 30 in revenues for a 10 pill-a profit of 20

That is what economists mean e say a situation ”could be better” If we can point to a change that could make at least one person better off, and nobody worse off, we say that the cur-rent situation is inefficient, or, in everyday language, that it could be better (We also say that the current situation is efficient if every change that could make at least one person better off will also make somebody else worse off It doesn't mean that an effi-cient situation can't be improved; it's just that there is no costless way to ieting, continuing to charge 1,000 in rich Western countries but supplying people in developing countries, like the Cameroon taxi driver, for 30 Suddenly, a whole new market opens up for PillCorp: the new discount allows the company to acquire millions of new customers at a profit of 20 a year, but at the same time, it still makes all the sales it used to make in rich countries

This assumes the cheap pills don't ”leak” back, which in practice is a massive concern for phars fro coness to pay in the United States, but who also sell to Canadian health care providers who refuse to pay high prices for drugs The risk, if the leakage continues, is that American providers simply refuse to offer discounts to Canada any reater price transparency brought about by the Internet and other improve-ments in communications occasionally has a downside: a co discounted products because they arepolicy creates a much better situation Customers in rich countries are no worse off Shareholders in PillCorp are better off And people living with HIV/AIDS in poor countries are also better off To use the business-school jargon, this is a in situation, or as an economist would say, a clear improvement in efficiency