From Failblog, via Marginal Revolution – an amazing new pricing strategy.
Local merchants in the Northbrae neighbourhood of Berkeley, California (h/t Marginal Revolution) are fighting against an evil competitor who wants to sell the same products at lower prices. Apparently, there was previously a tacit agreement that each store would keep to its own speciality and there would be no undercutting.
This quote was especially amusing:
Asked why Monterey Market should not have the right to pursue a business model that includes selling what it wants, Ng said: ”Sure, but they don’t have to carry exactly the same products. It’s not that there was no competition before — we carried some of the same items — but we had matching pricing,” Ng said.
What a cheeky idea: “competition with matching pricing”. Of course it suffers from a minor drawback – it’s illegal. But this kind of implicit deal exists in many industries. Lots of companies say they refuse to compete on price – partly to preserve their premium quality image, but undoubtedly also because it helps to keep profits high, supporting all suppliers at the expense of consumers.
[Monterey Market’s Sunday opening] has also had a direct impact on sales…opening hours used to be coordinated among the merchants, according to Ng.
It’s easy to mock this as naivety about how competitive markets work. But one can understand the impulse to maintain a local community of traders in the medium-term interests of both consumers and sellers.
In the short term, the new lower prices are good for consumers. In the medium term (if some of the other shops go out of business) they might be bad. But in the long term? I think this is the interesting question. Is the long-term survival of this particular group of businesses what people will most benefit from? Or is it better that the business mix in an area changes over time, as people figure out better (and/or cheaper) ways of doing things?
The answer is different for different people; some people value stability, some like novelty. But whichever of the two worlds you prefer, trying to forbid price competition probably isn’t the way to achieve it.
Shops which sell distinctive, high-quality goods can maintain a competitive edge in various ways. The most immediately appealing is the idea of packages: combinations or experiences that only you can create, and which give people a reason to come specifically to you.
In the case of ethnic foods (which I believe covers several of the merchants in this case) this could be recipes, special deals on ingredients which go together, cooking courses, or an online service for choosing and ordering a whole meal at once. Or it could simply be the fact that you’re on the cutting edge – seeking out the latest products in your category which the cheaper, generalist merchant has no time to find.
Any of these can help you maintain a price premium without collusion or the apparent sour grapes exhibited here. Of course they do all involve a bit of hard work. Surely the shops in this story aren’t suggesting they’re entitled to a living?
I quite liked the suggestion in this quote (in an exhibition at the British Museum) that you would buy money in this market just like any other good.
No mention of what you’d buy it with. I guess it’s a genuine Walrasian market like Nick Rowe keeps going on about. What’s the price of a dollar in the currency of indigo yarn?
I wrote this briefing for some of our clients a few months ago when the rate of UK VAT increased from 17.5% to 20%. I’ve decided to share it publicly as it may be useful for some of you when other increases take place (for instance raw material costs which have to be passed through) or if tax rates change again. And if VAT is going to increase in Greece, Ireland and other indebted EU countries, this could be a useful reference.
So, how should you update your prices if the rate of VAT goes up?
The simple answer, the one you’ll get from your accountant, is: increase all the prices you charge by 2.13%.
However, the more interesting question is a psychological one: how will your customers respond to the changes? There is room for some creativity here.
Here are seven things to consider. I’m using a case study of a local pub in order to give concrete examples with each point, but the same principles apply to any retailer and indeed to most business-to-consumer operations:
And two general principles to remember:
A note on rounding, as many retailers prefer to keep prices rounded to even numbers.
In our pub example, they may want to keep drink prices at multiples of 10p. This is fine – in fact it probably means that you can increase the prices by a bit more than the VAT rise. e.g. a £3.50 pint going up by just the VAT rise would be £3.57, so if you put it up to £3.60 you’ll get nearly an extra 1% in revenue. Even better on a half pint.
You may want to offer a couple of specific brands at £3.55 or £3.58 just to make people think the prices are being very carefully worked out – many customers will assume they are getting a better deal when they see prices like this.
And one other change businesses can consider [in the UK case, the increase was just after Christmas] is to increase their prices before Christmas instead. Demand should be high at Christmas, so a price rise may be a natural decision anyway. Then, simply keep the prices at the same level in January (perhaps tempered with a few judicious post-Christmas sales promotions).
And finally, the biggest problem of a tax increase: the 99p price point. There’s not much you can do about products at 99p or £1.99 – you may simply have to swallow the 2p reduction in margin. But other 99p/95p points are more flexible. For example, sales of an item at £4.95 are unlikely to be seriously impacted if you go to £5.95. And even with the VAT increase, your margin will still be significantly higher.
A nice brief analysis from Eric Barker of different strategies when you’re negotiating one-on-one with a buyer, versus when you are auctioning something off.
the final selling price tends to be higher when the seller makes the first offer and lower when the buyer moves first. This phenomenon is known as anchoring.
while in auctions:
in auctions starting low can often produce a higher selling price…in auctions the number of bidders is determined by the features of the auction. Maximizing the number of participants in an auction benefits the seller—a greater number of participants will usually result in a higher ending price
So if you have multiple buyers of what you’re selling and you can only sell to one of them, the auction strategy may let you achieve a higher price if you start with a low bid and let people drive each other’s willingness-to-pay upwards through competition.
While if you are selling to several customers and you can sell to all of them (for instance if you are a lawyer selling your legal advice) individual negotiations are the way to go; and be sure to make the opening offer!
This exciting opportunity for arbitrage emerged today at Tesco.
I cleverly took advantage of the second offer, which is half the price of the first.
I made an immediate profit of £1 at the expense of Tesco. Take that, corporate behemoth!
Er…Anyone want to take a Creme Egg off my hands?
Many businesses think it’s OK to increase their prices with inflation every year. It seems fair enough to the owners – if my costs have probably gone up, and my customers are paying a few percent more for everything else, why shouldn’t they pay more for my services too?
Well, not always. Arsenal FC has announced a price increase of 4% this year (in addition to incorporating the 2.5% VAT rise) after freezing prices for the previous three years. But the reason I found out about this was from two outraged tweets:
Will knows that tickets have been held for a while (he says “finally”) and yet he still clearly believes the increase is unfair. So do many other supporters.
It seems clear that fans are angry at Arsenal’s likely lack of success this year (especially as a potential opportunity for a league win seems to have been thrown away). They generally blame the board, who (with the apparent agreement of Arsene Wenger) seem unwilling to buy new defenders and a goalkeeper. And as the club is likely to be sold to American investor Stan Kroenke, there’s about to be a new focus for their displeasure.
In this context, people do not accept the natural justice of an automatic inflationary increase, even when there hasn’t been one for the last couple of years. They want more for their money – either an improvement in facilities, hospitality or seat position, or a better-performing team. If Arsenal were to announce a 15% increase in seat prices, conditional on winning the Premiership or the Champions League, I think most people would accept it quite happily.
One other sneaky rationalisation: the 2.5% VAT increase on top of the 4% inflationary increase. In fact, the 4% inflation figure already includes the effect of VAT, so this is double-counting. There might be better ways to communicate this.
Anyway, here are the two lessons.
Some final thoughts.
Other Premier League clubs don’t appear to have this problem – there seems to be no online surge of disapproval at Spurs or Chelsea’s price increases – though the OFT did persuade Man United last year to change their terms and conditions to treat customers more fairly, and their owners are much more disliked by the fans than Arsenal’s.
And keep in mind: Arsenal still manages to charge the highest season ticket prices in the Premier League – and crucially, the second biggest range of prices after Spurs – and has a waiting list of 40,000 for tickets. So they aren’t suffering too much.
Our research at Inon has enumerated 31 different pricing models over the years.
Is this the 32nd?
Some people (typically economists) love airline pricing and think that flexible, demand-based prices should be applied to all sorts of things (such as restaurants, in this posting from Rafi Mohammed). After all, if there’s a shortage of something (Saturday night reservations), it can be cured by increasing prices; this displaces price-sensitive customers to other nights, when the prices can be cut in return. Everyone wins, so why not?
And yet the pricing policies of airlines are among the most hated of all industries. Bill Saporito here suggests that the US Department of Transportation is imposing rules to increase the transparency of airline surcharges. The European Commission has already acted similarly, and the UK’s advertising standards authority has ruled several times against the misleading advertising of a number of airlines.
Do people dislike demand-based pricing because it is difficult to predict what you’ll pay, which imposes an extra cognitive load? Maybe, although I suspect this effect isn’t consciously considered by most people: instead, the cognitive laziness takes the form of anchoring. We anchor to the lowest available price and any higher peak-time price feels like a rip-off.
The dislike of surcharges is partly for the same reason – we anchor on the base price, and each extra charge feels like an extra hand in our pocket. Also, surcharges are often based on the concept of “drip pricing” – get people to start a buying process at a low price, and then when you introduce the extra charges later, they have already spent time and effort which makes them less likely to walk away. But even if they don’t leave, they’ll resent the bait-and-switch nature of this approach.
There are ways to get people to pay a demand-based price without resentment. Indeed, most successful businesses are already doing this, though maybe not consciously, or as well as they could be. I’ll write more about that next time.
Procter & Gamble and Unilever have been fined 315 million euros for price-fixing.
There are much more imaginative (and legal!) ways to maintain a price premium than this. Product innovation enables price differentiation; increasing the perceived value of your product allows you to charge more; and bundling your products in innovative ways can reduce commoditisation.
I know that Unilever at least is engaging in some of these things, and I’m sure P&G must do too. Naturally I am available to assist with behavioural pricing research if either company is interested in a chat…