Saturday, 29 November 2014

Black Friday, Squabbles, Prices, Who Pays What, & Why

Lots of people are aghast at Black Friday - they see news bulletins showing people fighting, squabbling and climbing over each other to get discounted goods in a 24 hour period. If they knew what was really going on they'd be less surprised - they'd see it as simply a more extreme version of what they get involved in every day - it's a phenomenon called price sensitivity, and here's how it works.

Let me show you two products from Starbucks.

This is a regular Cappuccino, for which you'll pay about £2:

This is what's called an Iced White Chocolate Mocha, for which you'll pay around £3.50:

What's the difference between the two products in terms of ingredients and production cost? Almost nothing at all. Why, then, is the second priced at £1.50 more than the first? The answer is to do with 'price discrimination' - a tool for seeing who is price sensitive to more expensive goods and who is not. Imagine you've just set up a new coffee shop - how should you price your items on the menu? Ideally you'd want to charge every customer the most they'd willingly pay - but you can't do that because you don't know how much each individual would be willing to pay. Plus if rich Rick pays more for his coffee than poor Pete there'll be an outcry.

By pricing similar products at different prices, what you're basically saying is: if you're the sort of customer who is price sensitive you'll probably buy the Cappuccino for £2, and if you're not you'll probably buy something more expensive, like the Mocha at £3.50. Let me expand this to other examples. Suppose Sainsbury's added 20% to the price of 30% of its wine, vegetables, linseed and sunglasses - those who are price sensitive would seek out the cheapest products on the other shelves - and those who are not would hardly notice they are paying more.

Have you wondered why in supermarkets the 'own brand' cheaper varieties look so unappealing in package design? They are mostly plain and un-alluring, but for good reason. The 'own brand' product appeals to very price-sensitive people, but it is also there to make more expensive alternative products more appealing. Someone who wants the cheapest corn flakes possible won't worry about the awful Tesco own brand packaging - she'll be glad of the savings. Others will consider the extra money well worth it to have Kellogg’s - and Tesco does not mind either way.

Here are other examples. When attending music festivals, price sensitive people will bring as much of their own food and alcohol as they can - those who aren't bothered and would rather have less to carry from the car to the tent area will just pay the marked-up festival prices. Hotels offer discounted prices on the Internet because they know that Internet shoppers are more price-sensitive bargain hunters. That's also why mini-bars have such expensive drinks - they know many guests won't pay for anything, choosing instead to get their water, fruit juice and beer from a near-by supermarket, but they know that guests who are not price sensitive won't worry too much about paying extortionate prices if it saves them having to go to the shop. Similarly in terms of prices paid for London transport, Oyster cards are there for price sensitive travellers, and full fares are like mini bars - they are there for those who are so insensitive to price that they can't even take the time, or have no need to take the time, to get an Oyster card (many tourists, for example).

As well as price discrimination, there are other factors that dictate prices - factors that go beyond customer price sensitivity. An example of a hiked up price with a rationale behind it is restaurant desserts. Have you noticed how desserts are disproportionately expensive in restaurants compared to the main meal? You can pay £10 for a big meal with meat and all the trimmings, and yet you can pay £5 to £6 for a couple of scoops of ice cream thereafter. But there is a good reason why: the value of the ice cream is not what you are being charged for primarily, it is the value of the table time*. While you're extending your stay to order and then eat dessert, you are taking up a table that otherwise could be sold to waiting customers who want to order a main meal. Naturally sometimes there'll be no waiting customers, other times there'll be several - but the restaurant can't know in advance, so it can't fluctuate its prices every half an hour according to demand, it must set fixed prices to allow for it.

Pricing is all about getting the balance right. Take pubs and tap water. Most pubs don't charge for a glass of water, but some do. Why should they charge for tap water that's so readily available and at such a small cost? It's for a similar reason to the price of desserts - water is a substitute for other liquid - while you're in the pub drinking water you're not drinking coke or lemonade or beer. Giving you a glass of water means giving you a substitute for the thing they are trying to sell - pub drinks. Now in most cases water drinkers are sparse; sometimes they appear alongside friends who are drinking other drinks bought at the bar, or they have water with a meal - and it is because of their sparseness that most pubs do not make a charge for water. Those that did probably would find the gains would be outweighed by the losses - water drinkers and their friends may well choose a different pub - one that makes no charge for water.

So why, then, are there so many Black Friday squabbles?
After reading all that about price discrimination and price sensitivity, it should be easy to see what's really going on in that 24 hour Black Friday period. If we need toilet paper, petrol or a new washing machine to replace the one that broke yesterday, we can't be too sensitive to whether those items are on sale or not - we have to make the purchases. In other words, they are not discretionary purchases. Now a lot of the things people buy on Black Friday are discretionary purchases - people buy them because they are on sale, but they wouldn't otherwise buy them. So on ordinary days shops set their prices to attract price insensitive shoppers, with sale items being for price sensitive customers. On a day like Black Friday stores know that price sensitive shoppers will be out in their droves, with price insensitive customers likely to stay away to avoid the crowds and squabbles. The less well off you are, the more price sensitive you are likely to be, so the more keen you'll be to struggle at close quarters among the crowds to grab that bargain you couldn't otherwise afford.

It's easy to see a couple of instances of civil unrest on the news and look upon Black Friday with utter regret (and yes, there are plenty of things about the concept to regret) - but to only have a downer on it would be to overlook the obvious gains. The millions spent yesterday will be a huge boost to businesses and their employees, as well as being a huge benefit to the tens of thousands of consumers who are currently struggling and couldn't afford to pay the non-discounted prices, but now have something they wanted.

* And to some extent the same applies to starters