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The Undercover Economist
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 trouble some to avoid unpredictable price increases -- and may not even notice them for lower-value goods -- but easy to avoid predictable ones...
Have you noticed that supermarkets often charge ten times as much for fresh chili peppers in a package as for loose fresh chilies? That's because the typical customer buys such small quantities that he doesn't think to check whether they cost four cents or forty. Randomly tripling the price of a vegetable is a favorite trick: customers who notice the markup just buy a different vegetable that week; customers who don't have self-targeted a whopping 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 more interested in snacking.
That is from Tim Harford's new The Undercover Economist: Exposing Why the Rich are Rich, the Poor are Poor -- and Why You Can Never Buy a Decent Used Car (don't trust Amazon, the release date is November, not January). This book is one of the very best introductions to the economic way of thinking. "Required Reading," says Steve Levitt, what better endorsement could you want?
Here is Tim's home page, including his FT "Dear Economist" columns. Here is Tim's Private Sector Development Blog. Here is Tim's recent FT piece on Thomas Schelling. Comments are open, in case you have other examples of comparable supermarket tricks.
Posted by Tyler Cowen on October 13, 2005 at 06:27 AM in Books | Permalink
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» Economics v. Armageddon from OUPblog
Tim Harford, author of the forthcoming book Undercover Economist, wrote a glowing appreciation of Thomas Schelling today. Schelling is, of course, the 2005 Nobel laureate in Economics (shared with Robert Aumann) awarded for his work to enhance "our und... [Read More]
Tracked on Oct 13, 2005 11:38:50 AM
» Uncovering the Undercover Economist from Catallarchy
With the long weekend of gluttony and shopping behind us, we’ve got a little special something to wake up your sluggish brains and perhaps even lighten the load on your burdened wallets. When I was in DC earlier this year visiting my fellow Catallarchi... [Read More]
Tracked on Nov 28, 2005 7:15:03 AM
Comments
I had a friend who worked at a Home Depot and said that anything that was hanging on "the steel" and at eye level was a product with very high profit margins. But this is probably old news: impulse items = high profit margins.
Posted by: Ian Lewis at Oct 13, 2005 8:29:24 AM
Supermarkets almost always put either their brand, or the most expensive brand, at eye-level, as most people don't really look hard.
There are all sorts of 'tricks', not just with prices. Harsh lighting and lots of cooling make the shopper uncomfortable and they desire to shop and leave as fast as possible (without looking hard for bargains). Often staples will be in the back of the store: have you noticed you need to walk through the entire store to find the milk?
And the biggest trick: discount cards. They track your purchases, giving plenty of free information. Also, I'm sure many people don't mind paying the "normal" price if they forget the card, though this is actually an inflated price.
On a side note, I’m curious how more aides for the shopper could affect this. There is talk of each cart getting a digital ‘assistant’. That can scan prices, answer questions about the location of a certain product, track how much you’re about to buy as you go along, etc.
Could people use the system to find the lowest prices? Would shoppers trust the system if it didn’t?
Posted by: Ivan Kirigin at Oct 13, 2005 8:42:25 AM
The entire layout of grocery stores is designed with this in mind.
Meat and other cold items are not placed around the outside rim because it is easier to get electric connections for the appliances. Rather, they are the high margin items they want to expose you to the most. The bulk items in the center isles are the low margin item
while the things at the ends of the isles are high margins merchandise.
Moreover, milk is always placed at the back of the store because people often come to the store to only buy milk. So they make you walk past other tempting items on the way to get milk.
Posted by: spencer at Oct 13, 2005 8:56:57 AM
It's not limited to grocery stores, or to different or differently-packaged products. I recently purchased some software on Buy.com, and found that the price on the "front page" of the site was 25% higher than the price of the same software if you browsed the site by section, which in turn was 10% higher than the price if you found it through the site's search feature.
Posted by: Grant Gould at Oct 13, 2005 9:14:41 AM
Does anyone know if Wal*Mart does this? If so it would belie their 'Low prices every day' motto.
On the other hand, if Wal*Mart does NOT do this, this would seem to be strong argument how gouging your regular customers is a bad business strategy. They might not notice the price hike on individual items, but even the laziest shopper can tell the difference between $100 and $115 at check-out.
Posted by: Brock at Oct 13, 2005 9:40:53 AM
I know someone who used to sell for P&G. Since
every grocery is going to sell Crest, the negotiations tended to
center around price and placement. The salesman wanted his product
at eye level, of course. He even had little magnets with his
products on them to help visualize the shelves. I find it
interesting to think of the game from their perspective, with
different salespeople trying to gain the best price, but keeping
the grocery store's margin high enough that they will put them
at eye level.
Posted by: Mike at Oct 13, 2005 10:06:25 AM
And yet, at the same, every grocery store I've seen in the last fifteen years has an automatic "price per volume" (or weight) amount printed on each shelf price, allowing people to easily compare the prices of goods that come in different sizes.
Higher prices for people who don't care, lower prices for those who do.
Posted by: John Thacker at Oct 13, 2005 10:07:45 AM
This is not a trick, but nevertheless interesting.
I was told by somebody working in the field that
supermarket chains in Europe get most of their
income from short-term investment, not from sales.
They are able to negotiate long payment terms from
their suppliers (2-3 months?), but sell the delivered
goods almost immediately (one week). So they get a lot
of money through trade credit which they do not have
to pay off for several weeks. They can invest this 'free
money' into a more profitable business.
Posted by: Oskar Shapley at Oct 13, 2005 10:43:39 AM
I'll probably buy Tim Harford's upcoming book just to learn why it's so hard to get a decent used car. A couple of months ago I was helping my stepdaughter look for her first car, and we were planning on spending about $7,500 and hoped to get a car maybe five or six years old with mileage under 75,000. Extensive car-hunting became an exercise in frustration, as the used-car market seemed to consist entirely of: 1) high-mileage, often decrepit cars a minimum of eight to 10 years old, or 2)low-mileage cars just two or three years old, selling for not much off their prices when new. There was no middle ground, which seemed peculiar in that many people finance new cars with 60- or 72-month loans and trade them in when paid off. But where were those cars?
By the way, we ended up getting a 4-year-old Volkswagen Jetta with just 32,000 miles, paying $12,000. We'd probably still be looking if I hadn't been able to go over the original budget.
Posted by: Peter at Oct 13, 2005 11:28:46 AM
John: My grocery store has prominently posted unit prices. For most items, it seems that they list price per ounce for half the brands, and price per pound for the other half.
Posted by: Micah at Oct 13, 2005 11:47:23 AM
I think Tim Harford's a great guy and his Dear Economist was very funny. So I'll probably buy the book. However, if you want something very similar that will also tell you why you can't buy a decent used car, you could do worse than read John Kay's book 'Everlasting Lightbulbs'. It explains the problem of asymmetric information in markets such as the automotive, where the supplier knows much more about the quality of a car than the buyer can. Or you could read the Akerloff work - the 'market for lemons'.
Posted by: Ross Parker at Oct 13, 2005 12:15:20 PM
At the local Super Target, if you look at the prices of different sized packs of over-the-counter medicines, vitamins, etc. you will find that the bulk packs consistently cost more per unit. For example you might see a 30-pack of a generic allergy pill for $3 and right next to it is a 100-pack for $12. My only thought is that they're betting customers assume the larger packs are a better deal and don't actually check the per-unit price.
Posted by: Noah Yetter at Oct 13, 2005 12:18:53 PM
Most of this is too clever by half, offering ad hoc analysis, and ignoring fundamentals such as product quality. Prepackaged fruits and vegetables almost invariably sell at a lower price per unit than hand selected items. Hand selection results in cream skimming, inferior fruits or vegetables unsold, and deterioration in product quality via handling. Ben Klein et. al. analyzed this as an over-search issue long ago. Where bagged items are priced at a premium, the bag is usually associated with a brand name, providing assurance for customers. (Such as in the case of Chile's cleanliness.)
In the case of high price items at eye level. Two factors should be kept in mind. First, demand and supply, at first pass, determine price. If demand increases one would expect price to go up, and to accomodate customers that seller would move the more popular items to more convenient locations. Second, shelf space is often purchased by individual suppliers who have the right to arrange items, not the store management. Why shouldn't popular products with higher margins win the better shelf space in an open competition with enforceable property rights. And in some cases their is a rent seeking competition among suppliers with property rights in shelf space poorly enforced (because of cost, thus blocking each others products or trying to obtain the preferred position.
I think the authors above are looking to hard for conspiracy and not doing much economic analysis.
Posted by: Davide Sisk at Oct 13, 2005 1:46:23 PM
Those variable supermarket prices are one reason I like my Trader Joe's staples.
Ah well, who am I to say. I shop aggressively for some things and spend freely on others. It's the old "different kinds of dollars" and "mental accounts" thing.
Posted by: odograph at Oct 13, 2005 3:05:37 PM
It seems to me that these varying prices could backfire. There is a nearby grocery I avoid because on a few occasions I have noticed outrageous prices on some items, and this has led me to conclude that its prices are generally exorbitant. If they were just playing the game described here then this may be an inaccurate conclusion, but I don't really care to investigate carefully. It's easier to go elsewhere.
Posted by: Bernard Yomtov at Oct 13, 2005 4:01:40 PM
I'll second the comment above about the largest packages having a greater per-unit cost than some smaller ones. Definitely trying to take advantage of those who naively assume that the largest package will always have the lowest per-unit price.
Also interesting is the profusion of variations in one brand that you see - twenty different flavors of Crest toothpaste for example. Given that the toothpaste manufacturer is paying for the shelf space, it makes me wonder whether there is a deliberate attempt to buy so much space that alternative brands are suppressed.
Posted by: bbartlog at Oct 13, 2005 4:16:30 PM
Around here, there's a store that tends toward bulk-- it's a bag it yourself place that does very well on most items. Except their meat prices are much higher than their competitors. If you buy a whole cart of various foods you'll save money over other supermarkets, but you'll lose if you weight it toward meats.
Few people seem to notice.
Posted by: ScottM at Oct 13, 2005 4:35:05 PM
I've been fascinated by the grocery store landscape since I moved to California; the discount cards that someone complained about above are nearly ubiquitous. Ralphs, Albertsons, and Vons all have them. Of course, if you forget your card, you just punch in your phone number or borrow the clerk's card -- I've never had that be an issue.
Starving graduate student that I am, I find the four grocery stores on a single three-mile stretch of road by my house are quite convenient -- of course, my schedule's probably less demanding than the average person's, which makes my price-consciousness more feasible. Anyway, if Diet Coke's expensive at one place this week, I know that it'll be cheap somewhere else. If skinless chicken breast is 5.99/lb. at Ralph's, it's bound to be 2.99/lb at Albertson. This is true of both high-margin and low-margin items. It's interesting to me how it almost looks like niche pricing -- Albertsons tends to price low its high-service items and charge high "in the center". Ralphs is the opposite. (I don't get all the way down the road to Vons too often.)
But I've often wondered too how much impact per capita incomes affect grocery store pricing -- there's no question in my mind that it partially determines store layout and stocking choices. (That three-mile stretch I mentioned happens to go from medium-income to very high-income to medium-high income, relative to the larger area. Gotta love San Diego.)
Do you charge more for staples (as opposed to high-margin items) because that's what lower-income customers are accustomed to buying? And lower your prices on the outside of the wheel to continue bringing in your normally higher-margin customers?
Yep, I think it's fascinating.
Posted by: Michael at Oct 13, 2005 4:43:04 PM
I don't know about making money on the trade credits,
but the grocery business is the classic high turnover,
low margin business.
Posted by: spencer at Oct 13, 2005 5:32:08 PM
I think I've sensed a change in price structure post "big box" but would be hard-pressed to say exactly what it is. Maybe they are forced to target specific items for profit margin in order to make the whole store "work."
As I'm sure you know, one reason Trader Joe's can go for the stable low prices on so many items is the reduced choices in their stores, and the primacy of store brands.
"Overall selection is narrow, and 80 to 85 percent of the store's 2,000 items consist of Trader Joe's various private labels. (The typical supermarket, by comparison, carries about 25,000 items.)"
more here:
http://800ceoread.com/excerpts/archives/001342.html
Geez, what a tough business in the big box age ... stocking 25,000 items (I've also heard 30,000) when the other "models" get to concentrate on the core.
Posted by: odograph at Oct 13, 2005 5:44:20 PM
For two years I worked for a fellow who was practicing grocery arbitrage, or what is commonly called a grocery diverting. Diverters buy and sell wholesale grocery items between different manufacture’s “regions”. The fellow I worked for would buy a truckload of say, apple juice from an Albertsons in Portland that was getting a manufacture’s “deal”, and sell it to a Ralphs in California. Because I saw the deals pass through the office, I also knew what the “specials” and the “end of isle” items were going to be in my own grocery store. The stores like Jacks buy diverter loads, hence the item is there one time but not the next. There is a diverter group out of Florida that does most of the grocery procurement for one of the major chains. With very little imagination you think mafia. The most interesting thing I saw was how the manufactures manipulate the market through quantity. If you watch some products carefully you will see the weight or quantity creep downward before the price and a new “size”. This is especially prevalent with things like potato chips. The grocery business, if you really get into it, makes you sick. It is a players game where money goes across and under the table faster than the eye can see. It was hard for me to believe what people were willing to do with food.
Posted by: Jane Morgan at Oct 13, 2005 7:29:13 PM
Are economists just noticing these tricks? Having spent 18 years in the consumer packaged goods marketing research business, I thought everybody knew this. A subscription to Advertising Age or Supermarket News would tell you all about these ploys. The University of Chicago is full of economists and the Chicago area is full of marketers and marketing researchers, but the U. of C. economists never seem to bother to ask the professionals why they do what they do.
I'm sorry if I sound like I'm repeatedly giving Tyler a hard time about the curious shortcomings of the economics profession, but the reason I read Tyler's and Alex's blog daily is precisely because they are so much more aware of the real world than are most economists. I am repeatedly amazed by all the things that economists are amazed to discover about reality.
By the way, in answer to the question about Wal-Mart, I haven't followed Wal-Mart closely in recent years, but when I used to call upon them in Bentonville to try to sell them stuff (not a fun job, by the way) in the early 1990s, their view was that the supermarket industry had been softened, even corrupted by all these price discrimination and similar gimmicks and there was therefore much room to drive down prices (and drive down costs even more), so they were entering the grocery business on a large scale. What has happened to Wal-Mart's strategy since, I don't know, but I know lots of former colleagues who would know.
Posted by: Steve Sailer at Oct 13, 2005 8:19:35 PM
By the way, I did a study in 1991 for my marketing research company that showed that the government's consumer price index was significantly overstating inflation because it was failing to take into account the increasing variability in the prices of consumer packaged goods.
Each year, we saw in our data, more and more groceries were offered by stores and bought by consumers "on deal" rather than at the regular price. If a 6 pack of Coke was at it's regular price of $2.99 that week, maybe they bought a 6 pack of Pepsi instead for 1.49, or they bought a 12 pack of Coke for 3.99 or they waited a week until Coke was 1.49. Or they'd buy it at the warehouse club for 4.99 for a case.
But the CPI was calculated based on a fixed grocery list: on the 3rd Thursday of the month, the government shopper would go to the Albertson's and note down the price of a 6-pack of Coke, no matter how absurdly high the price was compared to all the alternatives.
The excess payout in Social Security cost-of-living adjustments due to this was billions per year.
Posted by: Steve Sailer at Oct 13, 2005 8:29:02 PM
One trick I've noticed in my local supermarket...
Items are on sale for a week. While on sale, a small sign hangs off the shelf displaying the sale price.
The week after, the sale is over but the little signs are still there. However, a close look shows that they now display the "Everyday Low Price!"
The signs aren't taken down until a week after the sale ends.
Posted by: Frank DeWith at Oct 14, 2005 2:10:39 AM
Economics discovers stochastic resonance!
http://en.wikipedia.org/wiki/Stochastic_resonance
Stochastic resonance occurs when the signal-to-noise ratio of a nonlinear device is maximized for a moderate value of noise intensity. It often occurs in excitable systems with subthreshold inputs. For lower noise intensities, the signal does not cause the device to cross threshold, so little signal is passed through it. For large noise intensities, the output is dominated by the noise, also leading to a low signal-to-noise ratio. For moderate intensities, the noise allows the signal to reach threshold, but the noise intensity is not so large as to swamp it. Thus, a plot of signal-to-noise ratio as a function of noise intensity shows an upside-down "U" shape.
Posted by: EricM at Oct 14, 2005 6:50:55 AM
