Monday, January 16, 2006

A Pricing Lesson

Last week my brother commented about prices saying,

Prices, however, often give you no wiggle room. "An item is worth whatever the purchaser will pay for it." they say. I can't go into a Musicland and try to negotiate the price of a CD. I may think it's worth $5 but they want $20. No comprimise is possible.

It makes me very concerned because it implies that suppliers set prices and we, as consumers, have to take them. The reality is much more tricky. First, there is wiggle room when it comes to prices. If you think a price is too high, you can a) wait for a sale or b) get it somewhere else. True, traditional bargaining is very rare (particularly in the US) but we negotiate--in a sense--when we refuse to pay for something we feel is priced too high. Our actions put downward pressure on prices.

It is true that any random individual has very little control over what the tag says. But that goes for both demand AND supply. No one person sets the price from on high. It is the result of the wants and needs of millions of other people. Compromise is not only possible, it is really the everyday reality prices experience.

Hayek reminds us that prices are determined by billions of seemingly disconnected circumstances from all over the economy. They draw in knowledge that's unique to time and place, knowledge that's important but difficult to convey and, most astonishing of all, only the knowledge that's important (granted the "important" part is imperfect but it's still quite the impressive filter). "Prices" forged in the government sector (such as union wages, speed limits and sugar cane) stop being useful amalgams; they don't merge demand and supply, they ignore millions of tiny adjustments, and sidestep countless and qualifiable volumes of knowledge.

My brother quoted an old adage--"an item is worth whatever the purchaser will pay for it"--but we all know it's not quite that simple. If you think it is, try buying a yatch for the same price as your microwave.


Anonymous said...

"It makes me very concerned because it implies that suppliers set prices and we, as consumers, have to take them."
That is a true statement. The seller decides the prices. I can go to two different branches of the same store and find two different prices for the same item. Why? It's the seller's choice. Sellers determine when sales happen and for how much. Sellers compare prices with each other and try to match each other. When that happens, trying to comparison shop as a form of negotation is not as effective as you imply it to be.

Waiting for sales is also not as effective as you'd like because you always have to look for them, which usually incures the cost of a newspaper description in addition to time spent looking for them and deciding how long you should wait for said item. Sales are mostly meant for impulse items or to lure customers away from competitors. That's why the Black Friday ads are such a secret. Waiting for a sale is a gamble. It may be sold for a lower price or it may not.

Let's say I wait for a CD to go on sale. Each week I spent 10 minutes checking the ads for the price I want. After 6 weeks I find it for $4 less. So I spent an hour to save $4. Does that make sense? An hour of my time is worth more than $4. So I am still at the mercy of the seller.

Another example is when the Xbox 360 was released. The law of supply and demand means the price should have gone up, and it did - on eBay. But not at Best Buy. They had it for the same price as Fry's and CompUSA and Circuit City, and so on. All the retail prices were effectively the same and I don't remember hearing about any sales. The consumer did not influence the price. If someone else got the last console, you couldn't tell the clerk, "I'll pay $50 extra if you give it to me." No negotiation with the seller either.

Yes, we can go elsewhere, but shouldn't you also factor in the time and energy it takes to get that possibly lower price? For example Trader Joes has watercrest crackers for $1.19 and is about 5 miles from my apartment. Jewel has watercrest crackers for $1.89 and is in walking distance. Where is it better for me to get these crackers?

I don't think many people wait for sales when they want a specific item to a great degree. In my experience, people wait for a sale on something they sort of want THEN go out and buy it. So who has the power then?

"prices are determined by billions of seemingly disconnected circumstances from all over the economy"
OK for Xmas I got two pocket books. One was in a series based on a computer game. The other is a stand-alone self contained novel. Different authors, different lengths, different publishers, but they have the SAME PRICE. If Hayek is correct, shouldn't the books have different prices? Go to a bookstore and look at how much they want for paperbacks. Most are the same price, $6.99. You won't find any that are $6.91 or $7.03 or $6.35. If prices are determined by billions of factors, then why do they always seem to center around $x.99 or $X.95? They should be evenly distributed 0 to 99 cents plus X dollars.

Another example. King Kong took $200 million to make. Munich took $20 million. (Don't quote me on price, I'm giving my best guestimate.) So shouldn't the Kong DVD cost 10x as much? Want do you want to bet they'll be about the same price?


Anonymous said...

To append my post, has illegal file sharing of music files brought the cost of CDs down at all? The masses of consumers are telling us they believe the price of a CD is too high so shouldn't the music industry lower its prices in response?

David said...

Ok lots of things. Let's take them one at a time.

1) It's true that company A writes down a price that they sell at retail. And yes, they have some discretionary power when they deciede on a number. But they don't have nearly as much power as you imply. If they did, why don't they sell CDs for $50 or $100 or $1,000? Because people won't buy them. Consumers don't HAVE to buy any one particular product offered by one particular organization (except of government monolopies, like sercurity).

2) It's amazing how much people do wait for sales. Maybe not so much for CDs where you only want one of a particular CD, but when there's a sale on, say, Pepsi, I'd seen people buy 8 or 12 12-packs. It isn't that they will drink more over the week (though they might) it is that they are stockpiling so (hopefully) they won't have to buy more until there's another sale. Just think about Dad and how he scans the ads every week and then buys in bulk of whatever's on sale. People do this all the time, espeically for things that don't spoil.

3) Few people, though check for ads for one particular thing, for reasons that you cited. But they still buy it when it's on sale (they might see it while wandering the store). I did this with the Firefly box set because it happened to be on sale and I waited long enough for it to be on sale for more than Amazon. It all depends on how much YOU want it and when YOU want it.

4) So what's the deal with the different prices of the same thing and same prices of different things? First, always remember that products are package deals. You just don't pay for bread, you pay for customer service, the look of the store, the location of the store and so on.

Second, many items (like books) aren't as senstive to those differences. People are willing to make special trips to Barnes and Noble because it's fun and special; grocery shopping is a weekly chore. And because sellers DO have strategies for setting prices (using that little bit of room to play with), we see similar prices for (seemingly) different products. Getting a price as close to, say, $6 without actually hitting $6 is a time honored tactic in the marketing industry. (Note that on Amazon, that rule seems to go out the window. I'm not sure why.)

Third is the role of contracts. I would suspect that the reason the XBox retail price did not change was because Microsoft set the price in the contract to ensure they were all sold (or for some other reason, like to completely sell out so they would get press about how popular it is). But the simple fact that the new Xboxes appreared on eBay at a mark up demonstrates us economists aren't completely crazy.

Fourth, I personally haven't witnessed a fall in CD prices--I doubt others have, too--and there could be several reasons for it, again contracts being the first to mind. General stubbornness on the part of the record company/retail chain/artist could also be the cause. Remember, free market economics doesn't say people WILL always adapt, only that they should. (Also note that just because the price did not change doesn't mean there's no adaptation. Companies have encoded their products to discourage tampering, for example, into to continue to maintain the product's retail price.

The reasons why stuff costs what it does is complex and sometimes counter intuitive. But it is not willy-nilly set by faceless executives because they face real restraints based on consumer demand, contracts, and so on.
To assume that you are "forced" to pay for a CD simply because that's what it costs doesn't give you enough credit as a human being.

Anonymous said...

1) Companies charge as much as they think they can get away with. But items like CDs or books or games have one publisher. If Vivendi wants to sell their latest game for $50, there's not much anyone can do about it. If you want that game, you shell out the money they ask for. Or you wait months or more for it to go into the bargin bin. But that is detremental in the long run.

Being an anime fan, I know it is important to support the companies. They're very much in tune with supply/demand. If you wait a long time to buy an anime series, it reduces the chances of other series like that one being imported. Buying something is a bit like casting a vote. But when you vote, you're not just voting for the item, you're voting for the PRICE of that item. If you won't pay their price, is it because of the item or how much they're charging? Maybe they'll drop the price. Maybe they'll drop the item.

2+3) I've seen "stocking up" happen a little bit, but that logic can't be applied to other items. The way you describe a sale implies it's less about price and more about bait. The intent of a sale is to get people into the store and buy more. We're not exercising control over the price. We're allowing ourselves to be manipulated by the price.

A sale means the store CAN sell it for less, but only chooses to do so for one week. They are hoping that instead of one person making them a profit of $10, two people will make them a profit of $8 each. I've seen items go on sale that literally saves you only pennies, but people buy them because they're on sale and they don't check to see how little they are saving. Again, the consumer has virtually no control because they are effectively tricked into buying the item.

I also think Dad will get coupons for things he will already buy or plans on using. I haven't seen him stock up. Most of the time he uses a coupon to buy brand Y and not brand X. Why don't you call him and find out for sure? We need your new address anyway.

4) My point was that these "billions of factors" that determins a price are countered by conformity. Most of the time a generic item will have the same price (a book, a CD, etc) independent of creator or content. A gallon of milk is pretty much the same price in the same local area. Retail items are usually the same price across the nation. They have the same base price with local differences like location making up the difference. We still don't have any real control over what the final price is.

Amazon realizes this. Anyone who's been a consumer for more than 5 minutes knows that the ".99" gimic is a crock. You hold a $9.99 price to most people and ask them how much it is and they'll say "10 dollars". We add the extra penny because we're aware of sales tax. We know $9.99 really means "at least ten dollars" and depending on the sales tax, "eleven dollars". Some places don't bother with this lame legerdemain and have whole numbers on their menu. It makes it easeir and customers don't feel like they're being talked down to. You want a perfect example, gas prices. The last 9 in the price is a tenth of a penny. I think that's really pathetic. They're trying to trick their customers into thinking their gas is a whole penny cheaper.

Can you give me a concerete example of when consumers put their foot down and actually force a price to be lower? Then tell me how likely that event is to happen again. I bet I can match with two counter examples about how consumers just bend over and take it.

I think part of the problem is that people are passive because they don't think they can influence high prices. They don't think they can do anything about it (they haven't seen it happen before) so they don't try. People are suckered by the word "sale" sometimes for good, sometimes for not so good. In either case, the companies are trying to manipulate the people and not the other way around.

I got breakfast at the Corner Bakery and paid $2 (well $1.99 plus tax) for a small bottle of juice. I didn't realize how much it was, I was in a hurry. But they give out a URL and password for a survey form. I specifically said their price for juice was too high. How many people will have to make the same complaint before the price goes down? The number is so arbitrary it's useless. What happens if all the companies are stubbron? What influence can we have then? It's not selling oneself sort, it's experience in the real world.


David said...

Concrete examples of cheaper items? Why not give me hard task! Look around you; your monitor, television, computer, telephone, desk, pens, VCR, DVD player, and on and on are cheaper now than they were 10 years ago (in most cases even before you adjust for inflation). Remember when cell phones were a luxury and you had to watch your minutes carefully? Now people use them as a preferred substitute of a land line. Wal-Mart became a giant by selling at rock bottom prices.

Add to the fact that "cheaper" is a strange term. If an item improves in quality but doesn't change in price, it's become a cheaper item. All of those changes is because people, in large enough quantities, refused to buy at that price.

I take issue when you say people are "manipulated" into buying less when prices fall. That's like saying people were manipulated into buying iPods because Mac invented them. Manipulation implies a lack of control on the consumers part. That's silly.

Similarly, you were not forced to buy two-dollar juice, nor are you forced to buy a new game. If you feel harmed by waiting, then you factor in what we call a "time preference." Some people are willing to wait, some people are not. When lots of people want something now, the price increases. Just because you are impatient doesn't mean you are a victim.

Prices are not arbitary. You point out that a seller can make more by lowering the price (most goods are this way). But obviously if it's too low, they will loose money. To say a seller sets his price based on his mood that day or week is silly. While it's the seller that writes the price down, he's guided by millions of factors--from rent to consumer preference to even weather patterns. And the crazy part is, he's rarely aware of all these things. The crazier part is he doesn't have to know the details.

I know it seems that from the consumer's vantage point, sellers set prices based on whim or collusion. But they are taking into considerations you never see. How much does it cost to light Best Buy? I have no idea and I doubt most do. The same goes for shipping costs, builidng maintainence and so forth.

The reason why the factors of consideration increase so rapidly is because they are also subject to the secondary prices. If there's a permanent increase in the cost of shipping, we will see a price increase in good X. (Note that prices are sticky and strange. There are menu costs to changing prices so sometimes it's not worth it. Sometimes the firm tries to weather the storm because it doesn't want to loose its customer base so prices stay the same in times of, say, increasing gas prices. Sometimes there are mistakes and they should've raised when they lowered. Sometimes they are merely echoing competitors because that's cheaper than crunching their own numbers... But in light of all these exceptions, prices change and they change often. Most of that change happens in the stock markets and stops at the first of second firm in the supply chain, at least in the short run.)

If you don't think Dad stocks up on food, check the pantry next time you're home. They have enough canned tomatoes to last a nuclear winter.

Anonymous said...

No David, I mean concrete examples of prices going down solely because the consumers demanded it. We demanded lower gas rates last year. They didn't go down. We demand lower cable rates, they're going up. The only time I heard of such a thing was when a tampon company reduced the number of tampons in a package from 8 to 6 while they kept the price the same. (If quality improves but price stays the same means it's "cheaper" then quality goes down but prices stays the same it's "more expensive".) Consumers complained until the company did a "two free" promotion restoring the number to 8 and tried to make it sound like you were getting something extra. In the examples you provided, the lower price had more to do with technology improving and more efficient production and competition than consumer demand.

I don't think consumers have as much control as you imply. Consumers are pressured by a million factors just like the sellers. And when the seller decides to exploit the needs of the consumer, it becomes unethical. If you owned the only gas station in 20 miles (ie middle of Iowa) you could charge more because going to someplace cheaper would cost you more than you'd save. So everyone else has to charge more for their services or spend less in other places hurting the community's economy.

Yesterday (Valentine's Day) I saw a flower vendor in the train station. There was a demand for fresh flowers so someone set up shop. They do it every year and there's always a long line. But the price isn't any different than other flower shops. By your logic, the train vendor should have raised his prices because he's answering the demand from forgetful husbands.

It has all the exploitive nature of Coke machines that raise their prices as the weather heats up. They tried that once and the consumers rebelled.

Sometimes waiting is not an option or it doesn't do any good. For example by the time the Xbox fell to a decent price there were already ads for the Xbox 360 and once it was released, no new games for the original was made. Waiting only meant you paid for obsolete tech.

Prices are controlled by how much profit the seller wants. It is influenced by what they can get away with. Comcast is a virtual cable monolopy here. They upped their price and removed a channel I liked. There's nothing I can do about it. I can't use satilite because of how my apartment faces. At this point how much control do I have?

Consumers individually have effectively no control over prices. Even with competition, we can be forced to pay too much by a company exploiting our need. The only way out of it is to be perfect and that only exists in the realm of theory.