The Undercover Economist

by on October 13, 2005 at 6:27 am in Books | Permalink

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.

1 Ian Lewis October 13, 2005 at 8:29 am

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.

2 spencer October 13, 2005 at 8:56 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.

3 Brock October 13, 2005 at 9:40 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.

4 John Thacker October 13, 2005 at 10:07 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.

5 Peter October 13, 2005 at 11:28 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.

6 Ross Parker October 13, 2005 at 12:15 pm

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’.

7 Davide Sisk October 13, 2005 at 1:46 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.

8 Bernard Yomtov October 13, 2005 at 4:01 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.

9 ScottM October 13, 2005 at 4:35 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.

10 spencer October 13, 2005 at 5:32 pm

I don’t know about making money on the trade credits,
but the grocery business is the classic high turnover,
low margin business.

11 Jane Morgan October 13, 2005 at 7:29 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.

12 Steve Sailer October 13, 2005 at 8:29 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.

13 EricM October 14, 2005 at 6:50 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.

14 Aidan Maconachy October 14, 2005 at 9:40 pm

Bulk stores can be an amazing saving, at least in my experience.

I cook and use a variety of spices. If I buy these bottled or bagged in the supermarket, it will add up quickly. However by shopping in my local bulk store for cumin, coriander etc I end up paying only a fraction of what I would otherwise pay.

Another plus, is that the bulk store is popular so there is fast turn over, and the produce is always fresh.

15 Aaron October 17, 2005 at 6:19 pm

this looks like a good book. I’ll have to read it now. Thanks for blogging it.

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26 xiaofan April 27, 2010 at 4:02 am

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.

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