Good questions

Speedmaster, at the Pretense of Knowledge, asks a couple of good questions:

1. If companies/corporations can simply get rich by being greedy, “gouging”, and otherwise scr*wing customers. Why does any company/corporation ever go out of business?

2. If minimum-wage laws are necessary to prevent employers from paying less than that, why does anyone ever earn more than the legislated minimum-wage?

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Allocation Through Pricing

Several years ago a friend got me hooked on the annual tradition of buying Beaujaolais Nouveau in November.  This red wine is made from the grapes of this year’s harvest and is shipped out across the world on the third Thursday in November.

It was fun.  For a few years we went together to purchase the wine.  It made for a nice story on Thanksgiving.  And, it was cheap.  I think I recall paying around $5 a bottle for the wine.  But, you had to get there within a day or two or supplies would run out.

Another friend asked me if I bought the Beaujaolais this year?  “No.”  “Why not?”

My first answer was, well it has become too mainstream now.  Everybody knows about it.

Then I thought for a second and continued…

“And, they raised the prices.  At $5/bottle, I’d buy 2 or 3 bottles.  Now the prices are around $10 – $14.  I guess it wasn’t worth it to me.  I have other wines I enjoy more for that price.  Also, I notice you don’t have to get there on day one now, supplies last with the higher pricing.”

I thought back to the story of flashlight pricing at Big Box retailer in Russell Roberts’ The Price of Everything.

After an earthquake, Big Box raised prices.  Of course, that made everyone mad, yet Big Box was the only place in town where you could get what you needed (p. 71).

[Ruth – Econ professor]: “On the night of the big earthquake, there aren’t enough flashlights to go around. At the usual, everyday prices, people want to buy more flashlights than there are flashlights on the shelves, agreed?”

[Ramon – outraged consumer]: “Yes.”

“Given that there aren’t enough flashlights to go around, who should get them?”

“That’s easy.  The people who need them the most.  Not the people who already have one.  Not the people who have lots of candles.  Not the people who are going to sleep most of the night anyway.”

The conversation continued.  Ruth asked how you would decide who needed the flashlights the most.  She points out the problem is knowledge.  You could interview people and see who makes the best case, but Ramon is skeptical that people might not tell the truth.  Ruth adds that along with flashlights you would need to make the same decisions for candles, diapers, portable generators and items to numerous to have any hopes of being effective.

[Ruth]: “If you leave prices alone at their regular everyday levels, who gets the flashlights and the milk and the generators?”

[Ramon]: “The people who need them.”

[Ruth]: “I don’t think so.  If you leave prices alone, the people who get the flashlights are the people who get there first.  When you went to Home Depot, the stuff you wanted was already gone.  But at Big Box, anyone who wanted a flashlight could have one.”

[Ramon]: “If they were willing to pay for it.  That made it harder on the poor people…”

[Ruth]: “Agreed. But for thousands of people, there were flashlights waiting for them.  Remember that knowledge we wanted to have? The knowledge about who needed flashlights the most? When Big Box raises the price of flashlights, someone who had candles at home decided to do without the flashlight and left it there for you on the shelf.  No one had to interview either of you. The higher price induced both of you to act as if you had been interviewed.  The person with the candles, by refusing to buy the flashlight at the higher price, was saying, I’ll pass on buying a flashlight. I’ll leave it for someone who needs it more. But no one begged him to do the right thing or passed a law that would have to be enforced or interviewed him to find out who needed it the most.  The higher price made sure you got the flashlight, that seems pretty just to me.”

With the higher price on Beaujaolais, I decided to pass on it and leave the 2 to 3 bottles I would have bought on the shelf for someone else who valued it more.  I would make due with other wines and without the stories of drinking this year’s harvest.

If you’re still curious about poor people not being able to afford flashlights and would like to know more about what Ruth Lieber says, I encourage you to get a hold of Roberts’ book and read it.

As for me, I’m thinking about buying extra flashlights, batteries and a generator while the prices are reasonable.

Pizza Hut: Price to Value

It’s been fun watching promotions in the food industry over the past few years.

Subway kicked it off a price promotion with their $5 foot long promotion, which seemed to work for awhile.  It was a black swan that was happened upon by a Subway franchisee in Miami.  He put out a sign for $5 foot long sandwiches and earned more money.  Others followed suit and eventually the corporate headquarters picked it up.

But, price is rarely a source of a sustainable advantage.  It may work for awhile, but price promotions is something that is easily copied by competitors and eventually they too will find compelling offers.

The most important thing is the value proposition.

Early KFC began offering $5 meals.  Pizza Hut went to $10 for Any Pizza.  Both seemed to work for awhile.  The $10 Pizza got the mother of my Papa John’s-loyal nephew to try Pizza Hut and he liked it.

Then he came to our house and wanted pizza.  I started to call Papa John’s, but he said he’d rather have Pizza Hut.  It had been 10 years since I tried Pizza Hut because the last pizza I got from there was a grease ball.  I tried some of his Pizza and I liked it. It tasted good.

That’s value proposition.  In the beginning the $10 pizza got my nephew to come in, but it was the good quality pizza that kept him coming back.  Since then, I’ve ordered Pizza Hut several more times, likewise because of the quality of the pizza, not the price.

Pizza Hut advertising seems to reflect this.  Several months ago the advertising focused on the $10 Any pizza message.  A few weeks ago they changed their pricing to $8, $10 and $12.  Still simpler than before, but a little more variation to better align the price and the value.

This past Sunday I saw it come full circle.  Pizza Hut’s ad didn’t mention price.  It explained the value prop:  Good pizza and convenience, in ways people can understand like “this means I can spend more time with my daughter.”

Very Clever Starbucks

I bought two bags of Starbucks Pikes Place ground coffee at Target.  

There was an instant $3.00 off coupon with the purchase of two bags.  I also noticed that I could get a free cup of coffee at Starbucks.  Great coffee, low price.  No brainer.  I bought it.

I just read the details for getting my free cup.  I just bring in the empty bag.  Genius.  Now they’re rewarding me for finishing the bag.  That’s good.  They’ve solved a problem for me.  Before, the bag of coffee beans was precious and I tended to conserve.  Now they’re rewarding me for finishing it up.  Now I have less resistance to using it up. 

I’m not a fan of gimmicky pricing and discouting schemes, but I’m a fan of this one.  The $3.00 coupon got me to buy an extra bag at the store, which gives me more coffee at home.  The reward of a free cup of coffee at Starbucks with an empty bag solves the problem of wanting to hoard the coffee.