Price targeting (again) and spontaneous collusion (18 November 2006)

FT columnist Tim Harford had a column recently about breakfast cereal -- exciting as that may sound, it's actually about price targeting and spontaneous collusion. His point about cereal: the various brands are more or less arbitrary distinctions that have little to do with the grain products inside the box: "Most price-targeting strategies include a deliberately low-quality product at a low price. In the high-tech industry, this is often a professional piece of kit with the good bits disabled, but in the supermarket, it is simply the 'value' range, packaged to look like an air-drop from the World Food Programme. You might think that spoiling the look or performance of a product is a bad way to make money, but it’s simply a way of keeping the rich or careless customers buying the premium products." Thus, poor people wind up using poor-looking goods, in a sort of postmodern variation on sumptuary laws; only those who have no choice end up with junky looking stuff -- even cereal boxes -- with marks them as poor in the eyes of society and keeps the pressure on the rest of us to consume more attractively. Retailers are thoughtful enough to withhold any sort of brightness -- even in package design, though it wouldn't cost them more -- from the lives of the poor, because their squalor is more useful to them to threaten bigger spenders with. Class distinctions are carried out even in banalities like cereal boxes -- perhaps primarily through such everyday near-invisible things.

Harford is sort of a go-to guy on price targeting -- his Slate column about Starbucks' tortuous price points covers some of the same basic ideas, namely that retailers seek to charge different customers what they are willing to pay, not what they have decided a product is actually worth. (Another way of saying that is what a product is worth is what a customer will pay; thanks to marginal calculations, we are all beyond use value). WSJ has an article (on an obviously slow news day -- right next to an article on "gift" as a verb) highlighting another industry in which this occurs -- beer. The reason Molson Coors can charge more for its "craft" beer, Blue Moon, is not because it costs them more to make it, but because they know people who care about the way beer tastes will be willing to pay more for it. Period. "the craft segment represents a desirable demographic of young, educated, affluent beer drinkers willing to shell out more for their brew. And big brewers are eager to tap this market." (If you want use your taste in beer drinking to actually fight corporations like Molson Coors, check out Fermenting Revolution by Chris O' Brien.)

Along these same lines, in Naked Economics, Charles Wheelan proposes an experiment of asking the people sitting around you on an airplane what they paid for their tickets. It would seem as though the cost of flying has less to do with jet fuel and pilots' wages than with the context surrounding when you bought a ticket.

Price targeting seems more nefarious to me than it probably should, because it makes me suspect that it is in fact my responsibility if I get "ripped off" -- if those words even have any meaning once you've adopted this viewpoint. If we always pay what we are willing to, then we can't get ripped off, even if the next person in line pays half as much for the same product. But then I get bothered by how producers sabotage their own goods 9Harford offers the example of third-class rail and ugly packaging) to create pricing points based on fear and shame. You are expected to be afraid of what you might suffer if you let yourself consume the "lower" grade of good. Also, price targeting creates incentives for disinformation campaigns, for the manufacture of consumer idiocy, though perhaps I should see this as an opportunity to let those who don't research their purchases thoroughly (the Internet does allow one to make price comparisons and gather product reviews fairly easily) subsidize my consumption to the degree of their ignorance. I could readopt the attitude I had when I lived in Vegas, when I was happy about all the slot-machine-playing suckers allowing me to enjoy over-the-top absurdist architecture and $5.99 prime-rib dinners. There's no income tax in Nevada, but there is a stupidity tax.

But then I wonder if that isn't the real trap here, the false satisfaction one feels in "beating" the system that has in fact contained you. If I let myself glory in other consumer's stupidity or ignorance, then I have given myself incentive to keep them ignorant and aligned myself with the retailers rather than those like me, fellow consumers. If everybody follows suit, then we remain collectively ignorant at war with each other rather than with the retailers trying to stratify and bamboozle us. (That's why tuangou seems strangely appealing in theory.) This war of all against all caters to our individualism and reinforces competitiveness as the default mode of social interaction among peers. Shopping, which seems more and more the primary social activity, becomes a zero-sum game among consumers; we have no reason to cooperate. I gain when you lose. I fly cheaper when you pay more for your ticket. And I can think I'm a deserving winner and you are a deserving loser. This isn't a big deal with airline tickets, when it comes to our annual salaries or general class prerogatives, it becomes a bigger deal. This kind of thinking leads people to conclude that the poor are simply stupid rather than structurally disadvantaged; being poor, as this Ezra Klein post shows, is matter of having no safety net, no margin for error or bad luck in situations that are already stacked against you due to inherited disadvantages.

Harford's other point is about de facto collusion:

But economists have studied the breakfast cereal market. Richard Schmalensee, who analysed the US breakfast cereal market when it was under anti-trust investigation in the late 1970s, found that the proliferation of brands was simply a way of avoiding good honest price competition. Each new brand staked out new ground and discouraged competitors from entering. Economist Aviv Nevo reached similar conclusions more recently. He believes that although a few large companies supply most of the cereal market, there is no conspiracy at work. There does not need to be: the practices of price-targeting and product proliferation are enough to keep margins high and competitors at bay.

Just as price targeting encourages individuals to compete, it invites firms to cooperate.

This echoes a point Slee makes in No One Makes You Shop at Wal-Mart about cooperation between firms. Without explicit communication, dominant firms in a industry with few players can quickly figure out how to anticipate each other's moves and avoid the prisoner's dilemma of price-cutting wars by signaling reciprocation and retribution, by making their reactions predictable and reliable over time. Thus, as Slee points out, things like low-price guarantees and loyalty plans and inexplicable brand proliferations from the same company are actually ways by which firms tell each other not to compete for each other's customers by lowering prices.