Tuesday, 10 April 2018

Make sure you get your cocaine loyalty card stamped

In ECONS101, we cover many different pricing strategies. One of my favourites to discuss is customer lock-in and the associated multi-period pricing. This is because I get to use the example of drug dealers, who have been known to give away their highest quality product for free.

To see why, we need to take a step back. In order to lock customers into buying from them (enigmatically called 'customer lock-in'), there needs to be a switching cost - a cost of switching to some other seller. Switching costs might include contract termination fees, for example, but in the case of drug dealers it might be as simple as it being difficult for the buyer to find some other seller (drug dealers can't exactly advertise themselves in the yellow pages, after all). Drug dealing syndicates might reinforce these switching costs by using violence to ensure that rival sellers stay out of their turf, meaning that addicted customers really have no other option but to come to the syndicate to get their fix.

Why give away product for free then? Having established switching costs, you need to find some way to get customers to start buying your product (and then, having started buying from you, the customers find it difficult to switch to some other seller or to stop buying). Some firms give away free samples - this is also why cellular networks are so keen to give you a free or heavily discounted phone. In the case of drug dealers, they give away their product for free. The reason they give away the highest quality product is because it is also the most addictive. There's nothing like having an addicted customer, locked into buying from you because it is too costly for them to switch, if you want to increase your profits.

And one way you increase your profits is using multi-period pricing. Initially you give away the product for free, and then once your customers are locked into buying from you, you can raise the price and reap the profits. In the case of drugs, you can also lower the quality by cutting them with something worthless (after all, if the customers are locked in, they aren't going anywhere else for their fix).

Which brings me to this story from The Telegraph (paywalled, or try this version from the New Zealand Herald):
With its smiling face logo and tempting offer to buy five and get the sixth free, this loyalty card at first appears as innocuous as those offered by any High Street coffee shop or supermarket.
But, it is being handed out to wealthy cocaine users to boost sales and loyalty and reveals just how fierce competition between drug dealers fighting turfs wars for ‘market dominance’ has become...
The card 'scheme' offers stamps for bulk purchases giving the sixth and then 12th wrap of cocaine free, said the source who handed it to the Daily Telegraph.
A wrap of cocaine generally costs between £50 and £80, depending on the quality, the source said, adding that it is understood a network of couriers deliver the drug.
The loyalty card reads: "One freebie for every five stamps you collect!! Love Loyal-T". The smiley face design on the front is evocative of the 1980's acid dance scene.
Given how easy it is to profit from locked-in customers as per my description above, why would cocaine dealers offer a loyalty card? You only profit if your customers are locked into buying from you. If there are many competitors selling the same (or a very similar) product, then you haven't really locked those customers in. This is why drug syndicates try to keep competitors out of their turf.

But say that, for whatever reason, you couldn't keep competitors out of your market. Maybe your competitors are sending drugs into your town from outside and it is difficult to intercept their couriers. Or perhaps your customers have realised that they can get their fix by travelling to the next town, or by navigating to the right site on the dark web. How do you lock those customers in to buying from you? One answer is to offer a loyalty card.

How do loyalty cards generate customer lock-in? Remember, there needs to be a switching cost. In the case of loyalty cards (whether we are talking about coffee cards, cocaine loyalty cards, or even airline miles or Flybuys points), there is a cost of going to an alternative seller - you miss out on a stamp on your loyalty card (which would have taken you one step closer to a free fix). In the case of loyalty cards, the switching cost is small, so the lock-in is fairly weak. But overall, it explains why cocaine dealers would be willing to offer a loyalty card to their customers.

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