NBR has been running a series of articles on supermarket pricing this week, based on new daily product-level data from Ordian (called PricePulse). In the latest article (paywalled) in the series this morning, Maria Slade covered the pricing of alcohol products, noting the presence of 'sawtooth pricing':
One of the clearest trends it uncovers is sharp and almost weekly movements in alcohol prices...
For example, the average price of a dozen 330ml Heineken lager bottles ranged by 39% between mid-September and this week.
The price see-sawed every seven days, from a low of $19.89 to a maximum of $32.45...
This pattern of alcohol pricing was the same in each individual supermarket NBR checked.
I was interviewed by Slade on Monday, and some of my comments on the reasons for sawtooth pricing made it into the article:
As NBR has conducted its Price Check series this week based on the PricePulse data, commentators have pointed out that huge variations in products with no seasonality attached to them are part of a strategy of obfuscation by the supermarkets.
“I think what we’re seeing is that it’s incredibly difficult for consumers to make rational decisions when it comes to groceries,” Massey University Business School professor of marketing Bodo Lang says.
Creating confusion is not the only factor driving sawtooth alcohol pricing, Waikato University professor of economics Michael Cameron says.
There are two key groups of alcohol shoppers – people who are motivated by price, and those who buy regularly; both are captured by seesawing pricing.
Regulars won’t change their habits and take advantage of a special, so retailers make a good margin on them regardless, he says.
“Then, at the same time, when the price is low, you take the consumers who are price conscious.
“So, it doesn’t make sense to price low all the time for those price-conscious ones, especially when you haven’t got much competition,” Cameron says.
I want to take this opportunity to explain my comments in a bit more detail. Obfuscation doesn't make much sense as an explanation for sawtooth pricing. There isn't much for supermarkets to gain from making consumers confused about pricing, because the consumers can see the price on the shelf and make a decision based on that. As I note in my ECONS101 class, making consumers confused about the price makes them less likely to buy it, not more likely to buy it. Obfuscation is much more effective (and profitable) if the 'true' price can be hidden from consumers until they actually have to pay. That's the strategy that is employed in 'drip pricing' for example (see here). It's also why you should always get a quote from a contractor, or risk a sharp surprise when presented with the invoice.
A better explanation for what the supermarkets are doing is a form of price discrimination. That's when a seller sells the same product to different consumers for different prices. This isn't a textbook example of price discrimination, so it requires a bit more explanation.
Consider a market with two supermarkets (A and B), and two types of consumers [*]. The first type of consumers are regular shoppers. They shop on the same day each week, at the same supermarket, and usually buy the same products. The second type of consumers are price conscious. They shop around, looking for the best deals each week.
What should Supermarket A do when pricing a product? It could set a high price all the time. The regular shoppers would buy the product, but the price conscious shoppers wouldn't. It would be moderately profitable to adopt this strategy. However, there are two problems with this. First, Supermarket B could undercut the price, capturing market share, and reducing the profits from the high price for Supermarket A. Second, if Supermarket B also sets a high price for the product, then the lack of competition in the market may come under scrutiny from competition authorities. Instead, Supermarket A could set a low price all the time. Both types of shoppers would buy the product from Supermarket A. However, that may not be very profitable (unless the supermarket can use the product as a loss leader, inducing customers to buy more of the other products that it sells), especially if Supermarket B matches the low price (since Supermarket A wouldn't gain customers at the expense of Supermarket B in that case).
A third option is to 'sawtooth' the price, alternating between a high price and a low price each week. This could actually work best because of the presence of the two different types of consumers. In the high-price week, the regular shoppers buy from Supermarket A, but the price conscious do not. In the low-price week, both types of shoppers buy from Supermarket A. This is more profitable for Supermarket A than always having a low price, because the high-price week is more profitable than the low-price week. It may (or may not) be more profitable than always having a high price, but it avoids being under-cut by the other supermarket, and avoids the unwelcome scrutiny of the competition authorities.
In this case, sawtooth pricing is a form of temporal price discrimination, since the two types of consumers end up paying different prices for the product (on average). The regular shoppers pay a relatively high price on average (the average of the high price and the low price), while the price conscious shoppers pay a low price on average (since they only buy in the low-price week). When price discriminating, a firm wants the more price conscious consumers to pay a lower price, and sawtooth pricing achieves that.
It is worth noting that there are two reasons that a sawtooth pricing strategy works in this case. First, it works because the regular shoppers are unwilling (or unable) to adjust the timing of when they buy their groceries. If these regular shoppers recognised the pattern in the prices, they might be able to hold off on buying for a week, then buy a double amount of the product in the low-price week.
Second, it only works because of a lack of competition. With two supermarkets, it is easy to maintain sawtooth pricing, since each week one supermarket can price high and the other price low, then alternating between weeks. The more additional supermarket competitors you add into the market, the more likely it is that one of them will adopt a low-price strategy, undercutting the others in every week. However, the extent to which that is possible depends on how successful the new low-price competitor can be in attracting the regular shoppers away from their usual supermarket.
These last two points provide an obvious solution to sawtooth pricing, if we believe that it's a problem. First, making consumers aware of the pricing patterns will allow them to exploit it to their advantage. I'd expect sawtooth pricing to break down fairly quickly if consumers adjust their behaviour enough. The PricePulse tool is supposed to be rolled out for consumers in due course, so that might have some effect. Second, having a more competitive market makes this pricing strategy less likely to be effective. The Grocery Commissioner has their work cut out for them in achieving that, though, even if it is on their wish list.
To me, the only thing that is left unexplained (to some extent) is why it is alcohol products that seem to be most subject to this sawtooth pricing. I haven't seen the raw data, but I wouldn't be surprised to have seen this strategy employed for many products. As yet, I don't have a good answer to this question.
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[*] This explanation also works if you have many different types of consumers (what economists call heterogeneous demand), but it is simplest to explain for two types.
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