KEY POINTS:
In our second excerpt from The Undercover Economist, author Tim Harford compares prices in supermarkets.
Whenever I mention to people that I live near the Wholefoods supermarket in central Washington DC, they comment on how wonderful the store is: Wholefoods prides itself on being "The World's Leading Natural and Organic Food Supermarket", touts its community involvement and offers a jungle of fresh fruit and vegetables alongside hormone-free steaks, European cheeses and beers and luxury chocolates. It's a fun place to shop and offers great food. But my acquaintances also complain about how expensive Wholefoods is. But ... is it really expensive?
That depends on what you mean by expensive. Presumably people have some price comparison in mind. A fair one would be to compare prices in Wholefoods with prices in Safeway just five blocks away, a store known to the locals as "Soviet Safeway" because of the limited range of products.
Compare the price of the typical Wholefoods shopper's basket of goods, and nine times out of ten it will indeed be more expensive than the typical Safeway shopper's basket of goods. But that says more about the shoppers than the stores. As a matter of verifiable fact, when you compare the prices for the same goods, Wholefoods is just as inexpensive as Safeway.
Safeway and Wholefoods charge exactly the same for bananas.
Exactly the same for a carton of cherry or grape tomatoes.
Admittedly, Safeway's prices on onions, Irish butter and Cheerios are lower. But Wholefoods charges less for mineral water, Tropicana Premium orange juice and sweet onions. The simple truth is that if you bought a big basket of the same goods from Safeway and from Wholefoods, the price tag would probably come out within a dollar or two - and it would be just as likely that Wholefoods was cheaper.
That doesn't quite fit with our common sense belief that some places are cheap and some places are expensive. But that belief never made much sense. After all, if some places really did predictably charge more for the same product with similar service in a similar location, that would imply that all of their customers were just idiots. Wholefoods is more fun to shop in, but it's still just a supermarket, and you wander around filling your own cart just as in Safeway.
Wholefoods is not expensive in the sense that it charges more for the same goods. It is expensive because of where its price-targeting policies are focused: prices for the basics may be competitive, but the selection in Wholefoods is aimed at customers with a different view of what "basics" are. For example: Safeway charges more for Tropicana orange juice and for Poland Spring sparkling mineral water than Wholefoods does. For Wholefoods customers Tropicana juice and sparkling water are the basics, and so they need to be priced competitively, while Safeway customers might well consider that tap water and concentrated orange juice were perfectly acceptable alternatives.
A Safeway customer who buys sparkling water and fresh Tropicana juice is signalling a taste for luxury. A Wholefoods customer may pass by the cheaper option of Tropicana in favour of a more expensive Smoothie made of fresh-squeezed juice at the in-house juice bar.
The basic yellow and sweet onions are priced similarly at both stores. But at Wholefoods, customers have the option to pick fancy varieties: pearl onions, red onions and even organic onions, at a hefty mark-up. The Wholefoods shopper who is looking for decently priced products will find them. The Wholefoods shopper who grabs a bag of the first onions he sees will pay dearly for his lack of price-curiosity.
That is why a basket of goods from Wholefoods can cost so much more than a basket of goods from Safeway. It's not because Wholefoods is "expensive" and Wholefoods customers are stupid. It's because Wholefoods offers additional, expensive choices, which Wholefoods shoppers are willing to take because they perceive the quality premium is worth it.
Another common pricing strategy is sale pricing. We're all so used to seeing a store-wide sale with hundreds of items reduced in price that we don't pause and ask ourselves why on earth shops do this. When you think hard about it, it becomes quite a puzzling way of setting prices. The effect of a sale is to lower the average price a store charges. But why knock 30 per cent off many of your prices twice a year, when you could knock 5 per cent off year round?
Varying prices is a lot of hassle for stores because they need to change their labels and their advertising, so why does it make sense for them to go to the trouble of mixing things up?
One explanation is that sales are an effective form of self-targeting.
If some customers shop around for a good deal and some customers do not, it's best for stores to have either high prices to prise cash from the loyal (or lazy) customers, or low prices to win business from the bargain hunters. Middle-of-the-road prices are no good: not high enough to exploit loyal customers, not low enough to attract the bargain-hunters.
But that's not the end of the story, because if prices were stable, then surely even the most price-insensitive customers would learn where to get particular goods cheaply. So rather than stick to either high or low prices, shops jump between the two extremes.
One common situation is for two supermarkets to be competing for the same customers. As we've discussed, it's hard for one to be systematically more expensive than the other without losing a lot of business, so they will charge similar prices on average, but both will also mix up their prices. That way, both can distinguish the bargain-hunters from those in need of specific products, like people shopping to pick up ingredients for a cookbook recipe they are making for a dinner party. Bargain-hunters will pick up whatever is on sale and make something of it.
The dinner-party shoppers come to the supermarket to buy specific products and will be less sensitive to prices. The price-targeting strategy only works because the supermarkets always vary the patterns of their special offers - and because it is too much trouble to go to both stores.
