By David Grace: https://davidgraceauthor.com/
Old-Fashioned Ideas About Prices
The simplistic idea of pricing is that the manufacturer figures out its costs, adds in some reasonable level of profit, and the total is the price it charges. In this Dick & Jane world-view, competition forces the producer to set its prices as low as it can without actually putting the company out of business.
That’s how it works in the comic-book version of economics, but that’s not how pricing works for many if not most companies in the real world.
Maximum Revenue Pricing
For real businesses the Gold Medal of pricing is the monopoly price, which is the price that generates in the maximum possible amount of revenue.
Generally speaking, as the price of a product goes up sales decline, but for a while the higher price will increase revenue faster than the drop in the number of units sold decreases revenue. That means that the new, higher price will result in greater gross income even as sales volume is falling.
At some point the loss in revenue from the drop in sales will exactly balance the increase in revenue from the new, higher price. Prices below that point are said to be “elastic” and prices above that point are “inelastic.”
The price where the decline in revenue from the drop in sales equals the increase in revenue from the increase in price is the Maximum Revenue Price or the Monopoly Price.
That’s the price Mylan was trying to get with the EpiPen. That’s the price the insulin manufacturers are shooting for right now. That’s the price Adobe was charging for Photoshop. (Don’t get me wrong. I LOVE Photoshop.)
The Maximum Revenue Price has absolutely nothing to do with the cost of a product. It’s the Monopoly Price, the price that generates the most revenue for a product that has no effective competition.
The problem lots of companies have is that either they don’t have a virtual monopoly like Mylan or a cartel like the insulin manufacturers or their products are not so vital that people can’t stop buying them if the price is perceived to be “too high.”
Put another way, a manufacturer may not be able to charge the Maximum Revenue Price because of the availability of competing products or the Maximum Revenue Price may not be very high because the product itself is not very important to its customers.
No company likes price competition. No company wants to settle for just getting a cost-plus-reasonable-profit price. They all want as much money as they can possibly get.
So, how are producers and retailers going to get more money? How are they going to be able to avoid getting only those crappy cost-plus-reasonable-profit prices?
One strategy to get more money is “Individually Targeted Pricing” or “Demographic Pricing.”
Gasoline Is Demographically Priced
Demographic Pricing has been used for decades by the oil industry.
Generally speaking, gas stations mark up the gas they buy from the refinery by about $.20/gallon. It typically costs a gas station about $.15 — $.16 per gallon to cover their overhead costs so gas stations typically make about. $.04 — $.05 per gallon profit. This means that your local station makes about $.80 to $1 profit on the 20 gallons you buy when you fill up your SUV.
“If that is all true,” you may ask, “why does the cost of gasoline vary so widely from station to station?”
The answer is that the refineries charge different prices to different stations for the same quantity of gasoline on the same day, all depending on the retail location where the gas will be sold.
Refineries practice demographic pricing.
For example, recently a gallon of Valero regular gasoline in San Jose ranged from $2.69/gallon to $2.93/gallon.
At the same time a gallon of Valero regular in San Francisco was $3.25.
The Valero refinery sold the same gas on or about the same day to two different stations located within fifty miles of each other at a price differential of $.56/gallon or a price differential of about 21%.
Admittedly, this is a rough number. Gas stations have long-term contracts with refineries and we can’t tell exactly how much each station paid Valero for the gas being sold on any given day. The gas sold today in SF might have been delivered a couple of days before or a couple of days after the gas sold today in San Jose was received by the station in San Jose.
But, we do know that the sale price for each station had to be at least $.16/gallon more than the gas cost them because that’s what the station would need to charge in order to just break even.
That means that the San Jose station must have paid at least $2.53/gallon for the gas it sold for $2.69 and it probably paid $2.49/gallon for it.
We also know that it’s extremely unlikely that the Valero station in SF was making a markup of $3.25 — $2.53 or $.72/gallon on the gas it purchased from Valero so it must have paid Valero a lot more than the $2.49 to $2.53 that the SJ station paid Valero.
These numbers make it pretty clear that Valero was selling gasoline to the San Francisco station for at least $.50/gallon more than it was selling the identical gasoline to the San Jose station at or about the same time.
How did Valero come up with this approximately fifty-cents or more per gallon price differential for these two stations?
- Was it based on the presumed wealth of SF residents compared to the average wealth of those in SJ?
- Was it based on the level of competition, that is, how many other stations were in the area of each retailer?
- Was it based on the fact that SF is bounded by water on three sides and the drivers there have no place else to go whereas those in SJ have no such geographical limitation?
A friend who was in the gasoline business once told me that refineries use algorithms that uniquely calculate the price of gasoline based on the nine-digit zip code where each station is located.
(If someone reading this article knows about those algorithms, please write a comment telling us how they work.)
The important point here is that gasoline is not priced on a cost-plus-profit basis and it’s not priced on a pure market competition basis. It’s priced on attributes of the geographic location where it’s sold.
The price of gasoline is mostly based on where it’s sold, not what you’re buying.
Of course, where you buy gasoline says quite a bit about who you are.
What A Sales Location Says About Who The Buyer Is
The average person buying gasoline in SF is likely richer than the average person buying gasoline in San Jose. Also, the average person buying gas in SF has far fewer alternate sources for gasoline than the average person in San Jose.
So, it’s not much of a surprise that demographic gasoline pricing results in a 21% higher price per gallon in SF than in SJ for the exact same gasoline.
But demographic pricing is not going stay limited to just gasoline and it’s not going to just be based on geography.
Uber’s Demographic Pricing Plan
It used to be that two people taking Uber at the same time in the same general area for trips of equal distance and duration would pay about the same price. But now that’s going to change.
Uber recently announced that it’s going to begin implementing demographic pricing. For some trips Uber is going to set the price depending on how wealthy your trip data tells them that you are.
If you’re going to take a five mile/15 minute ride from the main bus station to a Walmart your price will be $X, but if at the same time on the same day someone is going to take a five mile/15 minute ride from the yacht club to the Ritz Hotel his/her price will be $X times some multiplier for a total of maybe $1.5X or $2X.
Because Uber figures that a trip from the yacht club to the Ritz means that you’re probably a hell of a lot richer than someone who’s going from the bus station to the Walmart.
Uber knows that the richer you are the more you’ll be willing to pay.
Economists have known for a very long time that the more dollars you have, the less each dollar matters to you. That’s why Joe Sixpack buys a Timex and Jared Bigbucks buys a Patek Philippe.
Jared’s got so much money that he doesn’t care how much his watch costs. Each dollar he spends means less to him than each dollar Joe Sixpack spends.
Demographic Pricing Is Not Going To Stop With Just Uber & Gasoline
Geographic Location Equated With Wealth
Using just a geographic location Safeway, for example, could customize it’s prices based on presumed customer wealth.
The Safeway in Palo Alto could charge $4.10 for a half gallon of milk while the Safeway in East San Jose could charge $3.80 for the same half gallon of milk because people in places like Palo Alto, Atherton, and Los Altos are, on average, much richer than people in East San Jose, Gilroy or Morgan Hill.
Safeway will ask itself, “If we can get an extra twenty or thirty cents per half gallon in one place over what we can get in another and we bought each half gallon from the dairy for the identical price, why shouldn’t we take the extra money?”
Of course, mere geographic-based demographic pricing is crude compared with the other methods available to sellers today.
Product Choices Linked To Individual Wealth
Where you live is at best only a very rough, crude indicator of your ability and willingness to pay. There are lots of other, more targeted pricing strategies.
Store discounts pretty much force regular customers to get a “Club Card” in order to avoid paying substantially more for regular purchases, but every time you swipe your Club Card the store updates its knowledge-base of the products you like. That gives the store the ability to create a custom “wealth profile” for you.
Suppose that you regularly buy steaks, organic produce, premium bacon, Acme French bread and Hagan Dazs ice cream. The store can easily compare your profile with that of another shopper who buys house-brand hot dogs, Wonder Bread, non-organic produce and Tombstone frozen pizzas.
It’s pretty easy for them to separate the richer shoppers from the poorer ones.
Legally, what’s to stop the store from giving the poorer shopper an average Club Card 10% discount and the richer shopper an average 3% Club Card discount?
In fact, what’s to stop them from charging higher prices to the richer shopper for the same items?
Product Prices Tied To Shopping Volume
Of course, that’s not the only tactic the seller can use to maximize revenue. Your purchase history might indicate that you regularly buy Ocean Spray Cranapple and Stouffer’s French Bread Pizza. That means that these items are important to you and perhaps the store can get away with charging you an extra five or ten cents every time you buy one of those items because you want them more.
If you wander into a 24-hour market at one in the morning to buy Sudafed or Zyrtec, a competent algorithm would figure out that you’re probably there because your nose was stuffed up and you couldn’t sleep. That means that you’re not in the mood to go running around comparison shopping at other locations. The store knows that it can probably get away with a 50% price increase for that Zyrtec because you need it now.
Specific Individual Wealth
Your credit score is no secret to merchants. Demographic pricing could be as simple as getting your ID from your credit card or phone-based payment app, checking your credit score and adjusting the price you pay up or down depending on how rich or how poor your credit score seems to indicate that are.
If you think about it, there’s no legal reason why stores can’t charge any price they like so long as the price variations are not based on race, ethnicity, religion or gender. There is no legal prohibition against price discrimination based on wealth, physical location, time of day, or the intensity of your need.
Mechanically speaking, the stores might need to switch from posting prices on paper-signage to e-ink signage but that’s doable. They can put an e-ink panel above each section of shelving and each panel would display the message “Wave Club Card For Prices.”
You wave your club card over the panel and the prices for you appear on the screen. If I wave my club card, then my prices will appear on the display.
How Do You Feel About This?
So, how do you feel about Demographic Pricing?
How do you feel about everyone being charged an individualized, different price depending on
- The time of day,
- The amount of nearby competing stores,
- Your personal product preferences,
- Your mobility or lack thereof,
- Your personal wealth or poverty,
- What the store knows about your buying habits,
- What the store knows about your personality (Are you the sort of person who cares a lot about saving money?), and
- Any other factors their AIs determine will indicate how much you’ll be willing to pay for any particular product at any given point in time and space?
How do you feel about living in a world where there is no set price for anything, where the price you pay will be one that the seller’s AI has determined is the maximum amount that you’ll be willing to pay at that instant in time?
This Is New
Never before in the history of capitalism has this been possible. The data wasn’t there. The infrastructure wasn’t there. The algorithms weren’t there. The computing power wasn’t there.
But now they all are. If we know anything about big business we know that it will do anything to make more money. To big business you are not a valued customer. You are a lab animal to be drained of as much blood as they can possibly squeeze from you without actually killing you in the process.
There is no way American business is going to fail to take advantage of the greatest profit-making opportunity since credit cards and computerized inventory.
Individualized, Demographic Pricing, coming to a store near you.
Give it five years.
By David Grace: https://davidgraceauthor.com/