You can arbitrarily divide the world into people who love shopping and people who hate it, although I suppose most are indifferent. Anyway, I’m in the shopping is evil camp. As such I used to get my hopes up when I heard coupons and discounts might go away, for example via the magic of internet shopping. But if you look at the economics of why coupons exist in the first place, you’ll see they’re likely to become more common than ever.
The internet version of why coupons will die goes something like this: a) comparison shopping between web sites is easier than driving to stores, b) so internet retailers are forced to match prices, and hence c) no need to comparison shop, coupons go away. And that has come true to a certain extant. For example from an article last Christmas:
For the children’s tablet LeapPad1 Explorer, for instance, Walmart appeared to be purposely undercutting Amazon, even if by a matter of pennies. When Amazon offered the tablet for $59.99 on the Monday before Thanksgiving, Walmart priced it at $59.97. On the Sunday after Thanksgiving, Amazon raised the price to $69.99, and Walmart followed, going to $69.97.
But this story of coupon death misunderstands why coupons exist. Coupons don’t exist as a game to excite people who like to shop, although there’s some truth to that. The business purpose of coupons is to create differential pricing based on willingness to pay. So if one customer is willing to pay twice as much, charge them more. And for price sensitive customers, charge less. This tiered pricing maximizes profit, and the only reason it’s not done more is because it’s historically been hard to do. But what about people who love to shop and brag about how they found a special deal? Where do they fit in? Economically they are willing to trade their personal time for money. As such, the only difference between poor people and wealthy bargain hunters is the latter can get incredibly annoying.
High Fixed Costs, Low Variable Costs
To make this more clear, let’s dig into textbook case for differential pricing: hotels and airlines. Economically these industries have high fixed costs and low variable costs. It costs a lot to build a hotel or buy an airplane. But once you have that hotel or plane sitting around, the marginal cost of filling an extra seat is very low. And since business travelers are willing to pay much more than vacation travelers, the proper business strategy is charging different people different prices. Optimizing profit through price discrimination is called yield management. The sad truth is the more price discrimination a business employs, the more it becomes necessary to make the “list” price obscure. There really is no “list” price as such, since the price changes by the hour and who is asking. Hotel rooms and plane tickets are coupon nirvana.
In contrast, Walmart built their business brand around everyday low pricing. When they tried discounting, it didn’t work. On the higher end, Apple also has a no discount policy. So in retail a no discount model can work, as long as you build your brand around it. What’s interesting is when former head of Apple retail Ron Johnson went to J.C. Penney, he tried to change Penney from a 300 sales a year model over to an everyday low pricing model. This failed and got him fired. Once a brand identity is set, it’s hard to change. Quote:
Wendy Ruud, a former Penney’s customer, …. hasn’t been back to Penney since the new pricing plan was implemented earlier this year. “When you have a sale, you really feel you are getting a better deal or a bargain,” Ruud, 49, said.
Now this option to run a retail business with flat pricing is possible in retail because a) it is hard to charge differential pricing with much finesse, and b) retail does not have the high fixed cost structure of airplane seats, making the payoff for differential pricing less. But both of these reasons for retail flat pricing become less important for internet shopping. Amazon is similar to Walmart in their low margin business culture and brand. But Amazon, unlike a Walmart retail store, is technically capable of customizing prices down to a single individual. What’s worse is the high fixed costs/low variable cost economic structure of airplane seats is applicable to more and more of what we buy: software, services, music, movies, newspapers. It takes a lot of talent and money to produce a movie, but in digital form the cost of each additional copy is practically zero. So for digital goods we are far closer to the economic structure of airplane seats than to Walmart selling mops. We should expect similar pricing structure as a result, with differential pricing by customer type or even at the individual level.
We can see this in how newspapers are starting to form pay walls, where you get unlimited access to the New York Times site for $15 a month, or you can get 10 articles a month for free. Think of the paying customers as business class, and the free ones as economy class. For the time being Amazon is in growth at all costs mode, so they’re likely to keep their prices Walmart regular and low. But their infrastructure is well suited to doing airline ticket style pricing so they may change their mind about it later. And if they don’t other internet retailers will. It’s clearly more profitable to charge each customer their personal max price.
If you hate shopping and coupons, this is rather depressing news. Coupons will never go away, and arcane discounting may be on the upswing. Healthcare pricing being a poster child for this trend. But in some ways it’s a relief. When something you dislike is inevitable, give up and try ignore it. Gotta go. Think there’s a sale on at Penney’s.