Price Targeting, Coffee Shops, and Supermarket Secrets

I recently started reading The Undercover Economist by Tim Harford. So far, it’s a little like Freakonomics but a bit more economics and with slightly less controversial topics.

One interesting concept explained was price-targeting. Let’s say a coffee shop has to spend 50 cents to make a cup of coffee, including labor and materials but not rent. Now, each person walking by has a certain trigger price. If the coffee is cheaper than their personal trigger price, they buy, and if the coffee is more expensive, they don’t buy.

In a perfectly efficient market, a person would be honest about their trigger price, and a business could sell their coffee to anyone whose trigger price is above 50 cents. A frugal person might walk up and pay 75 cents, while a spendthrift coffee addict in a rush would pay $4 for the same cup. Obviously, this wouldn’t work in the real world, so stores have to find a way around this. Getting people to pay as close to their trigger price as possible is called price-targeting.

Instead, you have the current Starbucks menu = an entire wall of caffeinated options differing slightly by roast, size, flavoring, and preparation. When I need to get out of the house, I usually go in and get an iced coffee for about $2. They will add milk, or I can add it myself and you can get their syrup sweetener for free since sugar packets are hard to dissolve in cold drinks. Alternatively, a frappaccino is basically the same time but blended with some whipped cream for $3.50. So the “frugal” version is for the people looking to spend $2 on coffee, and the “premium” frapp is for those willing to spend over $3. The frapp probably cost around 10 cents more to make, while Starbucks made an additional $1 in profit.

A similar thing takes place in supermarkets, and is summarized well in this CFP Board newsletter article Taking Aim at Price Targeting:

Imagine you’re at the supermarket and want to buy a bag of chips. If you tend to be an impulse shopper, grabbing the first thing you see, you’ll likely end up with the most expensive chips available, conveniently placed at eye level by the supermarket’s thoughtful management. If you’re bargain conscious, however, a brief scan of the shelves will reveal cheaper chips tucked away closer to floor level. By offering similar products at different prices, the supermarket can make everybody happy: the impulse shopper gets her chips, the bargain hunter gets his bargain, and the supermarket maximizes profits from both types of customer. “In price targeting, customers pay what they are willing to pay,” Harford says. “It doesn’t depend on being a sucker. It’s even a good thing because if companies weren’t able to target, then nobody would get the lower prices.”

This is also why supermarkets have sales on a rotating range of products, instead of the same products or just lowering prices in general. The price-sensitive frugal folks will pretty much only buy what is on sale, and they’ll be drawn in and the store will make a little profit with slimmer margins. The people who never check what is on sale or are just buying ingredients required for a specific recipe will end up buying a lot of non-sale items which are marked up at a higher profit margin. Again, the store tries to get as close to a “perfect” market as possible.

The lesson? Be aware of price-targeting, be aware of your own tendencies, and look around to make sure you’re getting the best price when presented with a variety of options.

Comments

  1. This was a great post – thank you! I was particularly interested in the idea that people looking for ingredients for a specific recipe don’t get the best deals. I am only now getting to be a good enough cook where I can go in without a recipe, buy stuff on sale, come home and actually put it all together for a good meal. Learning to cook things from what is available can be a good skill if you want to be frugal. Unfortunately it took me about 10 years of cooking meals to feel comfortable enough to do it this way!

  2. Interesting post and I’m at the other spectrum than Gretchen on the person going in buying ingredients for a specific recipe. I’m a newbie cook that can only cook off recipes so I am unfamiliar with brand ingredients or there variance in pricing and quality. I guess maybe in 10 years like Gretchen I won’t be paying a ‘premium’ to cook my meals anymore.

    I always knew supermarkets kept higher priced goods at eye level, but hartford does a great job an breaking down the pyscology of shoppers and people who are conscous of price and those who are not.

  3. I find more than anything the frequency of my visits has more to do with how much I spend than anything else.

    I used to go through coupons, but frankly, I don’t have the patience anymore and hate keeping them in my pocketbook and fussing with them. So when I go shopping now, I only buy more expensive items when they are on sale. Cheap stuff I buy (like oodles of noodles) at any price, they are never expensive anyway. But I only go shopping when the ‘fridge looks empty-ish. And since I eat out a couple of nights a week, I usually have leftovers from restaurants too. On average, I shop like every two weeks, except for milk, eggs and orange juice, which I buy at Dairy Barn. I often wish I have more fruit in the house, but I don’t want to make a shopping trip for that because I’ll end up with $100 worth of stuff just because I’m there.

    Basically, the less I’m there the better. But I don’t hold back much once I get there. I just need a nice little fruit store in between.

  4. interesting, the only connection which i see is Starbucks is the only shop which asks me do I need the receipt ?? they dont want you to ponder over the receipt once you are at home..

  5. I remember reading the book 3 months and I say book is really good. I hope to see more articles based on this book.

  6. I usually cook with recipes, but I am very liberal is make substitutions/additions based on what’s on sale. For example, in soup you can throw in pretty much any vegetable. And typically you only have to use a food from a class. For example instead of spinach you could use kale, or radish leaves, or anything like that. So that makes it pretty easy to use recipes (which I like, since it helps in planning), and still save money.

  7. I loved the part where the author describes that french “third class” train cabins are not carpeted just so second class passengers wont be tempted to downgrade to third class :)

  8. Another example of this concept I have seen when redeeming points for Gift Cards at places likeMyPoints: The gift cards for the expensive over-priced stores cost less points than the gift cards for the budget stores. The over-priced stores are trying to appeal to the frugal consumer who usually won’t shop at their stores.

    I used to do coupons too, but find I don’t have time for them anymore, which is why I like shopping at Aldi Stores instead of the big supermarkets. By using the business model of European stores and eliminating overhead, almost everything at Aldi is cheaper than the supermarket sale price so I don’t waste time comparison shopping or clipping coupons. The downside is they don’t have ever ingredient I might nned for a recipe even though they have a good selection of German foods since they are a German company.

    I also have been substituting ingredients most of my cooking days and have found some ingredient substitution websites helpful (like how much flour to use instead of corn starch to thicken sauces, etc..)

  9. I think mail-in rebates are another good example of price-targeting.

    Say there’s a hard drive on sale at Fry’s, regular price $140 with a mail-in rebate of $40. The first group is customers who don’t bother to fill out the rebate form (pays full price, manufacturer/retailer pay no rebate).

    The next group fills out the form, but some part of their application is incomplete and over the 8-12 weeks of processing they forget about it (also pays $140, but was drawn to the $100 price point, store and manufacturer still pay no rebate).

    And then the final group actually follows through, or has no issues with the paperwork and gets the rebate (effectively pays $100, manufacturer and/or retailer give rebate).

  10. Chris Alvarez says:

    About supermarkets and the shelf-eye-expensive-option correlation: most supermarkets have some sort of system in place where a brand can pay more to have their products at eye level. The most highly-marketed and therefore larger brands are typically the easiest to purchase when you are in a rush. On a side note, Whole Foods is bucking this trend, though I don’t how they do in fact choose what goes where.

  11. SanDance – I also think that the overpriced stores have much larger profit margins, so they can afford to sell their gift cards at wholesale for a lot less. If I was Walmart I might sell a $100 gift card wholesale for $95, but if I was Williams & Sonoma, I could sell it for $80.

    Randy – Great observation on the mail-in rebates!

    Chris – I have also read that shelf space in supermarkets is sold to the highest bidder. Of course, this still works out the same, as the products which cost the most probably spend the most on such advertising/placement.

  12. $5 Popcorn in cinemas is also a great example of price targeting.

Trackbacks

  1. [...] Price Targeting, Coffee Shops, and Supermarket Secrets [...]

Speak Your Mind

*