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Supermarkets raise the price of beer on the Fourth of July weekend because they know people will pay just about anything for suds, right? They hike the price of tuna during Lent, when many Christians don't eat meat, and they charge more for canned cooking soups at Thanksgiving, when broth demand peaks, don't they?
Nope, wrong on all counts. In fact, as many smart shoppers know, prices for seasonal supermarket items tend to fall right when the demand for them is highest. That contradicts what you're taught in Econ 101. But it turns out there's a perfectly sensible explanation for the phenomenon -- and it seems to undermine the logic of the business plans of Internet entrepreneurs, who want to use online auctions to fetch the very highest prices the market will bear.
The solution to the supermarket pricing puzzle comes from three professors at the University of Chicago Graduate School of Business who didn't mind getting their hands dirty with real-world data. Economists Judith A. Chevalier and Anil K. Kashyap and marketing professor Peter E. Rossi studied reams of transaction data from 1989 to 1997 from Dominick's Finer Foods, a Chicago-area supermarket chain that has since been bought by Safeway Inc. In processing the data, they pondered such minutiae as whether saltines should be considered "crackers" or "snack crackers," and whether to include the store-label 500-count bottle of aspirin in their bundle of analgesics prices. You can take a look at the entire report at www.nber.org/papers/w7981.
B2Bs STUNG? The researchers' purpose was to evaluate explanations for the mystery of why these prices dip when demand spikes. They looked at three alternative explanations. Theory No. 1 says that in peak periods, when consumers are doing lots of shopping, it pays for them to take the time to comparison-shop -- so supermarkets have to cut prices at those times to keep their business. Theory No. 2 suggests that supermarkets usually make a silent agreement with each other to keep prices high, but that "tacit collusion" breaks down in peak demand periods because price-cutters can make a killing by stealing business. And according to Theory No. 3, supermarkets use advertised products that are in demand as loss leaders to bring customers into their stores.
After detailed econometric analysis, their research concluded firmly that Theory No. 3 is the correct one. (But you guessed that already, right?) The first two theories weren't borne out by the data. For instance, the first two theories predict that prices should fall across the board at Christmastime, when overall supermarket shopping is heavy. Instead, overall prices rise. Only the prices of the goods with highly seasonal demand, such as cheese and crackers, seem to fall.
The big picture? Economist Kashyap says that the Dominick's strategy just goes to show that it doesn't always make sense to charge whatever the market will bear for products in high demand. Letting prices float to balance supply and demand is, of course, the concept behind the auction sites and B2B exchanges that have sprung up like mushrooms on the Internet.
If Dominick's Finer Foods is any guide, holding prices below what you'd learn in Econ 101 is often a sounder strategy. As the old proverb says, there's more than one way to skin a cat.
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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