Once upon a time I worked in a regional convenience store chain. One of my many duties was inventory management, so I ordered the stuff the store ran out of. As a result, I learned a lot about pricing, and the difference between the price you see at the register and the more hidden supply chain prices.
This particular store did about 80% of its profit from one item – coffee. A cup of coffee at this chain ranges from $1 to $2 depending on size, from 12 oz to 24 oz. A pot of coffee made with one of the pre-packaged bags of coffee I would order would make about 100 ounces, give or take. I ordered those pre-packaged bags by the box, and 500 came in a box.
The price to my store for that box was $9.
Do the math. You could take everything else in the store and throw it in the gutter and the store would still bring in a profit, even accounting for overhead, payroll, and all those other pesky operating expenses. In fact, one of the marketing lessons we learned there was that pretty much every item we sold was just a way to get people in the store to buy coffee. Every promo for any item included “buy this item and get any size coffee for just one dollar!” or something. Because even at a dollar for 24 ounces, it was hugely profitable.
Okay, that’s background. That’s not the point of the story. The point of the story is that one time I had the chance to talk to a senior executive at the company and I asked him a question that had been on my mind: Given that competition between coffee chains is SO competitive, and given that we have SO much profit margin to work with, why don’t we sell our coffee for 50 cents or something for a little while just to capture more of the market share? Since our per-unit profit was so huge and our marginal unit cost so low, surely halving our profit-per-unit but quadrupling unit sales would be good?
His answer was really interesting: they had tried it! And sales went way down.
There’s a lot of psychology behind buying decisions, and a lot of historical information affects that psychology. It’s not just an in-the-moment calculation. If people were robots, then seeing a lower marginal unit cost would increase sales in a straight line, no questions asked. They’d done a good bit of research into why that hadn’t happened, though. Here’s what they found:
- The customer was used to a certain price range for coffee. They were “anchored” to that price. A temporary reduction in price due to a sale was fine, because people “get” sales. But just reducing the price in a way that seemed permanent made people question why the price was going down. Had the quality of the coffee decreased? And if not, were they being ripped off before?
- Even outside of the relationship with just our brand, the “anchor” effect to a particular kind of product or service is strong. Regardless of brand, people think “a fancy cup of coffee is about 5 bucks, a decent cup of coffee is about 2 bucks, and a cup of crappy gas station coffee is about 75 cents.” So if you sell your coffee for 75 cents, people are going to put it in the category of “crappy gas station coffee” no matter what you do. And just because it’s cheaper than good coffee doesn’t mean it’s a better value in the eyes of the customer – if that were true, everyone would buy their coffee exclusively from Big Al’s Gas-n-Go.
That second point has all sorts of interesting effects in the world outside of coffee chains. If someone invented a fantastic car tomorrow and their process was so good that they could sell the car to the end user for two thousand dollars, it would be really difficult to sell. People’s intuition is that “any car that costs $2k is a beater/junker” so seeing that price tag tells them that about your car even if there’s no other reason to believe it.
There’s one place in our society where this particular psychological effect is doing major, serious harm to really huge swaths of our society: higher education.
You see, the proliferation of university education for the last half-century or so has created another “price anchor” for our society, which is “self-improvement that benefits your job productivity and career prospects costs about $80,000.” The effect of this on the individual is that we see something that gives us new, marketable skills for sixty thousand dollars as “a good deal,” but something that gives us new, marketable skills for five hundred dollars is “obviously a scam.” The price point of more efficient personal development is simply too many standard deviations below the societal price anchor for most people to trust it. The societal price anchor is much slower to adjust than actual productivity.
Don’t be a societal pessimist. It’s fine to examine a new thing that seems great, and you don’t have to leap on every single new option that comes along. But the things society provides the individual really are getting so much better, so much faster than you could imagine. Seven billion people are absolutely falling over themselves to compete to make your individual existence so amazingly great, and the compound effect of that is staggering. Don’t ignore it – it’s all for you.
The Opportunity Machine 