Saturday, February 27, 2010

A little good news in these dark days

Just found this story about firms returning call center jobs to the US due to higher costs from returned equipment and sending engineers to fix simple problems. It seems that with the high unemployment rate and relatively low cost of labor there should be an explosion of hiring in depressed places like Detroit, Flint, and Dayton. Instead companies, the ones whose CEOs claim to be visionaries, only look at the upfront costs and not on the impact of customer dissatisfaction. The initial savings from paying low wages is decreased when suddenly warrnties are being paid out because the customer service people cannot explain how to fix things, customers return items because they cannot understand what the person on the other end is saying, etc. Maybe some businesses will figure this out instead of the usual short-term thinking.

Sunday, February 7, 2010

Introduction to two-tiered pricing

In response to the question over differences between Wal Mart and Costco, I will introduce a new concept to explain differences in the pricing scheme between a traditional retailer and a discount club. The difference comes from the way prices are set to increase the propensity to consume for customers.

For a traditional retailer, their goal is to price with a difference of the cost and a percentage markup to cover the fixed and variable costs and have a profit. This markup is usually variable and can be none if the firm seeks to engage in loss leading to take out a competitor. Such a phenomenon occurs often with the opening of a new major retailer, since they can spread the losses out over many stores, so the damage to the company overall is negligible compared to the increased market share from removal of competition.

In contrast, a discount club store operates on a different pricing mechanism. By selling near cost, Costco or Sam's Club offers higher savings (known as consumer surplus) compared to the price they would be willing to pay for the same item in a traditional store. As a result, if the discounter only sold at cost, they would go out of business since the profit motive would be removed and they would lose money since the fixed and variable costs would make them lose money. To counteract this reality, the discounter makes up for the difference in consumer surplus by charging a membership fee which creates a small profit and covers the operating costs. As a result, the membership fee is usually tiered to a point where all consumer surplus is removed from all but the highest volume purchasers, so the consumer is not better off shopping the discounter than anywhere else. Naturally, some consumers, such as those with large families gain some consumer surplus, but the pricing including the membership fee precludes most consumers from benefitting economically, so the firm still realizes profit. This type of pricing is known as two-tiered pricing, and is done to ration things for which different classes of consumers have different levels of elasticity.