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CONSUMER PSYCHOLOGIST NEWSLETTER
VOLUME 1, NO. 2 - FEBRUARY, 2003
Copyright © 2003 Lars Perner, Ph.D. http://www.ConsumerPsychogist.com
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THESE ARE THE DAYS OF THE 99¢ STORE. "Bargain" stores have been around for a long time, but in recent years, we have seen a tremendous increase in 99¢ across the United States and the world. Why are these stores becoming so much more prevalent today?
First of all, of course, the current weak economy has raised many shoppers' interest in 99¢ stores. In bad economic times, finding good values is increasingly important. In Japan, discount stores originally had a very difficult time getting started. The Japanese have tended to be tremendously brand loyal customers who saw a strong relationship between price and quality. Today, however, "100 yen" stores do quite well and attract a great deal of shoppers.
Other factors are also at work, too. In an increasingly competitive market place, stores are faced with more and more choices of products they can offer. However, even the largest supermarkets have limited shelf space. To introduce a new product into their store, managers often have to "bounce" another one. Therefore, there is a great deal of pressure on products to "perform," and those that do not sell well at their full price have limited options.
Most new products that come out-even if they seem to have tremendous promise-tend to fail. One reason is that even if a new product succeeds in getting into the retail stores, it may well "drown" among many other products on display. Consumers simply don't have time to look at all the new products coming out. Consumers tend to lose interest particularly quickly in products whose use is not readily apparent, so if what a product does takes some explanation, it is especially vulnerable.
Changes in technology have made it more practical to operate 99¢ stores with a large assortment. "Mom and pop" 99¢ stores have been around for while. Large chains such as 99¢ Only Stores and Dollar Tree now have access to information technology that helps identify products available, determine how well these sell, and ship them efficiently to geographically dispersed stores. This not only makes "99 centing" more profitable, but it also allows stores to offer higher quality products at these prices. This, in turn, makes the stores more attractive to shoppers whose visits are rewarded.
99¢ stores do carry quite a variety. There are products in some of these stores that support cynical consumers' observation that "You get what you pay for." But value conscious shoppers know that there are great values to be found elsewhere in the 99¢ store. Sometimes, the stores are able to get large volume discounts on buying huge quantities of ordinary products, passing on the savings to consumers. Many times, too much quantity is produced in one region, or the manufacturer needs to liquidate the remainder of a product after it or its packaging has been redesigned.
It is a mistake to assume that 99¢ stores appeal only to low income consumers. Many shoppers there are quite upscale. After all, many affluent people became so in large part because of their frugal ways. The management of 99¢ Only Stores found that it is usually more effective to locate its stores in higher income areas. Apparently, low income consumers are willing to travel to more affluent neighborhoods to shop, but the reverse is not the case.
SUPPLY, DEMAND, AND CHRISTMAS SALES. The economist Paul Samuelson, is in his bestselling textbook, has quipped that you can turn a parrot into a "learned economist" by merely teaching it to say "supply" and "demand." Clearly, supply and demand dictate a great deal about prices. If prices did not adjust to supply factors (e.g., an abundant orange harvest) or to demand changes (e.g., a reduced interest in travel among consumers during a weak economy), stores would end up with either huge surpluses or large shortages. People are not going to drink more orange juice to make farmers happy, so the price must come down-and often quite significantly-before consumers buy more. When a factory that accounted for some 20% of the world's computer RAM chip production burned down some years ago, prices went up dramatically.
At first glance, then, the large Christmas sales that many stores feature might seem perplexing. Why would firms want to cut prices when consumers are intent on buying a large number of gifts? Are dedicated economists facing their worst nightmare as the laws of supply and demand are flaunted with impunity?
Part of the answer here depends on semantics. Economists, having introduced a great deal of assumptions in order to make their theories tractable, need to be very careful in the language they use. You may remember how economics professors are zealous in making the distinction between the terms "demand" and "quantity demanded." An increase in demand actually means that consumers will buy, say, a larger quantity of apples, if those are sold at 99¢ per pound, than they did earlier at that same price. Without knowing about the supply available, we can't tell the quantity that will be sold and the market "clearing" price. What we see at Christmas is an increase in the quantities that consumers set out to buy, but not a willingness to buy a larger quantity of goods at a given price. Does this sound nit-picking? It may be, but let's take a look at what takes place during the holiday season.
Why do merchants rush to put merchandise on sale at Christmas time, just when consumers seem to need it the most? The question can be answered at two different levels.
If we look at the question from the point of view of the individual retailer, the answer is obvious: He or she has to, or consumers will go to other merchants who are offering these discount prices. Christmas sales can be very profitable overall, but the merchant simply does not have the option to sell desired volumes of merchandise without offering competitive prices. We are, however, left with a "chicken-and-egg" issue: Why are the other retailers so eager to offer sales? Yes, lower prices tend to mean that higher quantities are sold, but this would also be the case at other times of the year when consumers are actually less interested in buying the products in question.
There are several reasons for merchants' "stampede" to offer bargains at this time. First, a great deal of merchandise is ordered in advance so that it can be sold at Christmas time. Some of this merchandise can be sold at other times of the year, but much of tends to have seasonal value, and it is thus essential to have as much as possible of it "moved" before the end of Christmas shopping. Because the stores often have to order a long time in advance in order to be assured a desired supply at a favorable price, the retailer may also be vulnerable to an economic downturn where consumers need to be "spurred" with discounts to make purchases at or near the predicted levels. What happens, then, is that stores may effectively start their "after Christmas" sales before Christmas! This introduces two sorts of problems. First, remembering what the store had to do last year to get the merchandise moving may cause the retailer to start discounting even earlier this year. Further, the retailer knows that other retailers are likely to think the same thing, and it may thus be necessary to try to "beat" competitors to the punch. This can quickly become a vicious cycle. Thus, Christmas sales began well before Thanksgiving in 2002. Antitrust laws in the United States are explicitly intended to encourage this kind of competition, and retailers are not allowed to "collude" to maintain prices. In contrast, laws in Germany have traditionally limited the extent and magnitude of sales permissible, but EU pressures for harmonization may bring an end to this.
Economic theory also provides a bit of a rescue for itself. Although economists assume in principle that buyers and sellers have "perfect knowledge" of prices, this assumption is quite unrealistic and has to be relaxed in practice. Finding information about market prices does, in reality, involve a great deal of effort, and economists can now fall back on their notion of "opportunity cost." The "cost" of a good bought includes not just the money that the consumer "forks out," but also the value of the time that he or she sacrifices to search for good prices and to complete the purchase. Travel between stores takes time. At Christmas time, when more items are bought, the opportunity cost of information search can be "spread" over more products, making more search worthwhile. Professor Kent Monroe, a world renowned expert on pricing, goes so far as to argue that retailers, being aware of this extra search behavior among consumers, rush to provide consumers with more information-in the form of advertising of large sales-to influence where consumers' search leads them. To be able to advertise these low prices, then, you must actually have low prices to offer at the moment. At other times of the year, search is less worthwhile since less is at stake when fewer products are bought.
Another issue relates to the issue of substitutability. It is customary for certain people to give each other presents, but there is often a great deal of latitude in exactly what can be purchased. At other times other times of the year, rather specific items may be needed, but at Christmas time, the consumer is free to search for values among a number of product categories for gifts. For example, one could give a nephew a spade, a cashbox, or a video game-all might make for a happy recipient. Thus, in economic terms, although a large number of "generic" gifts are demanded, the demand in each product category is actually quite low. Economists, then, can proudly proclaim that a very high "cross-price elasticity" is at work!