Sunday, January 07, 2007


Are Cable Prices an example of Price Discrimination?
If you go to a big electronics store, like CompUSA or Best Buy, and look at the prices for cables (USB, HDMI, CAT5, etc.) you'll find that they seem quite expensive. I used to work at a CompUSA years ago, and in fact the cables were priced way above cost--margins were sometimes 200%, 300%, or higher. I saw a post on Shacknews today by someone who had seen the employee discount on a cable, and apparently these high margins persist.


How could this be? Why wouldn't these high margins be competed down? I suspect that it is price discrimination. The classic example of similar price discrimination is popcorn at movie theaters. Movie theaters sacrifice some profit by charging prices for movie tickets that are below marginal cost, but gain large profit by then charging high prices for concessions, such as popcorn. The lower ticket prices attract larger numbers of customers, and those who really like popcorn will be willing to pay high prices, allowing the movie theater to extract more consumer surplus for itself. (Locay and Rodriguez, JEP 1992, has some problems with this story, and I have the same problem--why aren't popcorn prices just competed down?--but let's accept it for the moment).


Are cables similar? Suppose you buy a new TV or printer. You need cables to connect it to other devices. By charging low prices for the primary item--the TV, printer, or whatever--the store can lure in more customers. The store can recover some of that loss by charging high prices for cables. It may gain on net if it can lure in enough people with its low price items.
On the other hand, there are plenty of places where you can buy cables cheaply online. Similarly, there are plenty of grocery stores where you can buy cheap popcorn--but you can't take that popcorn into the movie theater with you. You can just buy cheap cables after (or before) buying the expensive electronic good. So how do these margins persist? Is it ignorance on the part of casual electronics buyers? I find that a little hard to believe; surely they do some research before buying television sets priced in the hundreds or thousands of dollars. Is it the convenience of getting everything at one time? Delivery of goods ordered online is pretty convenient. Perhaps it has to do with delivery and installation services sold by places like Best Buy. Do their installers require you to buy their cables? Or is it just so much more convenient to pay them for everything and have them worry about it that it is not worth saving $40 by getting cables from somewhere else?


I'm open to ideas, but "retailers are greedy and evil" isn't a thoughtful or acceptable answer (since it begs the question of why they can't get away with such margins on everything).

4 comments:

Ian McMeans said...

I bet it's ignorance. This would be easy to test experimentally: confront random shoppers in a best buy who are at the checkout with HDMI cables, and ask them if they'd prefer to save 90% of the cost by ordering online.

About popcorn being competed down: I'd guess this is also consumer irrationality. If popcorn prices could be competed down, then theatres wouldn't benefit by having low-priced tickets coupled to high-priced popcorn - they'd care about the total cost.

Mike Hammock said...

The problem with the "consumer irrationality" theory, it seems to me, is that it explains everything, and therefore explains nothing. Why do theaters compete over ticket prices? Because consumers are rational and shop around. Why don't theaters compete over popcorn prices? Because consumers are irrational and don't shop around. Why do printer cables cost so much? Because consumers are irrational and don't shop around. Why are printers so cheap? Because consumers are rational and printer manufacturers try to lure them with low prices. This all begs the question, why are consumers so rational for one good, and so irrational for another? There must be something else going on here. Why are consumers smart enough to look at print quality and price when buying a printer, but not smart enough to realize that ink costs will vary from printer to printer, so that the $50 printer may really cost far more than its price alone indicates?

I don't really have any answers here; just more questions.

Ian McMeans said...

I see it this way: People don't always do optimal things. I guess this could be an avenue of research, but it doesn't surprise me. Irrationality while buying cables and popcorn fits into a much larger scheme of people being suboptimal all the time, at all the tasks they perform.

You may as well ask why people accidentally pour their coffee into their cereal when they're sleepy - we make mistakes all the time, including when we make economic decisions (mistakes at economic decisions is just called irrationality).

In the case of HDMI cables, a consumer could plead ignorance (not knowing that cheap cables are on the market). But in other cases such as popcorn+tickets, they have all the relevant information available and still make reckoning mistakes. This applies to all loss-leader products at stores.

Our decision-making is a collection of behavioral heuristics and hacks tuned by evolution - it would be surprising if our brains were optimal in uniquely modern situations. If you want specific reasons why people make the mistake of not researching prices, you're venturing into psychology.

You may be able to come up with an ad-hoc explanation that can preserve consumer rationality, such as "the consumer considers the cost of reckoning about ticket prices to be higher than the expected money saved", but I bet that can be experimentally falsified. (People would be willing to do that reckoning work as a job, making a lot of money per hour - so it's clearly worth the time)

Saying that the price is due to "buyer irrationality" tells us something about how the rest of the market is operating. Saying it's irrationality rules out other sources of high prices - monopolies, cartels, veblen goods, or shortages and high demand. All the reasons you suggested for consumer behavior were rational ones, I'd be surprised if any had a big effect.

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