Arnold Kling  

Black Friday Discounts and Price Discrimination, Online

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A reader writes,

If the price-insensitive people are at home avoiding the crowds then it would seem the online stores would be getting shopped by a higher than average percentage of price-insensitive people.

It appears to me the 'price discrimination' theory doesn't work for explaining sales at online stores.

The essence of the price-discrimination story is not that price-insensitive people avoid crowds. That is more of an add-on.

The basic theory is that occasional discounts are a tool of price discrimination. You keep prices high most of the time to take advantage of people who want it now and are less sensitive to price, and you hold occasional sales where you offer discounts to get business from the people who time their purchases to take advantage of low prices.

This theory predicts that discounts will appear at more or less random times. The question is, why do discounts all get bunched on a certain day? I imagine that once most stores pick a particular day to hold a sale, it behooves you to pick that same day. If everybody knows that Black Friday is a sale day, then nobody will be willing to pay full price on that day, so if you don't hold a sale you will get no business.

The next question is, why is the sale day Black Friday? There is where my story about crowds comes in. If you figure that crowds drive away price-insensitive shoppers, you pick that day for a sale.

But the bunching of sales may be an example of a Schelling point. Nobel Laureate Thomas Schelling said that when people can benefit from co-ordination, they gravitate toward an obvious point. Black Friday may make as much sense as Schelling point for online sales as offline sales, even though crowds are not the issue.

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COMMENTS (4 to date)
Les writes:

Price discrimination may often be independent of crowds. So long as people can be segregated into groups there can be price discrimination between groups with different price elasticity of demand.

Examples are student and senior discounts, lower airfares for standby tickets or Saturday night stopovers, earlybird dinners, and "ladies nights" at bars.

TomB writes:

Sales (at least on days other than Black Friday) can also serve a practical purpose. Stores can only hold so much inventory. It makes sense to supply the stores with plenty of inventory at the beginning of a period so the store does not run out and lose sales. When the period ends, the store needs to dump its old inventory to make space for the new inventory. If a store did not dump inventory, it would require either a) more storage space or b) smaller, more frequent shipments. So the sales allow stores to dump old inventory and avoid paying the extra storage costs.

Marcus writes:

The Schelling point seems like a mechanism related to Hayek's spontaneous order.

Thank you for the reply. I am still digesting it.

CJ Smith writes:

I also think your point about Schelling points has strong correlation to bunched sales.

Black Friday refers to that day in the year when stores supposedly "go into the black," or become profitable because yearly fixed costs have been covered by prior revenues in excess of variable costs. Even online stores have fixed costs that have to be covered in terms of warehouse space, computer equipment, etc.

TomB is correct - many stores run on a calendar year for accounting purposes, so reducing stock prior to the year end inventory means labor and administrative overhead savings, which turns into more profit.

Additionally, styles and models typically change at year end, and staying with old styles and models can lead to loss of future brand buying customers, who will buy a new 2010 model over a new 2009 model, even though both are fresh off the production line, with no wear and tear.

Since Thanksgiving is the last major holiday before Christmas and the New Year, shops are trying to generate and capture price discriminating shoppers for a variety of reasons, The total consumer market is generally much larger on Black Friday, due to the prevalence of 4-day weekends given to employees. Many customers will use the free Friday to shop for the upcoming Christmas. Thus, the larger customer base also includes some price indiscriminate shoppers, and a large portion of price discriminant shoppers. In addition to this general increase in customer base, stores want to capture marginal customers who still generate some profit on each unit sale, and to reduce inventories. Perhaps surprisingly, Black Friday sales may be even more profitable than earlier in the year, as a portion of the excess revenue over variable costs is no longer needed for application to fixed costs. While this may be merely a timing or allocation issue issue arising from accounting and budgeting methods, it is fairly prevalent in most markets, as managers will leave a "cushion" or "oh, sh__" factor for unexpected cost increases, and appears to generate additional profitability prior to year end.

You won't see similar sales before Christmas (you may even see price increases) because the remaining shoppers are price indiscriminate for one reason or another, usually because they are last minute shoppers. You will see even larger discounts immediately after Christmas, as the drive to reduce inventory and clear shelves for the next year's styles and brands (and future inventory holding costs on now less desirable styles and models)outweighs even variable cost considerations.

Shelling's theory then come into effect. Once a significant portion of stores begin generating and attracting shoppers, other stores will join in, hoping to participate in the larger market and the shopper's feeding frenzy (even price discriminating shoppers can't be aware that some stores are marking 50% off items that were artificially increased 50% prior to the sale for a "real discount" of 25%. Shoppers expect bargains at stores with sales, and avoid stores that don't have a sale, regardless of whether or not the non-sale store's prices are equal to or better than the discount sale.

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