An airline “dent and scratch sale”

A classic story of price discrimination that textbooks tell is the appliance ‘dent and scratch’ sale in which an appliance store will deliberately create cosmetic damage on some of their washers and refrigerators so that they can sell them at a low markup to customers who won’t pay their regular high price. But they don’t want their high-profit customers to buy the marked-down appliances and the cosmetic damage keeps people like Bill Gates from getting the cheaper deal. Ironically, they dented appliances actually cost the stores more money than the pristine appliances because the stores have to pay employees to bang them up strategically.

Similarly, airlines charge a high markup on drinks nowadays, so they would rather not give anyone anything to drink for free. To encourage passengers to pay for water, they will give a cup of free ice, but not a cup of free water even though the free ice costs more than plain water would cost. Now that airlines want passengers to pay to pick their own assigned seats, some airlines are using algorithms to automatically split up families to encourage them to pay for the ‘extra’ service of sitting together.  Again, it costs more to develop a computer program to split up groups to get some of them to pay extra to sit together, but it only costs a little bit more to create the worse version of the product.

1843 Magazine has more examples:

In the late 1980s IBM’s LaserPrinter, retailing at $2,395, printed ten pages per minute. In 1990 it launched the LaserPrinter E. At $1,495 the economy model offered a big discount and printed at half the speed of its pricier sibling. But the new printer was not made using cheaper parts, or assembled by workers on lower wages. In fact it was just the original printer with extra inputs: microchips has been added to slow it down. IBM had not designed a low-cost printer, they had spent time and money making their original product worse.

…[Deliberate] product sabotage…

in 1849. French railways offered three classes of travel with the lowest tier pretty rough: the carriages had no roofs, and the seats were wooden benches with no covers. Surely, people complained, the discomfort was unnecessary. Dupuit pointed out the value in the inconvenience: by making third class really bad, only the truly threadbare would use it. Those with a little more cash would reveal their preference for comfort and stump up for a second-class ticket.

Today Eurostar offers a ticket that uses Dupuit’s logic. It offers ultra-cheap tickets that do not specify the time of travel (this is revealed two days before the trip takes place). Adding uncertainty to a traveller’s itinerary is a reduction in quality. But it is useful because it forces business travellers – who must be in London or Paris at a specific time – away from this bargain option.

It might seem like product sabotage should be banned. But as research by Preston McAfee – now chief economist at Microsoft – has shown, it can make customers better off. The key test is whether the practice means more goods are sold. Suppose the French had regulated trains so that all carriages had roofs. All those in second class might have switched to third class, potentially rendering both uneconomical to provide. Altering quality, even if that means damaging goods, can make total supply rise.

It rankles WaPo reporter Catherine Rampell that hotels are increasingly tacking on high-profit fees for necessities. This is partly price discrimination, but it is also obfuscation of prices.  After customers have practically put themselves in a hostage situation, the company surprises them with high charges for ordinarily inexpensive necessities like parking, WIFI, and a “resort fee” (even when it is a hotel on the interstate that has no resort). Movie theater and sports stadium concessions use a similar pricing strategy.

Posted in Managerial Micro

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