Revenue management and transaction costs

So I just sent off a letter to India. To be precise, it is a document I had to sign and send to my accountant there – who sends regular “letters” any more?

The process at the post office (which, in my suburb, is located inside a large bookstore) was simple. In the first screen of the touch screen kiosk, there was an option for “worldwide < 20 grams”. A conveniently placed scale told me my letter weighed 18 grams, and one touch and one touch of my debit card later, I had my stamp. Within a minute, my letter was in the letterbox.

The story of how we pay the same amount for sending mail over large areas (“worldwide” in my case today) is interesting. Earlier, mail rates were based on distance, but as new roads kept being built in the 19th century America, and distances kept changing, figuring out how much to charge for a letter became “expensive”. A bright fellow figured out that the cost (in terms of time) of figuring out how much to charge for mail was of the same order of magnitude as the cost of the mail itself. And so the flat rate scheme for mail, that is prevalent worldwide today, was born.

Putting it in technical terms, transaction costs trumped price discrimination in this case. Price discrimination is the art (yes, it’s an art) of charging different amounts to different people based on their differential willingness to pay. Uber surge pricing is one example (I have a chapter in my book on this). Airline fares are another common example.

Until the late 18th century (well after mail prices had gone “flat”), price discrimination was rather common everywhere, a concept I have devoted a chapter to in the book. In fact, the initial motivation for fixed price retail was religious – Quakers, who owned many departmental stores in the US North-East, thought “all men are created equal before God” and so it was incorrect to charge different amounts to different people.

Soon other benefits of fixed prices became apparent (faster billing; less training for staff; in fact it was fixed prices that permitted the now prevalent supermarket format), and it took off. The concept is the same as stamps – the transaction cost of figuring out how much to charge whom is higher than the additional revenue you can make with such price differentiation (not counting possible loss of reputation, and fairness issues). Price discrimination at the shop is now confined to high value high margin businesses such as cars.

And it works in other high gross margin businesses such as airlines, hotels and telecom. These are all businesses with high fixed costs and low marginal costs for the suppliers. Low marginal costs has meant that price discrimination ha been termed as “revenue management” in the airline industry.

During the launch function of my book last year, I got asked if Uber’s practice of personalising fares for passengers is fair (I had given a long lecture on how Uber’s surge pricing is a necessary component of keeping average prices low and boosting liquidity in the taxi market). I had answered that a marketplace needs to ensure that its pricing is perceived as being “fair”, else they might lose customers to competitors. But what if all players in a market practice extreme price discrimination?

Thinking about it, transaction costs will take care of price discrimination before businesses and marketplaces start thinking of fairness. Beyond a point (the point varies by industry), the marginal revenues from price discrimination will fall below the transaction cost of executing this discrimination. And that poses a natural limit to how much price discrimination a business can practice.

Levi’s Price Discrimination

So I’ve never managed to buy jeans on discount. Let me explain. Unlike most other people (if you go by what the store assistants tell you), I don’t like to wear faded jeans. It is perhaps an inherited hangover since my father used to consider jeans to be inherently dirty and would make me discard jeans as soon as they faded a little bit. It could also be more practical – since I sometimes like to wear jeans to official meetings, I want to wear jeans that look neat.

Now I’ve managed to drive my wife crazy with my shopping (and we’ve known each other for barely four years, shopped together for three maybe). She thinks I’m way too fussy about clothes, and can’t make up my mind easily. I’ve explained earlier on this blog why I take a long time over shoes (my sandals are now wearing out, so I’m getting ready for another ordeal). But the more fundamental differences that my wife and I have is with respect to jeans.

The problem is that we fundamentally disagree on what purpose jeans serve. I have traditionally looked at jeans as comfort wear. Trousers I’m absolutely comfortable in (I sometimes even sleep in my jeans), which I don’t need to wash too frequently, and which can be worn even after they get torn in non-strategic places. I’ve always bought “comfort fit” jeans, and after I graduated to branded jeans towards the end of my teens, my staple had been the comfort-fit Lee Chicago.

The problem is that my wife thinks of jeans as fashion-wear – things you need to necessarily look good in. Some of the jeans she owns are so skinny that sometimes she takes a really long time to change. She looks great in them, no doubt, but the problem is that she expects that I too wear such jeans. And so after some ten years, I have given up my loyalty towards Lee Chicago, and instead have to try out various skinny fits (as things stand now, I own only one pair of Lee Chicago, bought in 2009).

Ok all this is besides the point of this post (and the point of another post which I never wrote). Coming back to the point of this post, the deal is that nowadays I find it extremely hard to shop for jeans. Of course it doesn’t help that I don’t live in Kathriguppe (with its dozens of factory outlets) any more, and that in my part of town (Malleswaram-Rajajinagar) the only place you can find decent branded clothes is in malls, which are a pain. The bigger problem, though, is that it is very hard to find stores that stock my kind of jeans.

In the last couple of years, our strategy for shopping clothes has been to visit a multi-brand outlet in one of the two malls near our place, so that we have a wide variety of choice. Except that I have no choice. Because stores such as Lifestyle or Shopper’s Stop or Westside (which now mostly stocks private labels) or Central don’t stock my kind of jeans. At all. If you happen to locate a store clerk and ask him for “mid blue straight cut non-faded jeans” he will look at you as if you have just landed from another planet. He can be excused for giving you those looks, for his store simply doesn’t stock non-faded jeans, because of which he has never sold them!

So I happened to be on Brigade road over the weekend, and I had a small gap of about half an hour between two meetings, and thought I should visit the Levi’s flagship store there. I must mention that the salespeople there were definitely significantly more polite than I’ve ever seen at a multi=brand store. However, as soon as I repeated my mantra (mid blue straight cut non-faded jeans), the first thing the salesperson who approached me told me ¬†was “oh Sir, but there’s not discount on that!”.

It’s clever price discrimination by Levi’s, to not sell non-faded jeans on discount. For they know that people who buy non-faded jeans tend to be older (hey I’m only thirty), or will be buying them for office wear, and they are less price elastic than the typical college kid who buys faded stuff. So while the college kid needs discounts to be attracted during the “discount season”, the “formal jeans” buyer needs no such attractions, and will pay full price for his stuff.

It is interesting to note, however, that companies that make formal clothes (not Levi’s) also offer massive discounts during the “discount seassons” (one of which is on now). That, though, can be explained by the fact that most people need a few sets of formal clothes (even those that normally wear faded jeans), and discounts are necessary to attract customers.

Now I’m beginning to think that the market for “formal jeans” in India is extremely niche, and if I”m acting above my age because I prefer such jeans. I half-expect my wife to call me an “uncle” be cause of this.