The recession has brought down prices throughout the economy, in response to faltering demand. In Dublin, the most obvious example of this is Spar’s much celebrated €2 hot chicken-fillet roll. But in the same shop, many prices haven’t fallen as much. Why is this? Like the canary in the coal mine, the €2 hot chicken-fillet roll acts as an indicator in case of recovering consumer spending.
The phenomenon has been pretty common in Dublin over the last few months. Basically, shops advertise particular set sandwiches (say, a BLT roll) at an unusually low price. The principle always remains the same regardless of the sandwich’s contents.
There are some very obvious reasons for such deals to be advertised. They can certainly act to lure consumers into the shop for their lunch – only to see them spend more than they expected on over-priced merchandise elsewhere. This might be a reason for some prices (e.g. chicken-fillet rolls) to fall quicker than others (e.g. cans of soft drink). Consumers use the prices trumpeted outside the store as an indicator of the value for money they expect inside generally.
Why aren’t such deals as prevalent outside of the recession? Probably because firms aren’t as starved of custom. In an economy where fewer people are having their lunch out, competition is more fierce for those who are. Also, shops might be finding that lunch has become a more substantial fraction of their dwindling revenue.
There is also the asymmetry of reduced spending in the economy. In the same way that Tesco offer cheaper, lower-quality food stuffs for consumers on a budget, it pays for shops to have a two-tier price system in these recessionary times. If you’re still flush with cash, have a fancy sandwich at a high price. If you’ve fallen on hard times, we’ll offer you a substantially more limited range at bargain prices. Such “price discrimination” explains why airlines offer business class seats at huge premiums – they are trying to charge each customer the most he is individually willing to pay for the service.
More interestingly, the rate of uptake on these deals might be used as a proxy for the broader recovery of consumer spending. Why? If your income is back to its original level and your job is secure, you are more likely to begin splashing out on frivolous flamboyant sandwiches. At the very least, you are less likely to buy a €2 hot chicken-fillet roll every day of the week.
But the management of Spar will have a hard time knowing how to set their prices in a recession. How much of a price reduction is too much? If they try to keep all prices in the store aligned with whatever vague notion they have of the degree of economic recovery, it will be expensive and time-consuming to change prices everywhere. They might also suffer if their prices are not perfectly accurate.
So instead of changing all their prices, they change a few key items which have superior substitutes at higher prices elsewhere in the store. Then they don’t have to worry about when to raise their prices. As consumers start shifting towards more expensive options, the prices will “naturally” align. Customers will consume some combination of cheap and expensive sandwiches, according to their financial situation – the aggregate will be the price they are charged.
But there’s more information to be gleaned. Substitution away from €2 hot chicken fillet rolls and towards the range of more expensive sandwiches may communicate a recovery of consumer spending in this specific area. It doesn’t have to be a mass exodus. There would just have to be a noticeable decrease. Crucially, if all your prices were low, you’d never notice this increased willingness of consumers to spend – because all you know is that consumers are all willing to buy sandwiches at the current price you’ve chosen (which is the same for all your lunch options).
Once that substitution happens, Spar can then phase out their crazy deals and begin charging less extreme rates for all their lunch options. They want to do this as the earliest possible moment, because increased consumer choice yields higher profits in the long-run. If they do it too early though, consumers won’t be ready and will shop elsewhere.
What is the price of this knowledge to Spar? Well, they’re forcing a lot of people to eat €2 hot chicken-fillet rolls, when they could lower prices elsewhere in the store while maintaining profit. Since this makes consumers less happy than otherwise possible, that affects the store’s bottom line in the short run.
But it might be worth it, because firms will have a strong indicator of when they can adapt their pricing strategy to the reality of the recovering economic situation. Their prices will “naturally” align, as the proportion of consumers willing to pay more gradually shifts away from the €2 hot chicken-fillet roll. Is it fool-proof? Nope. But if sales are increasing at the smoothie bar too, the evidence for economic recovery will begin to mount.