Supermarket Price Wars = Bigger Profits

My posts appear to be coming monthly affairs. My new year’s resolution is to do better in 2012! It’s frustrating that I’ve been so busy because there’s so much to write about: the EU debacle, public sector pensions, the NHS reforms, the legal aid bill to name but a few.

But today I’m going to comment on a recent BBC (Panorama) programme titled “the truth about supermarket price wars”. According to the programme synopsis: “The deals at Asda, Tesco, Morrisons and Sainsbury’s might seem to be everywhere, but strip away the jargon and catchy promises of “huge savings” and “special offers” and you are just as likely to find tactics that experts say range from a bit cheeky to others that could lead to prosecutions for breach of consumer protection regulations.”

Examples included: the price of Comfort fabric conditioner advertised as “Now £2”, forgetting to mention that it cost £1.65 two weeks earlier; ‘bigger pack, better value’ for Clover lighter spread being more expensive per gram; £1 each or two for £2; and preventing price comparison by selling loose fruit and vegetables by weight but pricing packaged items by unit e.g. 5 bananas for £1 which would cost 42 pence loose.

Firstly, there is no price war. If there was a real price war we’d expect to see prices dropping rapidly and profits being squeezed. But profits are up.

So is there another explanation for this (mis)behaviour? Economics provides one answer: noisy price dispersion.

Given most supermarket products are branded and homogenous items (e.g. A 40 bag box of PG Tips) then it should be fairly easy to determine who has the cheapest prices, and competition should mean that one, low price should prevail. This isn’t in the interest of supermarkets; they would rather charge us more money and different prices from their competitors.

The secret is to increase our search costs, the costs we incur in finding the cheapest price. If they can drive up these search costs we are more likely to be prepared to pay a higher price: the cost involved in locating the cheapest price is greater than the saving to be had once you find it.

How can they achieve this? Noisy price dispersion occurs when firms charge different prices from each other for the same good and where this price changes in a seemingly noisy or random fashion.

Supermarkets’ price promises are a cunning pricing tool, which allow the supermarkets to change numerous prices frequently and seemingly randomly. This drives up search costs as it would take considerable effort to find the cheapest place to buy each item.

Even within a single store, making it difficult to work out the cheapest way to purchase a good gets us to part with more of our cash than we need to. Who has the time to work out whether it’s cheaper to buy those bananas loose or in a packet? And after a hard day at work, in a busy supermarket and perhaps with demanding kids in tow who has the mental energy to compare the ‘bigger pack, better value’ to ensure it truly is cheaper?

The economist in me thinks that this complex and ever-changing price regime is a useful trick to drive up your search costs and make it not worth your while to find the cheapest way to do your shopping.

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1 comment for “Supermarket Price Wars = Bigger Profits

  1. Colin Miller
    18 December, 2011 at 21:23

    I read your article with some interest but suggest that the big three or four or possibly five if you include M & S have found a more sinister method of shifting produce at inflated prices – by introducing the buy one for a price but buy two or even three for a lower individual price. This means that shoppers are ‘frightened’ into buying more than they need as they cannot afford the one off price. Even worse for the person living alone who is forced to buy one at the inflated price. What is our wonderful coalition lot doing to stop the majors from making such exhorbitant profits on their sales. As I explain to my wife when she is tempted to pay the three for price the correct price for the item is one third of the so called ‘bargain’ price so the higher ‘one’ price is totally inflated.

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