KEY POINTS:
In the third excerpt from The Undercover Economist, Tim Harford reveals how businesses make some products worse to coax richer customers into paying more.
It's not hard to persuade price-sensitive customers to steer clear of an expensive product, but sometimes it is more difficult to prevent the price-insensitive customers from buying the cheaper one. This is not a problem in the case of small price differences; we have already seen that you can get some customers to pay a modest mark-up in absolute terms (if huge in relative terms), just by wrapping some chillies in a plastic bag or moving a bag of crisps onto the top shelf. When it comes to more substantial buying decisions it is not always so easy.
Some of the most extreme examples come from the travel industry: travelling first class by train or air is much more expensive than buying a standard ticket, but since the fundamental effect is to get people from A to B, it may be hard to wring much money out of the wealthier passengers. In order to price-target effectively, firms may have to exaggerate the differences between the best service and the worst. There is really no reason why standard train carriages shouldn't have tables, as they typically don't in the UK, for instance, except that potential customers for first class might decide to buy a cheaper ticket when they see how comfortable standard has become. So the standard passengers have to suffer.
The 19th century French economist Emile Dupuit pointed to the early railways as an example: "It is not because of the few thousand francs which would have to be spent to put a roof over the third-class carriage or to upholster the third-class seats that some company or other has open carriages with wooden benches ... What the company is trying to do is prevent the passengers who can pay the second class fare from travelling third class; it hits the poor, not because it wants to hurt them, but to frighten the rich ... And it is again for the same reason that the companies, having proved almost cruel to the third-class passengers and mean to the second-class ones, become lavish in dealing with first-class customers. Having refused the poor what is necessary, they give the rich what is superfluous."
The shoddy quality of most airport departure lounges is surely part of the same phenomenon. If the free departure areas became comfortable, airlines would no longer be able to sell business-class tickets on the strength of their "executive" lounges. And it would also explain why flight attendants sometimes physically restrain passengers from the cheap seats from stepping off the plane before the passengers from first and business class.
The message is clear: keep paying for your expensive seats or next time you might be the wrong side of the flight attendant.
In the supermarkets, we see the same trick: products that seem to be packaged for the purpose of conveying awful quality.
Supermarkets will often produce an own-brand "value" range, displaying crude designs that don't vary whether the product is lemonade, bread or baked beans. It wouldn't cost much to hire a good designer and print more attractive logos. But that would defeat the purpose: the packaging is carefully designed to put off customers who are willing to pay more.
Even customers who would be willing to pay five times as much for a bottle of lemonade will buy the bargain product unless the supermarket makes some effort to discourage them. So, like the lack of tables in standard train carriages and the uncomfortable seats in airport lounges, the ugly packaging of "value" products is designed to make sure that snooty customers self-target price increases on themselves.
The most surprising examples of all come from the world of computers. For instance, IBM's LaserWriter E, a low-end laser printer, turned out to be exactly the same piece of equipment as their high-end LaserWriter - except that there was an additional chip in the cheaper version to slow it down. The most effective way for IBM to price-target their printers was to design and mass-produce a single printer, then sell it at two prices.
But of course to get anyone to buy the expensive printer they had to slow down the cheap one. It seems wasteful, but presumably it was cheaper for IBM to do this than design and manufacture two completely different printers.
Intel, the chip manufacturer, played a similar game by selling two very similar processing chips at different prices. In this case, the inferior chip was actually more expensive to produce: it was made by taking the superior chip and doing extra work to disable one of its features.
Software packages often have two or more versions: one has full functionality (the "professional" package) and the other sells to the mass market at a considerably reduced price.
What some people don't realise is that the professional version is typically designed first, and certain features are disabled for the mass market version.
Despite the high price of the professional version, it's the cheaper version that actually has an extra upfront cost for the developer, and of course both versions are sold on CDs, which cost the same to manufacture.
At the height of the internet bubble, giddy gurus claimed the different cost structure changes everything - but, as we've seen, the basic rules of making money in the high-tech business are not so different from those for train operators or coffee bars.
