A small pricing problem

The other day I was at Toby’s Estate’s Wooloomooloo outlet when I became inordinately interested in the menu pricing.

From my notes (I did mean inordinately) :

Short Black/Ristretto : $2.20

Long Black/Piccolo Latte : $3.00

Latte/Flat White/Cappuccino : $3.50

Here’s my puzzlement. It’s clearly not marginal cost pricing.  Whilst the extra labour and milk obviously add a slightly greater cost to the flat white compared to long black, these extra costs are also present to a marginally smaller extent in the piccolo latte which is priced the same. And the effort involved in adding already heated effectively free water to a cup for a long black can’t represent an 80 cent cost on top of a short black.

But we don’t expect perfect marginal cost pricing in many places anyway.

But the prices don’t reflect what I’d expect from typical price discrimination either. This location isn’t in a place of heavy foot traffic. Casual walk ins are likely matched in numbers by people that came specifically for this coffee, and this is a boutique roaster after all. In this situation the people who have the least price elasticity, and are thus most prepared to pay higher prices are not the hurried or those who are ignorant of alternatives, but the coffee connoisseurs.  They have less elasticity in their demand for higher quality coffee and are prepared to pay more (or walk out to Wooloomooloo) to get better quality. Casual drinkers will be less fussy head for cheaper options.  A price discriminating firm would attempt to price the beverages the connoisseurs drink at a premium.

But such connoisseurs would lean towards either “purer” forms of coffee unadulterated by other flavours, or uncommon beverages that might mark them as an expert. On this menu these would be the short black, ristretto and piccolo latte. The first is a taste hostile to the casual drinker, the latter two are terms that the casual drinker is unlikely to even understand. Yet these are three of the four cheapest options.

The pricing seems to be based more on expectations of fairness. Greater volume of beverage should command a higher price, even if the cost is the same, even if certain consumers value a greater volume less.  Violating these notions of fairness would inspire hostility amongst customers whom would stay away as a result.

This seems fairly obvious without thinking deeply, but I don’t remember anything about this in Microeconomics. I just wonder if this effect (if it exists) is significant enough to be worth incorporating into analytical tools. It might help explain the difficulty public policy has in creating markets or pricing things, whether Pigou taxes, utility prices or parking.

About Richard Tsukamasa Green

Richard Tsukamasa Green is an economist. Public employment means he can't post on policy much anymore. Also found at @RHTGreen on twitter.
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James Farrell
James Farrell(@james-farrell)
11 years ago

Richard, if people hang around socialising or reading, they might drink two cups. The probability is increased if the portions are smaller. The discount for the smaller portions must be just enough to make it worthwhile to choose two small cups rather than one standard one.

Ideally cafes would use second degree price discrimination — i.e. charge less for the second cup — but it would be too hard to police.

Patrick
Patrick
11 years ago

I think it is a more basic thing – charging what you think the market can bear, irrespective of what rational basis your belief is based in. Maybe if you called it something like ‘satisficing’ you might feel better about it!

conrad
conrad
11 years ago

I have some evidence (actually an anecdote) of expected fairness from the coffee place near where I work. Basically, I was sitting around having a coffee, when I assume what was probably a business student asked how much it cost the guy running the shop in ingredients to make one of the weird coffees (vanilla syrup coffee or something like that). The answer was that he didn’t know, and that didn’t seem to bother him at all. I imagine this is also why his coffee is rounded to 50c increments — it’s simpler for people to pay $3.00 vs. $2.90, and no-one really cares about the difference, obviously including the price setter.

Craig
Craig
11 years ago

You’re forgetting about the information problem. Only the connoisseur knows who he or she is. The price setter wants to charge the connoisseur the highest price, but must at the same time make the non-connoisseur’s coffees unattractive to the connoisseur. So there is a tradeoff: to maintain the higher price for connoisseurs, the price setter must also increase the price (or do something else like degrade the quality) of the average beverages, to optimise the overall returns. This could end up meaning that the average coffees are priced higher. This would be the case if the proportion of connoisseurs is high. This is assuming that costs have nothing to do with the prices, but this is more often than not the case. It also assumes there isn’t some sort of introductory pricing effect going on also.

Patrick
Patrick
11 years ago

Also, I very strongly doubt James’ Farrell’s explanation, quasi-rational as it may be. More than any other factor, coffee is actually a drug and very few people are sufficiently indifferent to their consumption as to be influenced by pricing strategies.

Arch
Arch
11 years ago

Building on Patrick’s comment, how about reputation and repeated interaction effects, Richard? A boutique cafe wants the connoisseurs coming back, but they are picky and and have the capacity to move around, so this drive the price of the `purer’ coffees down.

In contrast, if joe average stumbles in before work, Mr barista just takes him for as much as possible. Moreover, I guess this seems fair to Mr average, cause he got a big cup.

My recall of mechanism design fails me a bit here, but my hunch is that the two types of buyers in this market differ in more ways than the typical price discrimination models you implicitly refer to are capable of modelling. Interesting observation though!

Butterfield, bloomfield & Bishop
Butterfield, bloomfield & Bishop
11 years ago

Making coffee retail involves relatively high fixed costs so the prices mean customers are being ‘creamed’.

Having said that it is usually the largest profit ( but not revenue) earner in most cafes.

Tel
Tel
11 years ago

I suspect that if you ask a random city person, “What is the most popular style of coffee?” you would reliably get an answer of either “Latte”, “Flat White” or “Cappuccino”. If you did a follow up and tell them to rule out those three and ask what is the next most popular style of coffee you would get a reliable, “Long black”.

But such connoisseurs would lean towards either “purer” forms of coffee unadulterated by other flavours, or uncommon beverages that might mark them as an expert.

Leading to the conclusion that this particular outlet’s primary customers are not such connoisseurs.