The Honest Dollar | Where Finance Gets Personal

Price Discrimination and Why Coupons Exist

March 07, 2008 at 10:19 AM

One of Punny Money’s recent articles gives advice to a reader who’s too embarrassed to use coupons.  The article offers several reasons why the reader shouldn’t be embarrassed, including this gem:

5. Coupons are a great way to uncover a person’s true intentions. One of the most common instances when people may feel too embarrassed to use coupons is on a date at a restaurant, especially if it’s a first date. If you’re paying for the meal and your use of a coupon somehow turns off your date, then I think that says a lot about your date. Perhaps he or she isn’t as fiscally intelligent as you. If nothing else, it’s a great way to sort out who likes you for you and who’s in it for your wallet. So if you’re loaded and want to find somebody who isn’t looking to raid your bank account, purposely use a coupon on your first date and see how he or she reacts.

There is serious truth to the statement that “coupons are a great way to uncover a person’s true intentions.”  Coupons are a form of price discrimination, the practice of selling the same thing to different people at different prices.  Price discrimination only works if sellers can discover a person’s true intentions.

Why Price Discriminate?

Individuals can put different values on the same good.  Take a ham sandwich.  Harry loves ham, and he’d pay $5 for a good ham sandwich.  Sally doesn’t like ham as much, and she’d only pay $3 for the same sandwich.

I operate a ham sandwich stand outside of Harry and Sally’s office building.  I can charge $5 for ham sandwiches and count on Harry to buy one.  Alternately, I can charge $3 for ham sandwiches, in which case both Harry and Sally will buy sandwiches.  This means I make $6 instead of $5.  Great!  Except Harry would have paid $5 for the sandwich, and I only charged him $3.

In my dream world, I’d be able to charge Harry $5 and Sally $3.  I’d make $8 in revenue - much better than having just Harry buy a $5 sandwich or having Harry and Sally each buy a $3 sandwich.

This is why sellers want to price discriminate.  They can charge higher prices to people who are willing to pay higher prices, thus not leaving money on the table.  They can lower prices for people who aren’t willing to pay the higher price, thus earning revenue from people who would not have bought the good otherwise.

Isn’t Price Discrimination Illegal?

Contrary to what many people think, price discrimination is not illegal.  In particular, it is distinct from price-fixing, where companies in a single industry collude to raise prices across the board.

In fact, you’ve probably encountered examples of price discrimination several times in your life.  Airlines charge higher fares to flyers who have inflexible travel dates or who book late in the game.  Colleges offer scholarships (effectively a discounted price for education) to outstanding students or students with greater financial need.  In both cases, the same good or service is being offered for different prices to different people.

Why Doesn’t Everyone Price Discriminate?

Even though the law doesn’t prohibit price discrimination, the free market makes it difficult for most sellers to price discriminate.  Sellers face two significant obstacles: reselling and imperfect information.

In the ham sandwich example,  suppose I post a sign that says ham sandwich lovers must pay $5, and ham sandwich tolerators must pay $3.  Harry’s irked that he needs to pay more, so he makes a deal with Sally: “Buy me a sandwich and I’ll give you $1.”  So she does.  Sally is better off because she has $1.  Harry is better off because he saved $1 by buying for $4 something he values at $5.  Only I, poor ham sandwich peddler that I am, lost anything.

Now suppose I’m also new to this street corner.  I have no idea that Harry has bought a ham sandwich every day for two years.  Harry walks up and tells me, “I don’t like ham that much … but I’ll buy a sandwich for $3.”  I have no good way of knowing whether Harry - or anyone else - is a ham sandwich lover or merely a ham sandwich tolerator.  So someone who should be paying the higher price could just lie to me and get the lower price.

This is why price discrimination only exists in very limited markets: markets where reselling is very difficult and where it is easy to tell one group of consumers from another.  Ham sandwich sellers don’t price discriminate.  Airlines and colleges do.

Airplane tickets are bought under someone’s name, and reselling fails because the new buyer’s ID wouldn’t match the reseller’s tickets.  Moreover, it’s easy to tell who is or isn’t flexible on dates - just ask them.  Someone who has to fly on a specific date won’t risk lying.  (With discount sites popping up on the Internet, it has actually become more difficult for airlines to price discriminate - but that’s a story for another time.)

College scholarships are also impossible to resell.  You can’t ask your college to reassign your scholarship money to a buddy who doesn’t need the discount.  Also, need-based scholarships require applications that detail your financial situation.  It’s difficult (and illegal) to misrepresent your finances in order to get better aid.

Enough Economics - What About Coupons?

Coupons are a form of price discrimination.  Coupons split buyers into two groups: those who are not price sensitive (let’s call them Spenders) and those who are price sensitive (let’s call them Frugals).  Spenders couldn’t care less if they can save 50 cents on toothpaste.  Frugals wouldn’t buy the toothpaste unless they can shave 50 cents off the price.

Thus manufacturers found a brilliant way to circumvent the imperfect information problem: issue some coupons.  Frugals clip and use those coupons.  Spenders don’t.  Buyers actually sort themselves out into Spenders and Frugals!  Presenting a coupon for a good signals to the seller that you’re a Frugal who might not have bought the good at a higher price.  Voila: “Coupons are a great way to uncover a person’s true intentions.”

The Ham Sandwich Stand Prospers

So I publish $2-off coupons for my ham sandwiches.  Harry doesn’t have the time to clip the coupons, but Sally does.  She could track down a second coupon and make a deal with Harry, but this is too much effort for either of them.  So I end up selling a $5 ham sandwich to Harry and a $3 ham sandwich to Sally.

Not a bad day’s work, if I do say so myself.




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Comments

  1. Fiscal Musings | March 7th, 2008 at 12:00 pm

    This is one of the most informative posts I’ve read. Great explanation for the reasoning behind coupons.

  2. Lily | March 7th, 2008 at 1:10 pm

    Thanks!

    One thing I should add: The article focuses a lot on the seller’s perspective, but what about the buyer / coupon user? Are coupons worth the time and effort? Theoretically speaking, if you value a good at $5 but it is being sold at $6, then you should clip the $1 coupon and buy it.

    But I do know a couple of people who actually lose economically in the coupon game. They value a good at $4 but it is being sold at $6, so they clip a $1 coupon and buy it anyway. This means they pay $5 for something they think is worth $4 - a losing proposition.

    So there are a few considerations that go into the coupon-clipping process. Think about the time and effort involved. Then think about how much you truly value the good in question. But don’t think about it too much - use your time in efficient ways that make you happy. ;)

  3. thebaglady | March 10th, 2008 at 8:41 pm

    Hmm.. I’ve never thought of it this way. I always figured that a lot of coupons are used for promotional purposes. I use a lot of “FREE” coupons to try out new products, and I always think things could be cheaper so I use coupons. I did read somewhere that only 2% of the issued coupons are redeemed, though. I still don’t quite understand how coupon doubling works.

  4. Lily | March 10th, 2008 at 9:23 pm

    I think the free coupons would be mostly promotional. However, the “Buy 1 Get 1 Free” is actually a 50% discount and probably in part price discrimination.

    The 2% statistic is really interesting. Manufacturers must be making enough money from people who don’t use coupons to (1) recover the cost of printing coupons and (2) recover the cost from people who get discounts through coupons.

    I’m too lazy to clip coupons. Not very frugal, I know, but I value my time more than what I can save through coupons.

  5. Melissa | March 17th, 2008 at 10:32 pm

    People who think that coupons are not worth the time aren’t getting the most of out of them. Most people look at a coupon and think of it as only worth .50 or 1.00. The trick is to buy what you need when its on sale and when you have a coupon. Then its not 50 cents here or a dollar there, it can be a hundred dollars a week in savings. No matter how busy you are, who can’t use a $5000 a year raise?

  6. Lily | March 18th, 2008 at 7:05 am

    Melissa, I think you have a very specific point of view. For many people, their time is much more important than the money they can save through coupons. Bill Gates, for example, would not care whether he saves $5,000 a year through coupons or not. A father who spends 80 hours a week at work may also forgo $5,000 in order to spend more time with his children than clipping coupons.

    You may argue that clipping coupons won’t take up that much time. That might be true. But what about organizing coupons to make sure they don’t expire? Researching sales so you can maximize your savings? This all adds a significant time burden. And I fully believe that for some people, that time is better spent doing other things.

    This isn’t to say that all people make the correct time-money calculation when it comes to coupons. A lot of people will end up playing Guitar Hero instead of clipping coupons. So from a strictly financial point of view, maybe they should be clipping coupons.

    But who are you to judge?

    In economics, we have a measurement of happiness called an “util.” When studying consumer theory, we assume that consumers will maximize “utils,” not dollars. So if an hour spent playing Guitar Hero gives someone more utils than an hour spent clipping and using coupons to save money, then they should play Guitar Hero.

    The decision can become more complex when you factor in future happiness. For example, maybe forty years from now, the GH player will regret not saving money and putting it into a retirement account. But maybe forty years from now, the coupon clipper will regret spending his or her youth scrounging and not just letting loose once in a while.

    I can’t make that judgment. Even an economist can’t make that judgment. It depends on the individual and how he or she values time versus money. That’s why I don’t make normative claims like, “No matter how busy you are, who can’t use a $5,000 a year raise?”

    Plenty of people can, if the alternative is better in terms of utility, happiness, or efficiency.

  7. Lisa | March 18th, 2008 at 9:43 am

    I have had little success in getting my money’s worth from coupons when store brands are typically much less expensive than name brands, whether clipping a coupon or on sale. Almost all coupons that I find are for items I would not normally purchase, such as room deodorizers, Lunchables, and Doritos. I don’t recall the last time I saw a coupon for a dollar off a gallon of milk, five pounds of flour, or a dozen large eggs. Driving from store to store to find sales also incurs expense (and waste) through gasoline, wear and tear on my vehicle, etc.

    We have a joke in my family about how much money my mother and father “save” each other by buying things on sale. The underlying implication is that they’re still spending money, often on things that they don’t really need. That they spent less than the normal retail price for that item is beside the point.

    While I am glad that others can save a good deal of money using coupons, I have found that many times using them would simply cost me (and the environment) more.

  8. Lily | March 18th, 2008 at 3:24 pm

    Lisa - Companies definitely do issue coupons only where price discrimination would make them money. For example, coupons for Crest brand toothpaste will allow Procter & Gamble to make the most money off of people who prefer Crest brand and will buy it no matter what. P&G will also make money off of people who are indifferent between Crest and Colgate, but who will buy Crest if it’s cheaper with a coupon. The coupon means P&G won’t make as much money off of these people, but P&G will still make some money.

    In this and other instances of price discrimination, companies take advantage of brand differentiation. But there isn’t much difference between one brand of milk versus another, one brand of flour versus another, et cetera - assuming we’re not talking about an organic brand and a regular brand. There’s no advantage to be had with a coupon here, since consumers will likely go for the cheapest brand at the time of purchase. In fact, for these competitive goods, coupons become an added burden on consumers, an extra hoop that companies don’t want customers to jump through. It’d be far easier to just set a lower price.

    Maybe my refusal to clip coupons will change if I have a large family and I need more groceries. But right now I shop for 2 people, and I’m with you - I’d rather just buy the store brand and save money that way rather than spend time clipping coupons.

  9. andrew | March 18th, 2008 at 9:47 pm

    now I’m not sure what to do - clip, or play guitar hero? : )

    Lily - I was impressed by your post - but I’m more impressed by your wonderful responses to comments (this one merits no response).

    good blog - good blogger. i’m glad i found this one - you’ve clipped another subscriber. now go play guitar hero.

  10. Lily | March 19th, 2008 at 9:33 am

    Andrew - I’ll respond anyway. :) Thanks for stopping by and for subscribing.

    Now, can you tell me how to beat “Through the Fire and Flames” on Expert? Then I’ll know I made the right choice between coupons and GH3.

  11. Dana | March 19th, 2008 at 3:53 pm

    While I understand the general sentiment involved, I don’t see why using coupons effectively has to be diametrically opposed to spending time with one’s children. I used to help my stepmom clip and organize her grocery coupons every week, and it was actually kind of fun. I made sure to throw out the ones she hadn’t used yet that had expired, stuff like that–it made me feel kinda important.

    Let’s face it, things need to be done around the household and rather than imprison your kids in a state of perpetual childhood and make-believe such that they hit 18 one day and suddenly don’t know how to take care of themselves, OR become a slavedriver and force them to do all the household chores for you, you could achieve a happy medium where you and the kids do household stuff together, they learn important life lessons and they get to be with you. (My stepmom didn’t exactly reach that happy medium, but once in a while she came close.)

    Meanwhile, I don’t have much use for grocery coupons nine times out of ten because I tend to use store brands, and because most of the grocery coupons I can find anymore are for products I would never use. However, once in a while you get lucky. The other day my little girl’s dad and I were at Kroger and he looked through the nutritional supplements to see if he could find liquid or chewable B-complex vitamins. Turned out the Sundown vitamins were buy one, get one free. On top of that there was a coupon dispenser offering coupons for a dollar off a Sundown vitamin product. Score!

  12. Emily | March 19th, 2008 at 5:34 pm

    I think you left off a third group. Those that clip the coupons and use them when the product is on sale.

    Those that will never pay for toothpaste, shampoo, toothbrushes and bar soap. I could rattle off a list of food I don’t pay for as well.

    I’d call ‘em the “smart shopppers.”

    For instance the sundown coupon. In the Sunday paper the value is 3.00 off, the coupon on the shelf was 1.00 off. I’d clip a coupon and save an extra 2.00.

  13. Lily | March 19th, 2008 at 9:28 pm

    Dana - I’m not saying everyone has to choose between kids or coupons. I’m saying that for some people, those are the two mutually exclusive alternatives. For all people, either coupons make sense or they don’t - for whatever reason. To you, it sounds like coupons aren’t worth your time because you don’t buy the products they discount. That’s fine; the manufacturers don’t need to separate you from the Frugals or the Spenders because you weren’t going to buy their products anyway.

    Emily - I didn’t leave that group off. I’m only speaking from a manufacturer’s perspective. They don’t necessarily control when stores put goods on sale. They can only price discriminate based on what they can control - the coupons. Either a consumer uses a coupon (whether in conjunction with a sale or not), or that consumer doesn’t use the coupon.

    ~ * ~ * ~ * ~ * ~

    I want to thank everyone for stopping by and for sharing your opinions. It sounds like there are several staunch defenders of coupons. But my original point in writing this article is to simply explain coupons from the manufacturer’s perspective, and how it helps manufacturers make more money.

    I don’t necessarily think coupon users are “smart shoppers” or time wasters. I don’t think those who don’t use coupons are dumb shoppers or are doing great things with their extra time, either.

    Manufacturers don’t care if you cure cancer in the time you don’t spend clipping coupons, or if you eat a gallon of ice cream in that time. They also don’t care if you couple coupons (say that 3 times fast!) with your grocery store’s sales, since the grocery store has already paid them full price for the goods.

    So I say, if you’re a Frugal, clip coupons. If you’re a Super Frugal, clip coupons and use them with sales. If you’re a Spender, do with your free time what you want to do. To each his or her own - and that’s how we all get what we believe is our best value, and the manufacturers do too.

  14. Emily | March 20th, 2008 at 2:47 am

    Manufacturers offer low buy prices for a short period of time. Forcing stores to act quickly and offer sales for specific items. This comes from my experience working at a large grocer. One that hit recently across five different stores in my area was Peter Pan peanut butter.

    Peter Pan peanut butter put out a coupon for 1.00 off. Walmart, Super Target, Randall’s (Safeway), HEB (TX store), and Kroger each had it on sale for one dollar! Each store had the sale before the coupon expired. Peter Pan no doubt offered an extremely low buy price for a short time. It happened across the country.

    Dannon yogurt has also done this when they came out with a new product. They even had their vendors put coupons on the products, that made them free!

    When I see a coupon I know eventually that product will go on sale. I know this from one year of clipping coupons.

    An individual no longer has search every store for a good deal. Just join a coupon group, they will share the deals they’ve found.

    You can print coupons at home. Just do a search for a certain product before you go shopping. If your shopping at Super Target check out the computer kiosks and print coupons in the store. Some stores loyalty/club cards allow the customer to add coupons to their card. It takes five minutes to sign up and click the box to add them to your card.

    Currently price discrimination occurs with loyalty/club cards. I think that’s what needs exposure.

  15. Lily | March 20th, 2008 at 6:52 am

    I guess I don’t see that in my area because there are no major chain grocers in my neighborhood. But the loyalty card is a good point.

  16. Heidi | March 20th, 2008 at 11:29 am

    Frugals wouldn’t buy the toothpaste unless they can shave 50 cents off the price.

    I must be a Super!Frugal then, since I buy the same tube of toothpaste from the Dollar Tree and pay $1.08 for it, instead of going to WalMart and pay $4 or $5 for it (it’s NAME BRAND, too! If the Dollar Tree can sell NAME BRAND! toothpaste for a dollar, I certainly don’t see why WalMart can’t. It’s not as if they aren’t buying the tubes for like 40¢ anyways!).

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