Pricing and waiting in line

Every time I have to stand in what seems like an exceedingly long line for something, I wonder if they’ve got the pricing wrong. If they had their economics straight, I reason, they would raise prices to an extent where the market just “clears”, and there is no need for a line.

In this context, this piece by Tyler Cowen comes in handy, where he talks about the various advantages of lines and waiting in line. Apart from some superfluous stuff such as lines making us more patient and waiting in line being less painful now thanks to smartphones, Cowen makes some very interesting points. For example,

Higher prices also skew the customer mix toward wealthier and thus older people, who exert less influence over the purchasing decisions of their peers. They are less likely to text about a concert, put it on their Facebook pages or talk up its reputation to dozens of friends at parties. The younger buyers are usually the ones who make places trendy, thus many sellers use lower prices, with lines if need be, to lure in those individuals and cultivate their loyalties.

The above passage illustrates why it is sometimes necessary to keep prices lower than the “clearing price” and let lines form (as long as you have an orderly way of dealing with the lines). Essentially, by raising price until a point where the market just clears, you are optimising the revenues for that particular day or point in time.

However, if you are a “going concern”, as all businesses are normally assumed to be, you don’t optimise for revenues or profits on a particular day. What you optimise for is long-term sustainable profit, and you do what it takes in order to maximise that.

As Cowen says above, by keeping prices lower than clearing price, you draw crowds that are likely to talk about the experience of your offering, thus giving you free advertising. As the “flash sales” conducted by Xiaomi (where phones sold out in a few seconds after sales opened) show, lines can end up being reported in the press which creates free publicity for you – leading to greater future sales.

Then there is (Cowen touches upon this) the signalling effect of the line itself – that so many people are waiting in line for something signals that there’s something inherently worthy about the product, and results in increasing demand (and more people in the line!). The line is an act of discovery – you may not go to a food card if you didn’t see the line in front of it.

There is also the issue of price elasticity – beyond certain levels, prices can be extremely elastic, in that if you raise prices at a particular margin, demand drops significantly (this has to do with “price barriers” in people’s minds – possibly a behavioural issue). So it becomes impossible for you to set the price at the precise level where your establishment just fills up. So you have a choice between not filling up your capacity or getting people to stand in line. And the latter is more profitable.

The lesson from this is that you should think long term when you are analysing pricing decisions, and not optimise for maximising instantaneous profits! Read the full piece by Cowen. It’s well worth it.

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