When I first came to Spain, in 2004, it was a cheap country by most standards. In some ways, it still is, but one of the most notable shifts over the past 5+ years has been a dramatic rise in the cost of eating out. I remember visiting a bodega restaurant in Valdevimbre, Leon in 2006. The bodegas in Valdevimbre are famous all over the province – good, rustic, home cooked food served in unique caves carved into the hillside. And they used to be great value for money too. We paid €26 for lunch for three of us, including a whole tortilla guisada (stewed Spanish omelette), grilled wild mushrooms, lamb chops, bread, wine, desserts and coffees. I remember being so struck by the price that I kept the receipt to show people.
Consumer surplus is one of those useful little concepts you learn about in elementary economics that, once understood, sheds light on all manner of commercial activities and pricing decisions.
Without getting too technical, it’s the area under the demand curve and above the market price, as illustrated in red in the above diagram. The traditional notion in economics is that demand starts low when price is high (red line, start at the top left) and increases as price comes down (follow the red line as it falls to the right). What that suggests is that even at the highest price, at least one person is willing to buy it. But as we know, goods are sold at the market (or equilibrium) price where demand equals supply (also shown on the diagram), which means that the one person who was willing to pay top dollar, and all the people who were willing to pay at least something above market price, have got themselves a bargain, right? That quantity of money (all the people who were willing to pay more multiplied by the amount extra they were willing to pay) is the consumer surplus.
To an individual company, exploiting the consumer surplus means trying to charge each consumer just, and no less than, what they are willing to pay, which is notoriously difficult. Astute traders have known this for centuries and exploit the consumer surplus essentially by letting you haggle. Starting with a high price, a good commercial bargainer will quickly ascertain how much you are able or willing to pay for an item and try to sell it for you for just that. Sell high to the people who can afford it, and sell low to the people who can’t. Student discounts do exactly the same. Companies know that students have less money to spend, so they sell them exactly the same products at a cheaper price. This is not some seedy tactic – it’s going on in most of the shops in your local shopping centre. Fair? Probably not. Commercially effective? Definitely.
Once you grasp this concept, you’ll begin to see it all over the place. Another of the tactics that companies use is to repackage the same (or very similar) product in some way so as to be able to sell it at different price points to consumers. At your local supermarket, there are probably 3 or 4 different types of baked beans, or tinned tomatoes, ranging from the shop’s own brand, to some sort of gourmet brand in black packaging with gold writing. Do you really think there is much difference in these products apart from the salt content and/or 2 cents worth of oregano or some other ‘gourmet’ ingredient. No. They do this so that people who can afford to pay 3 times the entry level price will. And they’ll feel good about it too. I think Apple do this with iPads and iPhones. Does it really cost them anything significant to go from 16 GB to 64 GB? Probably very little. But the products are priced hundreds of Dollars apart. Why? So there are options for consumers who can only afford entry level units, and there are options for consumers with money to burn. Classic consumer surplus.
Anyway, why the hell am I rambling on about this on a Friday morning when I should be doing something more productive? Well, Jessi ordered some stuff online yesterday, which arrived today. We had a little theory about this order related to the concept of consumer surplus which proved, I think, to be correct. Let me explain.
Stradivarious (at least in this context) is a clothing brand with a chain of stores and an online shop. Jessi ordered some clothes yesterday (Thursday). Since she spent more than 60 Euro, she qualified for free delivery. When she got to the checkout, there were two delivery options: the ‘standard’ (free) one, which was quoted as taking 2-3 days, and the ‘express’ option for 6.99, which was next day. Since we operate an e-commerce business ourselves, we were pretty confident in thinking that mainstream national couriers, like MRW used by Stradivarious, do not offer anything other than an overnight service. It wouldn’t make sense. Since their infrastructure and procedures are built around getting a parcel from A to B in less than 24 hours, they’d probably have to work even harder to make it take longer. No, I suspected that what Stradivarious were doing here was exploiting the consumer surplus. Of course there will be customers who are very keen to have their stuff the next day, and will be willing to pay an extra 6.99 for the privilege. But then there will also be customers who balk at paying delivery charges. Great pricing tactic, no?
We tested the theory – Jessi chose the free delivery option. Sure enough, at 9am this morning the courier turned up with the parcel, clearly labelled as having been sent on an overnight service.
So let this be a lesson. To e-consumers – watch out for this tactic. I’m not sure how widespread this particular trick is, so keep an eye out for premium delivery service charges that don’t seem to add up. And to online sellers – depending on your degree of morality, perhaps this would be a good pricing tactic for you to milk a little more out of your customers. We won’t be doing it though.
If you managed to get past the title of this post and are still here then this article could potentially be of great help to you. If you’re bemused by the title but have stuck around thinking this might be an entertaining read, leave now – you are horribly mistaken.
“Avoid generalisations” – that’s what were taught from the very beginning. If you generalise, you’re either racist, sexist, ageist, appearancist, intellectualist or some combination of the many other undesirable ‘ists’ with which we’d rather avoid being labelled. As any serial generaliser already knows, ’sweeping generalisations’ most often get swatted down with a “you can’t say that”.Technically, you can say anything you want, so what’s really meant by “you can’t say that” is more like “you can’t conclude that”, or in a slightly more mathematical-socialogical way: “you can’t extrapolate the characteristics of one individual to an entire population or subset thereof”.
Whilst generalisation is one of those crimes of reasoning, logic or simply attitude with which we all get familiar from a young age, its opposite concept, specialisation or particularisation, is most often overlooked and it’s something we’re all guilty of to a greater or lesser extent.
Specialisation, for our purposes, means extending the perceived characteristics of a group to oneself. The consequences of deciding that a certain rule applies to you because you have observed it or heard that it applies ‘in general’ can lead to, at best, errors in decision making, and at worst, personal catastrophe. And it’s something I see happening more and more around me. People say things like:
- Now is a good time to buy, but if I wait for the housing market to drop even further, I’ll get a better bargain.
- Populations with high levels of fat consumption in their diets tend to exhibit high levels of obesity. Fat consumption makes you fat, so I’ll go on a low fat diet.
- The economy is bad at the moment, I’ll wait to sell my business.
- I can’t afford to go out and eat, this country is in the middle of a financial crisis you know!
Last year, I was looking around for a small flat to buy in order to make a smart financial investment for the future. The housing market in Spain has fallen massively since its peak in 2007 and there were some very good value potential purchases out there. Yet I argued almost weekly with my father-in-law. “The market still hasn’t hit the bottom yet, you should wait more,” he’d say. “Prices are predicted to fall another 10% within the next 12 months – if you wait you’ll get a better bargain”.
Here’s the thing though. I don’t care whether the housing market drops another 10% or rises 15%. These percentages are averages of millions of properties up and down the country. I wasn’t planning on buying the whole available housing stock of Spain, or even a statistically significant representative sample of it. I was looking for one flat. I only needed to find one emergency sale, conduct one successful negotiation, or find one isolated anomaly and I would have my bargain. It wouldn’t matter if the price of housing were to drop 10% in the 6 months after my purchase – as long as I could get the flat under value I would have done well.
Don’t get me wrong, finding a bargain is significantly easier in a buyer’s market, but concluding that a general 10% fall in house prices will mean you can get the house you are interested in for 10% less is a mistake is a fallacy of specialisation.
Of course there are markets with such low variance in the value of transactions that the general is a perfect indicator of the specific. If I want to sell some shares and their price is 10% lower this month, then to a very tight degree of accuracy, I’ll get 10% less for them. If I partake in a fund that invests in a basket of shares and suddenly 50% is knocked off the value of the stock exchange, then I just lost about 50% of my money.
But even if the stock market falls 50%, somebody always comes out winning. Why? Because the headline statistic is always just an average. And averages are made up of a lot of stuff in the middle that follows the trend pretty closely, and then a few outliers that do crazy stuff. In the stock market example, there were probably a load of stocks that fell by about 50% along with a few that fell by much more and a few that actually rose.
Therefore, your task is to be on the positive side of average. To rise when everything else falls.
The current employment situation in Spain is bleak and has been for a long while. Youth unemployment is up somewhere around 50%.
What does that actually mean? Well, on average, across the whole country, only half of the young people eligible for work are actually in work. That’s the general picture, and it’s a genuine tragedy for the current ‘lost generation’. But that’s just the group perspective. If I am a young person looking for a job, what should I read into this static which is trumpeted loudly on the news almost every single day on national television? Should I assume that I have only a 50% chance of getting a job? Should I assume that I will have to wait 50% longer to find a job? That I will earn 50% less?
I’ve heard all of these conclusions.
The truth is that these statistics are almost irrelevant to any one individual. Yes, we should worry about them from a point of view of social consciousness and group economic prosperity. But to an individual, averages are just that, averages, and any individual has the ability to buck any trend with relative ease. You are one in ten million, a hundred million, 2 billion, do you think that the statistical world will implode because you have managed to find a flat for 20% less than its value, or find a job when 50% of your competitors can’t, or lose 10Kg on a high fat diet when the general advice is that high-fat diets make you, well, fat?
Did you know you have a 1 in 119 chance of dying by suicide? Damn, better be careful then. Or perhaps just don’t commit suicide.
Let this be our little secret. You are you, and that’s it. You are not representative of the average. The general does not apply to you. Be wary of generalisation, but be even more wary of specialisation. When the news tells you that taxes, divorce rates and the cost of of living have gone up, that educational standards, living standards and life expectancy have gone down, and that we’re in for a rubbish summer, turn off the TV and say “I don’t care – this year I will be richer, happier, smarter and healthier than ever”, and go out and do something to make that happen.
If you’re running a small business selling goods to other small businesses, the chances are you’re giving credit. There’s also quite a good chance, especially, I would guess, if you’re a ‘family’ type business, that there’s a bit of ‘give’ in your credit policy. You know what I’m talking about. Supplying customers with too many open invoices, or too much balance in excess of their agreed limit. Perhaps you do it because you understand their predicament, perhaps you’re too weak to say ‘No’, or perhaps you’ll think they’ll stop buying from you if you don’t keep extending them credit. The truth is that they very well might stop buying from you. And the problem is that the reason behind their decision probably won’t be financial, it’ll probably be personal. In my experience, the worst thing about giving customers credit is not the endlessly mounting Accounts Receivable ledger, it’s the fact that it almost always ends in tears.
Customers Don’t Like to be Told ‘No’. They take it personally.
Even with the best intentions and the most regularly paying customers, you’ll almost certainly get into the territory of having to make uncomfortable decisions about extending credit. Perhaps in very large corporations it might be possible, out of sheer bureaucratic indifference, to stick to a hard-and-fast credit policy, but I doubt there are many small businesses who can just say “Sorry £500 is the limit”. We all know the phone call: a trade customer right on the upper edge of his credit limit who is just desperate for a delivery and who will pay you first thing on Monday morning – promise. How can you say ‘No’? And what kind of person will you look like if you say ‘No’? All the credit control manuals and “How to Run a Small Business” books say that you should absolutely refuse and that your customer will understand and respect you for it. Sorry, but that’s bullshit. Your customer will absolutely not understand and will absolutely take it personally, since as the business owner, the decision is entirely yours. They may well decide not to bother buying from you any more and you know that. You’re treading on thin ice now. How do you know when to say ‘No’? Truth is, you don’t. You just use your best judgment and sweat it out at night while you lose sleep over who owes you money. Wouldn’t it have been better to never get into this situation? When this customer approached you three years ago and asked “Hey, do you mind if I pay you after delivery? I’ll pay you the very next day and it’ll never be more than £100”. Maybe you should have just politely said “Sorry, we don’t do that”. End of story.
Customers Don’t Like to be Credit Chased. They take it personally.
Then there’s the monthly call – the one you dread making. How many times have you heard these common excuses?
- “The person that deals with the payments is on/has been on holiday”
- “I’m sorry, it’s just been so busy over the last couple of weeks, I’ll pay you tomorrow”
- “Can you just give me a little more time, we’re really slow at the moment”
- “Really sorry about that, I’ve been in hospital recently”
What type of heartless bastard doesn’t accept those excuses? But what happens after the third or fourth month running without payment and the continual stream of excuses. Do you insist? Do you get angry? Do you make threats? Well I’m sorry to say that once you’re into that territory, this customer is gone. Finito. And it’s not because he doesn’t want to pay you. No, it’s because of your disgusting aggressive attitude towards credit chasing. He, after all, knows that he’s a decent, honest guy with full the full intention of paying you straight away, so why are you harassing him? It’s only been, like, 4 months and you should know he’s been closed for a month while he was in Tenerife and his girlfriend’s mum’s sister’s had chicken pox. Didn’t you know that?
Wouldn’t it have been better to say ‘No’ 12 months ago when he asked you if you wouldn’t mind just making an exception this once because he didn’t have his card to hand?
Customers Can’t Organise Their Accounts Payable. You’ll Have a Disagreement. They’ll Take it Personally.
This is the one that gets me most and I have to say, it’s probably the most common one too. When customers pay up front, there are exactly zero administrative complications. An invoice is raised and paid in the exact same precise second, their account balance is always zero and their statement is a nice, shiny blank A4 piece of paper.
When credit starts, all that goes out of the window, and if your customers are anything like mine (restaurants), they will have their brother Tony doing the paperwork at the bar at 1am and will be leaving you voicemails (at 1.30am) saying things like
Hi Jon, it’s Brian here from the Turkey & Mongoose. We’ve just received your statement which says we owe £1350.96, but according to our records we only owe you £2.50. Of course, the chef is a woodpecker and eats most of the invoices, so we might have missed the odd one here and there and oh, I found one down the back of the cooker the other day but it was covered in pickle sauce so the accountant wouldn’t accept it. Would you mind sending us a copy of every invoice since 1998. Of course, seeing as all this is in fact your fault, we won’t be paying you for another month. Please let me know if you disagree with any of this.
Wouldn’t it have been easier….