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.