Take a look at the popcorn prices in the photograph below.
As you can see there are significant volume discounts. The smallest size is $5.69, the next size up costs fifty cents more and the largest size an additional fifty cents. What you can’t see in this picture is that with the largest pack size you also get a free refill.
To get the full picture though we needed to know the actual pack sizes. We found that information on the website belonging to the movie theater chain. Using that information we can see the unit costs are as follows:
|Price per Cup
*The actual package size of the large is 20 cups but with the free refill you get double that.
If we were to chart the prices it would look like this:
At the smallest size we pay $0.81 per cup. Spend just $1.00 more for the largest size and our cost drops to $0.17 a cup – a discount of 79%! It is the most extreme example of volume discounting I can recall seeing.
The first reaction is usually “Well of course they can discount like that! The popcorn costs them almost nothing and their margins are huge!”.
Very true. The margins on movie theater popcorn are the kind most of us can only dream about and they do allow the exhibitors to discount in this extreme way.
Another important factor is that the product is extremely perishable. We can’t stockpile it – I can’t buy a large and save half for my next trip to the movies. It means that the exhibitor is not cannibalizing future high margin sales on return visits to the theater.
But that’s really the how they can afford to do it. And how isn’t the same as why. Smart operators don’t just do things because they can.
After all regardless of how extravagant the margins might be nobody wants to give away margin unless they have to. The same cost plus formula that instructs a vendor to charge $5.69 for the 7 cup small size would also tell them to charge about $11.38 for the 14 cup medium size, less a small discount reflecting the lower cost of a single container and a traditional volume discount. The cost plus vendor would probably settle on $10.99, maybe $9.99 if they were going to be really aggressive. Why give up any more?
But the movie exhibitor, who seems to be doing quite well, is choosing to slash prices on larger packages of popcorn. Why?
Let’s start by looking at the high initial cost. The price of the first seven cups is outrageously high, but there in the movie theatre, we associate popcorn with the experience, plus we can hear it popping and smell the melted butter. Our desire is strong and our options limited. It might be possible to sneak in a bag of fresh, warm, buttered popcorn but it wouldn’t be easy. For most people the concession stand is our only option. The exhibitor knows that and prices accordingly.
But, like many products, popcorn offers diminishing marginal utility, which in this case means that each handful is a little bit less rewarding (less utility) than the last. That first bit of popcorn... that is the one we really crave. The next few are good. After that, for most of us, enjoyment tapers off pretty quickly.
And because we enjoy each additional handful of popcorn less we value it less. It simply isn’t worth as much to us. We might be prepared to begrudgingly pay exorbitant prices for the popcorn we’re really going to enjoy, but we aren’t going to pay the same prices for additional popcorn we know we are going to enjoy less.
If you were to chart popcorn enjoyment by volume consumed it would probably look something like this:
The people selling the popcorn know this and they have to make a decision. They can stubbornly stick to their cost plus formula, insisting that they deserve those margins and won’t give them up.
Or, they can maximize profit by increasing consumption by aligning the price of additional units with the value people place on them. They’ll make less on each additional unit but they will also sell a lot more of them.
It makes perfect sense. You are in the theater, standing at the snack counter, ready to spend money. The vendor has no idea if or when that will happen again. All they know is that they want to get as much of your money as they can and, understanding the diminishing marginal utility their product provides, they are prepared to work with you a little.
This pricing structure also helps the vendor by putting the most profitable size (large) in the most favorable light and making it look more attractive. We often assign value to things by comparing them to other similar things. It’s hard to assign an absolute value to movie theater popcorn (on one hand it seems like a gouge, on the other it is the only available option) so, instead, we try to come up with an apples-to-apples comparison: small vs medium vs large.
In that light the large seems like the greatest deal ever. The small? Seven cups of popcorn for $5.69? It feels like a total ripoff and I’m outraged. I would never pay it, even though it is about as much popcorn as I could really enjoy. I’d rather have no popcorn than pay that much.
But the large? 40 cups for just one dollar more? Almost six times more popcorn for less than 20% more money? A savings of almost 80%? In comparison that seems like a great deal. It’s still expensive in real terms, it’s more than I can eat, certainly more than I can enjoy, but, in comparison... what a deal!
You probably don’t have the kind of margins that allow you to discount this aggressively. But, if you have a product that offers diminishing marginal utility, can you discount a little to try and get your prices inline with the value your client places on the product?