Why Popcorn Costs So Much At the Movies? And all about Theatre Economics

I recently visited my neighborhood theatre for the latest Blockbuster. I paid $8 for a ticket and headed towards the concession counter. The friendly staff quoted me these prices and I quickly grabbed a combo and walked in

Popcorn (M) - $6
Popcorn Coke Combo - $8
Coke (S, M, L) - $1.8, $2.5, $2.8

As an economist, prices have always fascinated me. After the movie, I asked some friends what they though about these exorbitant prices at the cinemas. Their response was quite unanimous. Monopoly and lack of competition resulting in insanely high profit margins. Since, customers have no choice once they walk in a theatre, they are forced to buy popcorn and cola at whatever prices the theaters charge.

But is that all? Are the cinemas really exploiting customers? What's the real economic intuition behind high popcorn prices? 

A Theatre's revenue is driven by 3 main sources- Movie Tickets, Concessions and Advertisers. Revenue generated from tickets have to be shared (in an predefined revshare split) with the movie studios. With movies becoming increasingly expensive to make, and add to it the operational expenses and cost of maintenance etc, the margins for theaters on the reasonably priced ticket sales alone is quite insignificant.

To stay profitable, more and more theaters are opting to show Commercial Advertisements before start of the movie. However, these ads compete for airtime with the studio ads (movie trailers), which traditionally have always been free and encourages repeat viewers to the theaters for new movies.

Now let's focus on concessions, the expensive popcorn, cola, etc. which in most cases have profit margins as high as 900%. This profitable price discrimination strategy is also know as "Metering Price Discrimination", where the theaters shift their margins from tickets (primary product) to concessions (secondary product), to incentivize the marginal customer (the undecided viewer) thereby increasing the movie attendance. It is a really efficient pricing strategy since the loss of consumer surplus from high prices on concessions is offset by the immense gain in surplus from increasing viewership. Had the tickets been more expensive less people would have got a chance to watch a great movie.

Implicitly, prices reflect the consumer's willingness to pay for a good. If there are people still buying popcorn at movies, it signals their high perceived value for the popcorn be it just as a means of satisfying hunger or enhancing their movie experience.

Hartmann and Gil presented these findings in their paper titled “Why Does Popcorn Cost So Much at the Movies? An Empirical Analysis of Metering Price Discrimination.” 
Concessions were found to be purchased in greater amounts by customers that place greater value on attending the theatre. The benefit to the general consumer is that the price for the primary product, the ticket, remains relatively low.

I have often cribbed about the expensive popcorn but on the hindsight, cheaper tickets and an option to not get the popcorn next time, is more favorable versus high ticket prices. Eventually, everyone wins, theaters remain profitable, Society enjoys high consumer surplus and we all get to watch amazing movies at the cinemas. So what do you think?

Credit: http://www.filmjournal.com/filmjournal/content_display/columns-and-blogs/snack-corner/e3i724486204375a106d0fbded728e3de60
Image Src: http://news.everest.edu/post/2009/09/movies-on-a-budget

Why are hotel minibar prices so Exorbitant?

You must have often wondered why the can of coke, stacked in your Hotel room's minibar is priced as high as $4 when you can get one from a vending machine or the mart, right across the road for a buck. What justifies this high markup on the hotel minibar items?

If you guessed the hotel is exploiting the price you are willing to pay for the convenience, you are not entirely wrong.

This is what I think.
The vending machine or the mart sell in high volumes and can take advantage of the efficiencies of scale and specialization, enabling them to price the can a lot lower. This could justify, say an additional dollar for the Hotel to cover the cost of selling the can, in order to recover it's fixed and variable costs. But why $4 and not $2?

Hoteling is an expensive Business to run. It has a high fixed cost which has to be incurred irrespective of the number of occupants. Land, Building Cleanliness, maintenance, utilities, floor staff etc. Marginal cost for each new guest is relatively low. Thus ideally they need high occupancy rates to recover their sunk costs.

Hoteling Business is quite competitive (in most places) and to achieve higher occupancy rates, hotels are under pressure to offer competitive prices. The additional markup is a neat mechanism for the hotel to target discounts to price sensitive customers.

Many hotels provide discounted rates to Internet bookings, which is consistent with evidence that Internet users are more price sensitive and have lower search cost due to readily available information to compare and contrast.

Due to this competition, hotels do not enjoy high profit margins by renting out rooms. Since they have to charge uniform prices, and in order to offer higher discounts (and stay competitive) , they must find a way to collect additional revenue from the less price sensitive guests.

Hotels perfectly know that offering minibar items at inflated price results in lesser takers. But they also know that guests who are less price sensitive are willing to forego the high prices for the added convenience. Hotels can use this surplus (in form of additional revenue) to offer deeper discounts to an average guest.

Now imagine a hypothetical case where Hotels can perfectly discriminate room prices based on your willingness to pay. That is, if each guest pays a different price for the same room, you wouldn't see an inflated minibar since the Hotel has already extracted all the Consumer surplus.

Since the above is really hard to implement, a common price discrimination tool is to offer tiers of hotel rooms- Standard, Deluxe, Royal Suite etc, each clearly differentiated and targeted. Surplus from the more expensive suits can be used to subsidize the lower tiers, ensuring higher occupancy rates.

This is similar to airlines pricing economy and Business class seats.

The hotel minibar problem is yet another really interesting problem where the Consumer behavior affects the way the Supplier prices his goods, with an intention of at least breaking even amidst intense market competition.

So, what do you think about the Hotel Minibars. Please leave your comments.
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Art of Bargaining

I find bargaining with street peddlers and merchants highly challenging. My mom on an average can haggle 30% lower than my very best effort.
Interestingly, I am far more educated and professionally qualified than my mom. And I am often called upon at work to analyse multi-million dollar procurement deals and help them negotiate the best possible price.

Bargaining is an art and as I try to understand this failure of mine and the uncanny success of my mom, it is an interesting problem nevertheless.

Let's assume I am walking on a narrow stretch in South Delhi in my home country India when suddenly my eyes fall upon the most beautiful scarf. It's bright orange with beautiful hand crafted glass pickings. I know I have to get one and gift it to a certain someone. So I ask the merchant, how much is one, and he immediately replies " 500 Rupees Sir" (~11 USD).

Obviously my gut feel says it shouldn't be more than 100, so I reply back in our local language "Bhaiya hum to yehin ke hain. Sau rupai le leejiye. Usse zyada nahin ( Brother, I am from here. I am not paying more than 100) ". Our discussion continues and 5 mins later, we seal it at 150. I return home satisfied with a neat 70% reduction from his initial quoted price, but before I can celebrate, my mom returns with two such scarves at 80 Rupees each.

Amazing right. To deduce the above, I follow my mom, the next time to find out how she did it and construct my hypothesis. So here it is.

Defining Bargaining
Let's define two parties- A Buyer  and a Seller. Both of them have personal incentives to negotiate for the best possible price. Assuming this a niche good, and no one else in the vicinity sells exactly the same scarf, we would call the Seller a Monopolist.

This single buyer and seller situation is trickier than a competitve market, since competition can drive prices towards an equilibrium, nullifying any need for negotiation. And the goods in question are niche, non comparable items with no fixed marked price.

Perceived Value of the traded good
Compared to my mom, I value the scarf more, for it's an opportunity to impress the ladies. Imagine this pickup line, "Well, I was rushing for some urgent work when I saw this and thought how wonderful it would look on you. Hope you like it".

I would love to get the scarf (with all the other ancillary benefits) at 100Rs, but I can compromise till 150. This is my utility enhancing, perceived value of the scarf. Anything less, I would be happier. Anything more, I am better off not purchasing.
On the other hand, the only reason my mom is interested in it is a fact that long back I had told her to help me get something nice for my colleagues at work, each time I visit India. Her perceived value is my emotional gratitude to her for remembering my request. Let's not quantify mother's love by assigning a value to it.

This difference in perceived value leads to two things. Firstly, it makes me quote a higher first lowest bid (100 in my case whereas it was 50 in my mom's), after which I can only bid up. Secondly, I have a higher risk of losing the scarf if the exchange falls apart with the seller deciding not to sell, or not to quote below 150 ( my price tolerance limit). On the other hand, my mom has nothing to lose.
We economists call it a first degree price discrimination where the Seller (Monopolist) tries to ascertain our individual price tolerance, in order to extract the maximum value that each of us are willing to pay. The bargaining process is just a tool to assist him in deducing this perceived value.

Perceived Value of money
Living away from India has definitely spoilt me. For 150 Indian rupees, you can get 7 liters of milk, or 2 Big Macs (called Chicken Maharaja here) or a month of mobile talk time, or a 25 km cab trip from airport to home. Whereas for 5SGD in Singapore, I can only get 1 Big Mac or 2 cartons of milk or a 4 km cab ride from the nearest food court to home or just a small cafe latte at starbucks.

Hence, it's easier for me to part with a 100 than my mom to part with her 50, for a scarf which has a higher perceived value to me.

Uncertainty and Rational Behavior of the Seller
Economics teaches us, a rational individual will maximize his utility given certain constraints. For the seller, his utility is proportional to his profit function.
Say, he procured 100 scarves from a craftsman for 50 rupees each. Let's assume his transportation cost was 500, his other fixed costs add up to 15 more for each scarf. For him to earn profit, he must sell all of them at an average price above 70.

His range of negotiable price would be as high as he can quote to, and as low as 50 (variable cost), keeping in mind, he can sum a neat profit in the end.

But why quote 500 then, when it is a whooping 614% profit? I guess, a couple of reasons for it. Firstly, his nett investment on the 100 scarves is 7000 INR. When he starts selling, he is a bit unsure on how many he will sell. Assuming, before me, he managed to sell only one. He safely estimates if he can sell off 20 at a premium, and remaining 80 at a loss, he can still pocket a good profit.
If we do the math 7000/20= 350

Now even if he sells the remaining at 20 each, he gets 1600 which is a 23% profit.
Interestingly, he starts his quote at 500 and not 350, knowing that his customers would always bargain and try to pitch a lower price. Also, as he starts selling more scarves with profit, his confidence of recovering his investment increases, and he is more forthcoming to bargaining. Thus if you buy later, you might end up with a better price but as a tradeoff you have lesser colors to chose from, since all the better ones have already been bought with a slight premium.

The starting quoted price (500 in this case) is also a function of the economic condition of the society. In a relatively poor society like in India, sellers will often try to cheat the more affluent customers who find it hard to guage the true value of the commodity. It is also a lot easier for the seller to price discriminate based on the appearance and personality of each buyer. Were all buyers alike, it would have made the Seller's job a lot harder.

Also, merchants are often required to bribe their local authorities and mobs to do a hassle free trade. This corruption increases their fixed cost. And now add to it the customer's higher percieved value of the good and their lower percieved value of money. This results in merchants often quoting a lot more to rich or new buyers. Foreigners are privy to such unfair experience. 

Based on the above discussion, there is a reason why my mom is more successful in this ancient art of haggling. So words of wisdom, the next time you shop, don't forget to bring your mom along. Happy shopping!

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