Posted by John Irons at November 03, 1999 02:39 PM

This past weekend the news wires were all buzzing about the latest idea to come from the world of soft drinks. Coca-Cola is apparently considering creating a new kind of vending machine that would test the outside temperature and adjust the price of a can of soda upwards when it is warmer outside.

Here's some of the typical reactions to the idea:

"a cynical ploy to exploit the thirst of faithful customers" (San Francisco Chronicle)
"lunk-headed idea", (Honolulu Star-Bulletin)
"Soda jerks" (Miami Herald)
"latest evidence that the world is going to hell in a handbasket" (Philadelphia Inquirer)
"ticks me off" (Edmonton Sun)

What did they think the Coca-Cola company was doing anyway? Selflessly providing the world with a glorious beverage to further the goals of all mankind? Why should all these people be suddenly offended by a company trying to maximize profits?

"Price discrimination" is the term economists use to describe the practice of selling the same good to different groups of buyers at different prices. In the Coke case, the groups of buyers are segmented by the outside temperature (i.e. Jill when it is hot outside vs. Jill when it is cold). If possible, a company would like to charge a high price to those who place a high value on the good, while charging less to those that do not.

So, are you personally offended by Coke's plan to charge more for soda's when it is warm outside? Well, you had better get over it pretty quickly, there is already plenty of price discrimination out there, and there is MUCH more to come.

Rampant Price Discrimination

Price discrimination is quite common. Ever wonder why hardcover books are produced first and are so much more expensive than paperback books? Or, why it is so much cheaper to buy airline tickets far in advanced? Or, why there are student discounts? Or, why matinee prices are cheaper for movies? Ever tried to buy a soda from a vending machine at a hotel or at a movie theater?

All these examples are attempts by sellers to charge different people different prices for the same good.

Much of the price discrimination in the economy may in fact be quite hidden. How do you know that the Crate and Barrel catalogue you just received has the same price for you as for someone living in another zip code? Perhaps those with a 90210 zip code see higher prices on their catalogues.

Why is the Vending Machine different?

In principle, the temperature sensitive vending machine is no different from any other form of price discrimination.

Although, I do think the idea that the process is automatic generates some additional discomfort - it is the idea that technology can effectively gauge our buying interests. The heat sensitive machine is a small step toward applying machine "intelligence" to profit maximization.

If you think that the vending machine idea is worrisome, just wait - the internet will be the most sophisticated price discriminator the world has ever seen. Smart vending machines will be the least of your worries. Online vendors such as Amazon.com may know quite a lot about you - your past purchasing habits, your internet preferences, your zip code, etc,  - and they may want to use this information to adjust prices. Did you buy a Stephen King book last month? Maybe you'd like to buy another, more expensive, Grisham novel this month with a smaller "discount" chosen just for you.

The internet is much better than the "real world" at price discrimination, because it is so much easier to change prices. In fact they can set a price just for you. It's hard to imagine a traditional store doing this ("Hey, here comes John. Quick, raise the price of the new Krugman Book."). But for an on-line e-commerce store, this is feasible and, with a clever programmer on the payroll, quite easy.

Not all bad: Discrimination means increased efficiency

Actually, price discrimination can actually increase the overall efficiency of a market.

A loss of economic efficiency may occur when a company has some abililty to set prices and there is no discrimination. The seller must pick a price that balances their desire to charge a high price to those that really want a product, with their desire to sell a higher overall quantity to those that are not willing to pay very much for it. Because of this, there are trades which would benefit both buyer and seller that do not happen - the resulting price is "too high" and the total quantity traded is "too low".

By identifying individual groups of consumers, a seller can provide an additional unit at a lower price to someone who before would have been priced out of the market. The company would now be willing to do this since they would not have to sacrifice profits by lowering prices for the high-demand group.

In the Coke case, some consumers - those who drink Cokes on hot days - will be worse off since they must pay a higher price, while some consumers - those who drink Coke on cold days - will be better off since they will receive a lower price. The Coca-Cola company, of course, will be better off.  The sum total will be positive (pick your favorite Introduction to Economics textbook to see why).

Would you really be as offended if it was described as a discount on cold days?

So, if you are still stewing about the potential of higher Coke prices, I suggest you stock up the refrigerator and put some of that retirement money into Coca-Cola stock.

Comments? Is Coke evil? Post in the Forum.
More Features

More Links
Veja, a Brazilian magazine initially got the ball rolling when it published details of the new machine from an interview given by Doug Ivester, Coke's chairman. Here is a sampling of the stories and commentary that followed.

Coke's Automatic Price Gouging
Have a Coke, and Big Brother is sure to smile
The Irish Times - Coke's chilling concept
Coke: It’s the real (greed) thing
Miami Herald: `Soda jerks:' Coke tests machine that raises prices in hot weather
Toronto Star: News Story: Some like it hot at Coca-Cola - October 29, 1999
Edmonton Sun - Greg gets peeved

Posted by John Irons at November 03, 1999 02:39 PM