Sunday, July 22, 2012

Incentives to Cosumption, Disincentives to Consumption

When marketers want to move product, they will eventually break down and offer you a straight deal.

During the dark days of the recession, in 2008, the big-3 car companies were on the verge of, or actually going bankrupt.   And everyone was scared and no one was buying anything.  So, the car companies did something totally radical.

They actually offered cars for sale at a fixed, low price.

Shocking, isn't it?  I mean, who does that sort of thing in this day and age?   No, no!  If you want to move iron, you offer "free gas" or a "loaner for life" or free oil changes or whatever.   Actually just offering a simple, no-frills deal with direct and transparent pricing?  What are you, a fucking Communist?

GM offered consumers its "Class A" employee discount, back in 2008.  This was the pricing I paid when I worked for GM.    It was simple, and direct, without too much in the way of gimcracks and doo-dads added on.

Since then, however, the economy has recovered somewhat.  The DOW went from 7,000 to nearly 13,000 and people started to relax.  And many folks, who had been hanging on to older cars (even through "cash for clunkers") decided that today was the time to buy.

But of course, this is 2012, not 2008, and in four years, much has changed.  Employee pricing evaporated like water on the road after a Summer rain storm in Georgia.  Today, such simple and direct pricing is nowhere to be found.

And we are back to the good-old-days of Truck Month, and Toyotathon, cash-back gimmicks, free gas, and of course, 0% financing and "rebates".

Of course, buying a brand-new car is never a very astute deal.  Even during the days of "Employee Pricing" a late-model used car could be had for less (why would anyone pay more for used?  That is one problem with severe price cuts - they cut used car prices as well, making it harder for automakers to unload the turns-ins at the end of a lease).

No, that is not the point of this posting.   What is the point is how pricing - which in this day and age is so obfuscated as to be ridiculous - can vary, based on the desire of a merchant to encourage consumption and to discourage it.

In 2008, they were in a situation no merchant wants to be in - desperate to sell product.   Merchants make money when people come in, ready and willing to buy, and you can then dictate prices and terms to them.   When people don't want to buy, you have to go to them, and you've lost all leverage you have in the transaction, at that point.

No car salesman every wants to be in that situation, to be sure!

Today, however, car sales are brisk.  Thanks to the tsunami shortage of Japanese cars, as well as the downsizing of production at the big-3, car supply is finally in tune with car demand, if not slightly behind.   So gone are "employee pricing" deals, and even 0% financing is giving way to 2.9% financing.   $5000 rebates have melted to $2500 rebates.  And car companies are again pushing leasing.

They can afford to offer these disincentives to consumption as people are more desperate to buy.   And disincentives, they are.   These new deals are not transparent, direct, or simple.  The complicate pricing and make it harder to buy and harder to even understand how much you've paid - or whether it was a fair amount.

The more popular a product, and the more it is in demand, the more disincentives they can offer.  And the more you are willing to jump through these hoops, the more they know they 'have you' in terms of a sucker on the line.   Once they have you emotionally committed to buying a product, you have lost all negotiating power in the transaction.

Now, this may seem ironic to some, who believe the media and the pundits (and the political hacks) that our economy is in the tank because we have a staggering 8.6% unemployment rate (which is about 2% higher than our normal historical rates - so I guess we'd better panic, right?).  After all, with "so many people unemployed" you would think merchants would be offering better deals, right?

Well, merchants don't look at unemployment figures when pricing their smart phones or new cars.  They look at the people banging on the showroom doors, demanding to be let in to buy the product.  And for some products, this is indeed the case.

So, to maximize profits, you create disincentives to buying.  This allows you to up the price and sell less product at a higher profit margin.

In a way, it is like the cover-charge and the velvet rope at bars.   Believe it or not, at one time in this country, there was no such thing at your local youth hangout.  In the Disco era, however, bar owners were noticing that people were eager to get in - and that the place filled up rapidly.   Why not charge for the privilege of entering?

And as economists have noted, sometimes when you charge more for an item, consumption actually goes up and demand rises as people perceive the item to have increased status and higher value.   So you put a velvet rope out in front of your club and make people wait to get in (or don't let them in at all) and what ends up happening is the opposite of what you'd expect.  People don't get pissed off and leave.  No, just the opposite, they line up even more, to get in.

And in a way, that was the problem with "employee pricing" in 2008 for GM.  GM was facing bankruptcy and its cars were poorly made.   The discounts and incentives offered were just a validation that their cars were not worth buying at any price.   And to some extent, this is true.   A friend of mine who is a GM fan had a bankruptcy-era car and then traded it for a post-bankruptcy model (and yes, they complain about money all the time and wonder where it all went).   The difference in quality between a 2008 Chevy and a 2012 is palpable.

But no so much a difference as to warrant the delta in pricing between now and then.

And again, this illustrates a basic fact that is lost on consumers, about prices.  Prices are based on the laws of supply-and-demand, not on the cost of manufacturing plus a "profit margin".

Many consumers really believe that the price of a good is determined by how much it cost to make, plus an added on "reasonable profit".   This is not true, except perhaps, for regulated utilities.   In the real world, pricing is whatever the market will bear.

This is why consumers bite on bait like "dealer invoice" as we are all so desperate to see what the dealer "paid" for the car - even though, of course, that he paid far less than the "invoice" price.  As the example above illustrated, the actual price of a car can be thousands less than "dealer invoice".  And yet many consumers crow over paying "$300 under invoice" for a car, as if they stole it from the dealer.

And of course, it goes without saying, that if they tried to re-sell the car right away, it would be worth far less than what they paid for it.  That is the real market value, not some pricing scheme, even "Employe Pricing".

When I worked at GM, we were allowed to buy one car every two years, using the GM "class A" discount.  Many of my co-workers would buy such cars, finance them on a "balloon note" and then drive them for two years, and then sell them for more than the balance on the note.    With a popular car, you could do this and actually make a little money, break even, or, at worst, pay very little to be driving a brand-new car every other year.

Today, this game is probably less well-played, as pricing is more transparent today than in the past.  You can go online to a number of sites and see what a "reasonable" price is for a new car (or a used one) and even arrange to buy the car via the Internet.  And the dealer profit margins have been slimmed in recent years, somewhat.

And of course, today, they are no longer offering the Employee pricing to consumers, anyway.  They can afford to offer disincentives to consumption as demand is back up again.