Rafi Mohammed

Holiday Turkeys, Correlated Product Demand, and Chinatown Twin Lobster Deals

Posted on December 25th, 2006 (0 Comments)

From time to time, I’ll summarize key ideas from seminal academic papers written on price strategy. Given that today is Christmas and many of us will be dining on turkey, I thought it appropriate to discuss Patrick DeGraba’s paper titled: “The Loss Leader is a Turkey, Targeted Discounts from Multi-Product Competitors” which was published in the International Journal of Industrial Organization in May 2006.

Before starting, a brief sidebar on myself. I always get a wry smile when at this time of the year, people will stammer “Mer--…uhh…Happy Holidays” to me. I know it’s politically correct and sensitive, but being born in Milwaukee and raised in Cincinnati, I’ve always thought of myself as a red blooded American that celebrates Christmas. And Christmas is a big deal in my family – with both of my parents being immigrants – they always invite friends over for Christmas dinner. My mother roasts a large turkey and ham – it’s a warm family celebration. And my mother makes some killer stuffing…“ancient Japanese secret” she responds whenever asked for the recipe.

Back to Pat DeGraba…Pat is truly an economist’s economist. I’m always impressed that after I invest a lot of energy developing an idea, Pat immediately grasps it and inevitably adds to it in a direction I had never thought of. He is one smart economist and a good friend. Pat was a professor at Cornell University, chief economist of the Common Carrier Bureau at the Federal Communications Commission, and is currently a senior economist at the Federal Trade Commission.

The punch line of Pat’s paper makes perfect sense. Every week newspapers are full of circulars advertising great deals (often priced below cost) in hopes of attracting customers who will purchase other, presumably profitable, products. Pat’s advice to retailers is to take the “hope” out of this practice and apply more science to loss leaders. Instead of drastically marking down staples like orange juice, Pat advocates discounting products that large volume customers typically purchase. For example, given that families tend to be relatively large volume customers, why not discount items like diapers? Discounting these types of items increases the odds that other products will also be purchased. I’ll build on Pat’s idea by suggesting focusing on customers that will make additional profitable purchases. Enticing large volume customers is beneficial only if they purchase profitable products. Enticing small volume customers with, for example a sale on brie cheese, can also lead to highly profitable sales of chardonnay, pate, and French bread.

Retailers are starting to take note of Pat’s idea. I’ve recently spoke with pricing software companies that are developing software that analyze customer purchases to figure out which products make the most sense to discount (e.g., identifying loss leader products that will generate additional profitable sales).

I’ve found it interesting that unlike anywhere else in the world, many restaurants in Boston’s Chinatown offer twin lobster (1 and 1/4 pound each) dishes for $10. That’s an eye-popping price, wouldn’t you agree? Of course… there’s a catch. To get the $10 special, you have to also purchase at least three entrees (rice or noodle dishes don’t count). But for large groups, buying three additional entrees is not a big deal. These savvy restaurants leave little to chance. To dine on these delicious loss leader lobsters, you are required to purchase three full priced entrees.

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