Rafi Mohammed

The "Secret" Cash Cow for Gas Stations...89 Octane

Posted on June 25th, 2008 (0 Comments)

So how do you decide which local gas station to patronize? For most of us, price is the key decision factor. Here in Boston, I fill-up anytime I see a price below $4 per gallon (boy…how times have changed).

Running a gas station these days is not as profitable as you might think. With relatively low barriers to entry, the market is competitive. This results in low margins - if your price is too high, I’ll go to the guy down the street. In fact, ExxonMobil recently announced it was selling 2,200 of its company owned gas stations citing low retail margins.

To survive in this cut throat market, gas station owners have to offer competitive prices. Research shows that we either use a product line’s lowest or highest price as the key reference price to decide if a retailer is offering a good or bad deal. So in the case of gasoline, we tend to focus on the prices of either the “good” (87 octane) or “best” (93 octane) products. What’s interesting is that even though many of us purchase the “better” product (89 octane), we generally don’t focus on its price to judge value. Perhaps it’s too difficult to keep an eye on that “middle” price. As a result, gas stations have capitalized on this psychological quirk.

The typical pricing pattern at gas stations has been: good (87) price = base, better (89) = base + 10 cents, and best (93) = base + 20 cents. So for example, good = $3.999, better = $4.099, and best = $4.199. Has this been your experience? Now here’s what’s interesting…most gas stations only have two octane storage tanks: 87 and 93. So when someone fills-up with 89 octane, the pump creates a blend from its storage tanks. The ratio is roughly 70% of 87 and 30% of 93. So really…from a cost perspective, 89 octane should only be 6 cents more than 87 [(70% at base price) + (30% multiplied by 20 cent premium)]. But stations have long charged a +10 cent premium.

Just to be clear, I’m not advocating cost plus pricing (…the ultimate sin in pricing). But it’s interesting that in such a competitive market, gas station owners have kept this +10 cents pricing intact for 89 octane. You’d think that some stations would break this mantra to attract more customers. Since it’s so easy to implement, my guess is that some stations probably have reduced this +10 cent premium. But this pricing move did not increase profits - anecdotal evidence that consumers don’t focus on “middle” prices.

I should note that with gas prices skyrocketing in recent months, some stations are tinkering with this +10 cent pricing practice…but not in the direction you would think. Often, 89 octane is selling for more than 10 cents higher than 87! A sign that station owners may be lowering their margins on 87 (to attract the increasing number of price conscious drivers) and making their profit off 89 and 93 octane customers (who probably drive more expensive cars therefore less price conscious).

My sincere thanks to my good friend Chris Maxwell (economics professor at Boston College) for pointing out this pricing anomaly to me.

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