Steamed over ‘sticky’ pricing

Before the bottom fell out of the economy last fall, consumers were, well, consumed over the skyrocketing price of gas at the pump and food at the supermarket.

 “Input inflation,” industry-speak for the rising cost of ingredients, as well as soaring transportation and energy costs, created budget-busting chaos for many Americans. At one point in 2008, retail food prices were up 5.8 percent over the previous year to date. The price of corn, for example, was up 151 percent; soybean prices jumped by 80 percent; eggs, up by 67 percent; wheat, 65 percent; gasoline, 39 percent; and whole milk, 15 percent.

When the full blast of the recession hit, commodity costs sunk like a stone, but prices at the pump and at the local supermarket didn’t seem to tumble nearly as quickly. In fact, the price of some goods, like ice cream, kept rising. What gives?

According to Lars Perner, assistant professor of clinical marketing at the University of Southern California’s Marshall School of Business, the phenomenon is not a figment of my imagination, and there’s actually term for it: “sticky pricing.”

That's what economic experts call it when companies maintain higher prices on goods although the basis for the increases no longer exist. Firms have been padding profits for years with such tactics, and it’s not limited to grocers or big oil. Other businesses have been taking advantage of sticky pricing, too. Notice how many hotels, airlines, and rental car companies, for instance, still tack on energy surcharges.

Such behavior makes it easy to understand why so many of us are quick to shout conspiracy.

“Consumers have a right to be cynical,” says Harvard Business School professor John T. Gourville.

Companies typically price their goods based on what the competition is charging, not necessarily on what it costs to make them, Perner explained. The first company to hike prices runs the risk of losing customers to a competitor that holds the line. On the flip side, if one company decides to undercut a competitor it could ignite a price war. So there’s a lot at stake.

“If stores stick together, prices tend not to come down,” says Perner. “No one wants to blink first,” because others might follow.

Like it or not, another reason companies are hesitant to drop prices is concern that the good times won’t last. Sure, gas prices are lower now, but inevitably they’ll rise again. It sounds like voodoo economics, but by maintaining the existing price, the theory goes, they can avoid antagonizing consumers down the road and salt away a nice chunk of change in the meantime.

There’s also a behavioral explanation as to why companies may be reluctant to lower prices, according to Gourville, and it has to do with a behavioral phenomenon known as “loss aversion.”  In a nutshell, that means people tend to find more pain in price increases than pleasure in price decreases.

“In other words,” Gourville says, “a 50-cent price increase elicits a bigger reaction than a 50 cent decrease. Once you have taken a price increase, and people have painfully adjusted to the new price, you may be better off keeping the price there than lowering it, only to have to raise it again later. As a manufacturer, only if you are sure that the price decreases are fairly long term, would it make sense to drop your prices down again.  The last thing a manufacturer wants to do is be yo-yo-ing his prices.”

To be fair, manufacturers don’t always pass along the full price increase to consumers.  For instance, in the airline industry, when the cost of jet fuel rose tremendously, the airlines raised price somewhat, but not enough to fully cover costs (the end result being they lost a bundle), says Gourville.  “Therefore, not cutting prices immediately upon a drop in the price of inputs may be a way of recouping some of the lost profits. This is tough to say definitively, but it is possible.”