Waging Price Matching War

In game theory they talk about deciding your move based on what rational opponents would react. A variant of that strategy is to convince your opponent that you are no where near rational so they better not expect you to do the rational reaction to your action.

For example if you are playing a game of chicken in cars, if you were to break the steering wheel and toss it out the window in front of your opponent then he knows you are not going to swerve. (source: Art and Science of Negotiation). That is strategic irrationality.

In the game of chicken played in retail prices, Amazon is such a strategically irrational player. A recent BusinessWeek article screams

Amazon’s Jeff Bezos Doesn’t Care About Profit Margins

Mr.Bezos has signaled to all other players that he has thrown away his steering-wheel and placed a brick on his gas pedal. They are not going to let up on lowering prices and they can keep at it as long as they can because they have the full trust of their shareholders.

The right move in this game is not to do exactly the same and agreeing to match prices. But other retailers don’t seem to get it.

Target is the latest retailer who decided to play the price matching game not realizing their opponent’s stated irrationality. Target announced they will match all Amazon prices if customers can show proof.At least, unlike BestBuy’s mistake of making it easy for customers to get the price match, Target has added manual steps for customers. But that isn’t enough to stop the bleeding – either customers will do that additional work or simply go to Amazon.

If one player in a market says they will match any lowest price in the market the rational move for others is not to lower their prices because they get no advantage from it and only erode their margins. But Target is not dealing with rational player.

Fundamentally, by agreeing to match Amazon prices, they are saying their store provides no unique products, no unique value and  is undifferentiated from an online store. The right strategic move would be to ask,

“what unique value the store provides to its target customers and what is the right product mix that makes the customers buy from them”.

Even if this would result in severe revenue reduction – because they end up eliminating many products from their shelves – in the long run it would help make Target a profitable venture.

Instead they chose to play the game of chicken with with an opponent who has given up on steering.

This isn’t going to end well for Target. Circuit City here we come.

Startups and Cognitive Biases

If you are not irrational enough it is highly likely you won’t start a venture.

See also Mind of Analyst.

Why we still buy incandescent bulbs?

CFL (Compact Flourescent Light) delivers savings in two forms

  1. Longer life and hence savings from replacement costs
  2. Energy efficient leading to savings on operational costs

The lowest grade  CFL lasts  five times as long as a high quality, “long life” incandescent bulb and saves $36 over its lifetime in energy costs.  The  said CFL costs $5.22 and the long life incandescent costs $0.42 each. Even excluding opportunity costs of buying and changing light bulbs, that is a total savings of  $33 over five years. (Source WSJ)

This does not even address the environmental costs savings from using less energy.

So why do we still keep buying incandescent bulbs when the economics of a CFL are clearly better?  I think the answer lies in our we discount future benefits. If we are rational decision makers then  the present value of $33 will guide us to simply choose the CFL option.

We are not. We have the tendency to underestimate future benefits and hence value it lower than the value of an option with near term benefits. We read news stories, we understand the benefits of CFL but when it comes to the moment of choice our value curves switch and we pick the incandescent bulb which is priced at $0.42 compared to $5.22 for a CFL. George Ainslie called this the hyperbolic discounting, the same concept that is used to explain addiction and temptation. In some sense we give in to the temptation of the present and forgo future benefits because of our ways of discounting the future.

The EU and the US Governments have announced plans to phase out the incandescent bulb in the coming years. I wonder why wait a few years? Is it not time to put some Nudge to work? Why not take away the temptation that stems from higher near term benefit? The Governments should charge a very high tax on these bulbs, to bring their price close to that of a CFL. Anyone buying incandescent bulb even after  these highly taxed prices do really have a need for them and should be charged another price premium.