The Economics of Driving Around

It's time for a new feature here on Utah Economist Blog: The Economics of Driving Around.

I like driving around, and one of the best things about it is the real-world economics you can see as you go from place to place. Even if you don't like driving around, you probably have to do it --- and it's a great opportunity to look for economics.

I had some errands last Tuesday, and managed to catch a few snapshots.  I was also messing around with Instagram (a billion?  with a b?), and uploaded shots there.  The Economics of Driving Around really benefits from the geo-tagging feature of your typical smartphone, and I've linked so as to show you both a photo and a map.

So, here's a picture of some Powerbars.  This was taken at the Common Cents convenience store at Bangerter and about 200W.   And here's some more Powerbars --- the same kind, in fact --- taken as the Fresh Market grocery store on 900 East and about 17th South.

What's the difference?  Well, same product.  Similar display.  Difference price.  At the C-store, the bars go for $1.69 while at the grocery they are $1.59.  So here's where you can put your brain to work as you're out running errands.  Same product, so why not the same price?

Typically, people jump to thinking about cost differences, and very often to differences in the fixed costs associated with running each business.  But fixed costs don't (directly) affect optimal pricing decisions.  As we learn in a basic managerial econ class, the profit-maximizing price depends on two things:  marginal cost and demand elasticity.

So one possibility is that the convenience store pays a higher wholesale price for Powerbars, and selects a retail price accordingly.

But another possibility is that demand is more elastic at the grocery store than at the c-store.  Demand elasticity is a measure of how sensitive quantities are to prices.  If demand is elastic then small price changes lead to big quantity changes, while if demand is inelastic small price changes lead to small quantity changes.

It works out that if your demand is elastic (rather than inelastic), then it makes sense to charge lower prices and accept lower margins?  Why?  Well, the benefit from reducing prices is that you're going to sell higher volumes.  And if your demand is elastic, then a price reduction gives you a big increase in volume, and this big increase in volume can make it worthwhile to accept lower margins.  If, on the other hand, your demand is inelastic, then a price reduction gives you a small increase in volume, in which case it probably isn't worth it to accept lower margins to sell more.

All this can be made horribly precise --- the inverse elasticity pricing rule is the governing equation --- but the key point is to think about potential differences in elasticity in addition to potential differences in cost when thinking about price variation.

So the question then becomes:  Is there any reason to think that Powerbar demand would be more elastic at a grocery store compared to a convenience store?  Is there any reason to think that a c-store price reduction would have a smaller impact on quantities sold than a grocery store price reduction?  And that's a good question to ponder, as you're thinking about the why behind the price variation we observe every day.

Here's some more food-for-driving-around thought:

• 3.59 for regular unleaded
• 3.64 for regular unleaded

Roadside MBA

I've gotten a few e-mailed questions this week about the "Roadside MBA" project, so I thought I'd explain a bit more about what we're doing, and why.

Mike Mazzeo and Paul Oyer are economists and strategy professors at Kellogg (Northwestern) and Stanford, respectively, and I helped hire both of them at Kellogg in the '90s. (Yes, they *do* owe all their successes to me. Paul especially.) Paul and I have written many articles together, and I've known Mike since we were both undergraduates at Stanford in the '80s.

About two years ago, we were on the phone discussing economics-based strategy courses for MBA students, and were lamenting the fact that the typical Harvard Business School case study focuses on Procter and Gamble, or Ford Motor Company, or Microsoft, or Pepsi, or ... somebody big with billions or hundreds of millions in annual sales.

One of us --- probably me, but I don't actually recall --- pointed out that owners and managers of small and medium-sized businesses might benefit from thinking through their problems using an "Economics-of-Strategy", principles-based approach... but that our profession doesn't always do a great job of encouraging this given that we produce a lot of "big-business" case studies. We all agreed that small business needs attention from economists interested in strategy.

So we decided to hit the road in search of stories that we could use to help translate MBA strategy frameworks for owners of small and medium-sized businesses.

Our first trip was from Memphis to Omaha in August of 2010. We went from Denver to Oklahoma City in Winter 2011, Charlotte to Atlanta in Spring 2011, Missoula to Portland in Summer 2011, and as I type this I'm on a plane headed back to Salt Lake after a weeklong tour from Chicago to Cincinnati. We typically meet in City A, rent a car, stop in Cities B, C, D and E on consecutive days, visit 3-4 businesses per day, and fly to our respective homes out of City F. We have grown to like Holiday Inn Express quite a bit, although to date they have not offered us a sponsorship deal.

(I'm sure by now you're trying to imagine what it's like to drive across America in a rental car with economists for the better part of a week. Really, it's not that bad. I mostly drive. Paul mostly navigates, and, yes, we get lost a lot. Mike sits in the back and interjects with humorous commentary on whatever argument Paul and I happen to be having. By far the worst part is Mike's continuing affection for the New York Yankees, and his constant updates on how many hits Derek Jeter has --- like I care. The winter trip was my favorite, for obvious reasons.)

To date, we've visited 100+ small and medium-size businesses. We try to set a meeting with the owner or a general manager with significant operational and strategic oversight responsibility, and we usually start by just asking for the story of the business. From there, our visits usually turn in to a conversation in which the three of us ask questions about pricing, positioning, strategy, organization, succession, or other topics, depending on what strikes us as interesting. The people we've met are, without fail, creative and energetic, passionate and thoughtful, interesting and driven. It's been really fun, and we have learned so much.

What exactly have we learned? And how can our catalog of examples, stories and mini-cases help other owners of small and medium-sized businesses? We're not telling the stories quite yet, because it's important to for us to get signoff from business owners before putting anything out there publicly. But we're in the process of cataloging, analyzing, and writing; we're hoping to get something interesting down on paper --- er, pdf --- soon.

Hitting the Road

Give me some room to warm up, so I don't strain a blogging muscle.

I will be ending my term as Associate Dean shortly (77 more days!), and I am looking forward to doing more of the things I became a professor to do... Teach, write, think, etc. Part of the "write" plan is to restart this long-dormant blog. So, hopefully people are still interested in economics out there.

I'm writing from Chicago, where I'm meeting some economist friends for another installment of the Roadside MBA. We're making a circuit from Chicago to Cincinnati this week, talking to small and medium sized businesses all along the way. There will probably be a book written sometime, but first I need to get back to the whole "write" thing. (See above). I'll post some notes as we go along this week to try to slowly ease my way back into actual thinking as opposed to being an administrator!