photo: law_keven
Everybody knows that it costs 45p for a pint of milk - wherever you are in the country or whichever supermarket you go to. No supermarket dares to increase the price of milk: it makes them look expensive. Nor will they dare to reduce the price to look cheaper than the rivals - they know that the other supermarkets will price cuts of their own. If all the supermarkets cut the price of milk, none of them gain any customers but they all make less money. So in essence, the price of a pint of milk is “fixed” at 45p.
Sainsbury’s 1% Milk
As someone with a bit of a background in economics, it’s absolutely fascinating seeing how companies deal with restrictions such as these. As a supermarket, how can you reduce the price of your milk without reducing your profitability? How do you design a pricing scheme that allows you to be competitive at pricing milk without starting a price war?
Sainsbury’s have dealt with this problem by introducing 1% fat milk (orange label). The qualitative difference between this milk and semi-skimmed is virtually zero. Yet 4 pints of this milk costs just £1 (25p a pint).
How does this arrangement help Sainsbury’s?
- First off, most people will continue buying the same milk that we’re used to. We notice when the price of milk changes, but it’s something that we buy on such a routine basis we would never compare the prices of different types of milk. So most people will continue to pay 45p for a pint of milk - no profit lost for Sainsburys.
- The only people who are likely to notice that you can get a new type of milk for 25p per pint are people such as students who do look after the pennies. But then, students don’t typically buy 4 pints of milk a week. If this offer can encourage students who normally consume 2 pints of milk @ 90p to now buy 4 pints @ £1, there’s additional profit in there for Sainsburys. Not to mention sales of complementary goods such as cornflakes would go up.
- Rival supermarkets won’t respond by cutting their own milk to 25p. The reason being that the “headline milk price” at Sainsbury’s is still 45p. This way, Sainsbury’s avoids a price war.
This stuff could easily be a textbook example for price targeting and game theory with regards to how monopolistic companies set prices.