The Economics of Self-Imposed Price Ceilings
By David Henderson
About once every two weeks, I drive to Costco for my favorite fast food per dollar: the famous Costco hotdog. It’s priced, along with a soda with free refills, at $1.50 plus tax. In Sand City, California, my local Costco, the tax-inclusive price is $1.62.
A few years ago, a former student was visiting and he had interviewed at Costco. I told him that I thought the $1.50 price was hard to justify and, presumably, led to losses. I suggested that Costco, even it wanted to have a “Schelling point price,” could set it at $1.85 and, therefore, even in very high sales-tax localities, the overall price would still be below the magic number of $2.00. And, I said, Costco would probably make substantially more money on hot dogs.
My friend grinned and told me that in his conversations with Costco executives, he had learned that many new executives, when they first started at Costco, would make similar proposals and get nowhere. It turns out that James Sinegal, the co-founder of Costco and, until recently, CEO, had a strong belief in keeping the price at $1.50. No one could talk him out of it.
So what to do? Cut quality. I’ve noticed two changes, one that happened about 5 years ago or more, and the other that happened more recently.
Once you get your hot dog, you go over and put on your own condiments. Until about 5 years ago, these condiments included relatively fresh sauerkraut. You turned a crank and the sauerkraut came out. About 5 years ago, the sauerkraut was gone. I learned, about a year after it disappeared, that if you asked for it, you were given a little plastic container of sauerkraut. About 2 years ago, I noticed that the sauerkraut in the plastic containers was kind of old. So I started asking for it fresh, but that takes the server time to go back to the fridge and get it. So that’s two incremental cuts in quality.
While in the hot dog line a few weeks ago, I was pointing this out to a friend and he noted that no longer were the hot dogs the high-quality Hebrew National brand. Instead, they are Kirkland, the in-house Costco brand. Another reduction in quality.