Last week, I went snowboarding in Vermont for a couple days. I booked my hotel room at the very last minute, only a couple of hours before I left on Wednesday. There were a few reasons for my procrastination, including a blizzard menacing the Northeast.
The fourth hotel I called, an inn with 23 rooms, originally quoted me a price of $129 a night, with breakfast. However, when I said I’d call back if I wanted to book, the innkeeper immediately offered to drop the price 20%, to $105. That was only $6 more than the lowest price I’d heard so far, and this was a much nicer place, so I said OK and booked the room.
What the innkeeper was doing is called price discrimination, which sounds kind of bad, but is actually good.
If you’ve ever taken an economics course, you’ve probably studied price discrimination. The example I remember from my college macroeconomics class used movie tickets: Most theaters offer cheaper tickets for children, students and seniors, even though they take up the same amount of space in the theater as a full-paying customer.
The reason is that many members of these groups have a lower ability—or desire—to pay. The movie theater’s regular ticket price is set (hopefully) at the point that will bring in the most money from ticket sales, without driving away customers. In New York City where I live, most movie theaters have set that price around $20.
But for students with no or little income, and seniors on a fixed income, $20 might not be the right equilibrium point: It drives away more customers than the theater makes up for by charging the rest $20. So theaters offer lower prices—$12 or so—for these groups, which still makes the theater money and attracts more customers than a $20 price would.
This sort of discriminatory pricing is legal in most cases in this country.
Supermarkets and big box stores mass mail coupons to consumers in their neighborhood. Some even make them available at the store. Theoretically, all their customers could use them, which would be bad for the store. But only those who care enough to look at the coupons and buy the corresponding products actually will—creating a discriminatory pricing scheme based on effort.
Online shopping sites, too, will reward even a small amount of effort with a discount. Websites like coupons.com and currentcodes.com allow you to search for coupons or discount codes by website or brand. Most (though not all) online retailers know about and accept their presence, realizing that many of their customers still won’t go to the relatively little effort of finding a code or coupon.
And then there’s air travel.
Faced with rising competition and rising costs, airlines have taken price discrimination to new heights.
Everyone knows the price of a ticket depends on when you buy it: Book months in advance, and you’ll probably get a good deal. Sometimes you can also get a good deal by booking at the last minute, as I did for my snowboarding trip.
What day of the week you book your ticket can also affect its price. The weekend is the most expensive time to buy a plane ticket, in general, and Tuesday is generally the cheapest. The reason? Airlines often begin sales on Monday, prompting other airlines to meet or beat their price by Tuesday afternoon.
Those all seem like reasonable enough ways of competing on price, or matching price to supply. It’s when airlines start messing about with the rules that things get byzantine.
“Hidden city ticketing” is the airlines’ name for buying a ticket with a stopover, with the intention of staying in the stopover city instead of continuing on the second leg. Why would this be cheaper than just buying a ticket from your point of origin to the stopover city? Usually, it’s because the stopover city is dominated by the airline you’re flying (especially if it’s the company’s hub), while the ultimate destination is a competitive market. They can charge as much as they want to fly from your origin to their hub, because few others fly that route, but they compete heavily on the route from your origin to the ultimate destination.
It seems like a fair enough pricing scheme, based on competition. But it begins to look a little more draconian when you learn that, to prevent savvy travelers from circumventing their clever pricing scheme, many airlines outlaw so-called hidden city ticketing. If you get caught, they can charge you for the more expensive ticket, revoke your frequent flyer miles, or take other action.
Another pricing scheme airlines want to prevent you from evading is the practice of selling round-trip tickets for less than one-way tickets. “Throwaway ticketing” is what airlines call it when you buy a round-trip ticket, and only use half, and it’s also banned by many of the major U.S. airlines.
Finally, most also ban so-called “back-to-back ticketing,” which is the practice of buying two round trip tickets and using half of each. Usually, it’s a way of using cheaper fares that include a Saturday-night stay, intended for vacationers, for business travel. Airlines make much of their money off less-price-sensitive business travelers, so they have an interest in preventing such tricks. (Low-fare airlines JetBlue and Southwest are the notable exceptions that don’t ban these practices.)
One way to look at this complicated system of fares and rules is that airlines are simply using the same kind of discriminatory pricing as other merchants, as is their right.
Another is that travelers are being forced to maximize airlines’ profits, even when they’re aware of and trying to opt out of the price discrimination.
How do you see it? Are these rules legitimate business practices, or unfair manipulation of customers? Share your view by leaving a comment below!
To get to investing, today’s investment of the week is the only stock that appeared in both our Investment Digest and Dividend Digest Top Picks issues this month. It was chosen as a Top Pick for 2011 by two different newsletters, but one submitted it as a growth stock, and the other as an income investment.
The stock is Microsoft Corp. (MSFT). Here’s what the experts wrote.
In the Investment Digest (which covers all types of stocks), James Stack, Editor of InvesTech Research Market Analyst, wrote:
“With an almost indispensible impact on modern life, Microsoft Corp. and its products are household names. From the ubiquitous Windows operating system and Office productivity suite (Word, Excel, Outlook, etc.) to server products and entertainment devices, the vast majority of us use numerous Microsoft products every day. The timely launch of the company’s upgraded product lines is currently benefitting from the post-recession resurgence in corporate spending. Windows 7 is now the fastest-selling operating platform ever and Office 2010 is off to a tremendous start with revenue growing over 15% during its first full quarter on the market. Cloud-based offerings (Azure) also fit into Microsoft’s strategic plan, and Bing is now powering Yahoo search in the U.S. and Canada. When looking at the firm in terms of valuation, the argument for Microsoft only gets better. Since the peak of the technology bubble, revenues have grown impressively at 10% per year and valuation multiples (P/E, P/S and P/CF) are all well below historic norms. With the company’s strong market position and excellent valuation, this stock is poised for long term gains.”
A week later, in the Dividend Digest (which covers only income-producing investments), Steven Check, Editor of The Blue Chip Investor, wrote:
“Microsoft Corp. is the world’s largest software firm. Windows still dominates the operating-system market, Office has a 90%+ share, and Xbox is a leading videogame console. Investors worry that the advent of tablet computers and the increasing interest in cloud computing will undermine Microsoft’s market franchises. While these are valid concerns, the company is moving to address both risks. Meanwhile, MSFT released two major products in the past year: its Windows 7 operating system and Office 2010. Both received very positive reviews and have spurred sales. Microsoft’s recent performance has been strong. In the September quarter, revenue rose 25% and EPS increased 55%. Net income in fiscal 2011 will approach $21 billion. The firm enjoys superlative financial metrics. It has a net profit margin of 30% and a return-on-capital of 36%—with little debt. Microsoft retains $30 billion in net cash on its balance sheet, providing great strategic flexibility. MSFT repurchased $4.4 billion of stock in the most recent quarter and has retired 19% of its shares since 2005. The stock currently trades at a P/E of 11 with a dividend yield of 2.3%. We believe the strength of Microsoft’s franchise, its strong cash flow and low valuation offer a very compelling risk/reward scenario.”
While I’m a lifelong Mac user myself, I’m not so biased as to deny facts when they’re put in front of me (plus, I use Microsoft Office nearly everyday, and I stream Netflix on an Xbox.) Microsoft pays a quarterly dividend of 16 cents, amounting to a yield of a little over 2%, but it’s also got growth potential. The stock hasn’t exactly been an outperformer in 2010, but it looks solid enough recently, and the company’s earnings strength and financial position are undeniable. If you’re looking for a stock that offers the best of both worlds, this one’s for you.
Wishing you success in your investing and beyond,