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August 01, 2006 at 04:00 AM
If you’ve been searching for the perfect economics book to take to the beach, The Undercover Economist lives up to its spy-thriller title with plenty of street-level insight and observation. As the “Dear Economist” columnist for the Financial Times, Tim Harford knows how to use fundamental economic principles to explain everyday situations, and in this book he demonstrates that knowledge on page after page.
He starts off by exploring the economic relationships that bring us our morning cappuccino, noting that the main reason that Starbucks can charge $2.55 for a cappuccino is because there isn’t another competing shop next door selling it for just $2.00. Starbucks has a significant advantage in its hefty number of locations. And many of them are situated where thousands of coffee-craving commuters will have them right in their line of sight. “The nice margin that Starbucks makes on their cappuccinos is due neither to the quality of the coffee nor to the staff: it’s location, location, location,” he writes.
Ultimately, the hunt for a prime location puts even the best caf? at the mercy of its landlord–but by the same token, prime coffee-bar locations will command high rents only if customers will pay high enough prices for the coffee to keep the caf? from closing. “Rush-hour customers are so desperate for caffeine and in such a hurry that they are practically price-blind. The willingness to pay top dollar for convenient coffee sets the high rent, and not the other way around. Cheaper rent is not compensation for the loss of a flood of price-blind customers.”
It may come as a surprise, but Whole Foods, another upscale retailer, is no more expensive than Safeway when it comes to staples. The high prices associated with that brand correspond to “customers with a different view of what ‘basics’ are.” For example, Whole Foods charges less for Tropicana orange juice and Poland Spring sparkling mineral water, because for its customers, such items are basics that need to be priced competitively. “It’s not because Whole Foods is ‘expensive’ and Whole Foods customers are stupid. It’s because Whole Foods offers additional, expensive choices, which Whole Foods shoppers are willing to take because they perceive the quality premium is worth it.” As a result, Harford concludes that people seeking bargains shouldn’t try to find a cheap store, but that they should shop cheaply.
