Saturday, September 9, 2017

Price gouging and the generous free market

Gary North published members-only articles recently (here and here) discussing how Hurricane Harvey has affected economic life in Houston.  He makes an important point about prices and customers that I have not seen elsewhere.
Other things equal we know scarcity or high demand will drive prices higher.  Sellers of diamonds are rarely accused of price gouging but when prices for everyday commodities take a big leap in a crisis almost everyone calls it price gouging.  It’s an easy call: People are in desperate need of critical commodities, while certain suppliers are charging scalper prices.  Conclusion: The suppliers are craven profiteers. 

Wikipedia defines price gouging as “a pejorative term referring to when a seller spikes the prices of goods, services or commodities to a level much higher than is considered reasonable or fair, and is considered exploitative, potentially to an unethical extent.” Merriam-Webster says price gouging is “charging customers too much money.”  How much is “too much”?  What is “reasonable or fair”?

People don’t know, exactly, but they pass laws against it anyway.  The fine for gouging a senior citizen in Texas is $250,000; gouging someone younger is only $20,000.   Amazon has algorithms that suspend the accounts of sellers charging high prices relative to other sellers.  During Harvey’s onslaught in Houston, a photo on gritpost showed a Best Buy store posting $42.96 for a case of bottled water; Best Buy later issued an apology on behalf of the store.  

By the way, do we ever get apologies from government?

As they do during every emergency, free-market commentators have rushed to the scene to correct the public’s misunderstanding about price gouging.  Though their arguments are available to the public, the public never reads them.  Later, during the rebuilding, they’ll correct similar fallacies that sees economic windfalls in broken windows.  Once again the public remains pristine in its ignorance.

Customer Loyalty

Rather than make the case for gouging, North took a different approach.  
When we go to a supermarket, we do not argue over price. Everything is programmed into a computer, and it is all run by barcodes.  When a hurricane comes, a supermarket is not in a position to raise prices. In any case, a supermarket would not raise prices. It would make great profits for one day, and then it would lose customers on a permanent basis on the day after the hurricane blows through and blows out. People remember being gouged. . . .
State governments have laws against gouging. These laws are irrelevant. A seller knows not to gouge. He does not want to appear to be a bad guy. He knows that he will lose customers after the crisis. So, he sells at what the price was the day before the hurricane. He thinks long-term. He doesn't want to alienate people.
In rare cases, a seller may put up a sign: only one to a customer. Customers are generally in favor of this policy. . . .
Where there is no brand loyalty, you will see high prices immediately prior to a hurricane. This takes place, for example, in gasoline sales. There is no brand loyalty any longer for gasoline. . . They compete exclusively in terms of price. So, the day before the hurricane, some of them will raise prices unless there is a state law against it. They won't alienate long-term customers because they don't have any.
So what might a supermarket do during a crisis to keep its customers happy?

H-E-B is the largest grocer in Texas.  Shortly after Harvey “slammed into Texas as a Category 4 storm,” it managed to open 60 of its 83 stores in Houston.  

According to Scott McClelland, president of the chain’s Houston division, one of the stores had only five employees — “one stationed at the door as crowd control and four working the registers, trying to get people out as quickly as possible.”

A whirlwind of improvised and exhausting activity went on behind the scenes to maintain some semblance of normality.  What should the distribution centers ship immediately after a storm hits?  Bread and water.  A little later milk, bread, and water.  Then canned meat.  And batteries and tuna.  

Local employees were fighting the hurricane, so where do you get people to run the stores?  From nearby cities not affected by the storm.  “They hopped into cars and they just drove to Houston. They said, we're here to help.”  And they helped for 18 hours a day then slept at someone’s house.

H-E-B called suppliers and told them to ship toilet paper directly to the stores and bypass the warehouses.  They called Frito-Lay and told them to ship only their bestsellers.  H-E-B normally produces 50 varieties of bread; during the storm they cut it to three: white, wheat, and hotdog buns.  They did this and much more while working on relief efforts.  They sent mobile kitchens into the hurricane area to feed first responders and evacuees.  

This is how capitalism works, North tells us.  
Profits come from efficient service of customers. The hardest sale to get is the first one. The money is made through repeat sales.
Repeat sales will continue long after Houston dries out.  Loyalty will run the gamut from customers, to employees, to employer, to suppliers.   
The owners of the store have established their reputation. Having a good reputation is basic to establishing the long-term profitability of any enterprise. . . .
This is how the free market works when it works profitably. There are business people who do not understand fundamental principles, but they are rarely rich and successful. They go for the short-term profit, and they do not survive in the long term.
Reputation is crucial. Short-term profits are not. Charging people 30% or 40% more because of a hurricane is an unwise policy for a store that expects to be in business a week after the hurricane. This is not just theory. This is economic reality. The senior managers in this company understood how the free market works. They took advantage of an opportunity. They did not take advantage of customers. They will wind up with lots more opportunities and lots more customers.
Response to Irma

As Hurricane Irma bears down on Florida and the southeast at the time of this writing, we’re seeing companies as well as private Americans providing disaster relief for the millions of evacuees.   

Comcast has opened “137,000 Xfinity WiFi hot spots free of charge to Florida residents, including non-Xfinity customers. . . . Non-customers will be able to renew their complimentary sessions every two hours through Sept. 15.”  

U-Haul is offering “30 days of free self-storage and U-Box container usage to residents who stand to be impacted by” Irma.  Check the link for more details.

Airbnb is encouraging hosts to open their homes free to evacuees and is waiving the normal booking fees. 

The major airlines capped prices for evacuees.  JetBlue is increasing the number of flights out of affected cities and is “waiving cancellation and change fees for existing reservations.”

Finally, the nonprofit SPCA “is offering veterinary care and basic pet supplies at no cost” to evacuees with pets who are are in New Orleans.

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