Cow’s Blog

June 1st, 2008

photo: PPDIGITAL

Why is popcorn at the cinema so expensive? At my local cinema, you’d expect to pay about £3 ($6) for some popcorn or about £8 ($16) for a meal deal including maybe a hot dog and nachos. This is absolutely extortionate given you can get popcorn for a third of the price at the supermarket just across the road and for £8 you could get a decent sit-down meal at a good restaurant.

So is this a rip off for consumers? In this article, I discuss the issue of expensive popcorn, how it can be explained with price targeting and suggest that isn’t a rip off at all.

A cup of coffee…

Let us imagine a cup of coffee which costs £1 to produce.

There are 6 consumers who all value the cup of coffee differently. Person A is willing to pay £1 for a cup of coffee, going all the way up to Person F who would be willing to pay £3.50 for a cup of coffee.

The shop decides to charge £2 for a cup of coffee so for every cup of coffee sold the shop makes a profit of £1. As we can see in the table, Persons A and B would not buy the coffee because it costs more than what they would be willing to pay. 4 people would buy the coffee, giving the shop a total profit of £4.

Let’s increase the price…

Of course, the owner of the coffee shop wants to increase his profits. So he could increase the price of a cup of coffee: say to £2.50.

What’s happened? Well, Person C no longer wants to buy a cup of coffee as it would cost more than they were willing to pay. Persons D, E and F will continue to buy the cup of coffee. The coffee shop sells 3 cups of coffee and makes a total profit of £4.50. The downside is that Person C no longer has access to a cup of coffee.

We could try increasing the prices further with the aim of trying to increase profit. If the price of coffee rose to £3, the profit on each cup of coffee is £2. But only Persons E and F would buy it, giving a total profit of £4.

As we can see, the optimal price to charge is £2.50. This would give the coffee shop maximum profit without using price targeting.

What if we use price targeting?

My argument lies around “price targeting”. What exactly is price targeting? It means charging people exactly what they are willing to pay. Take the following scenario:

So what has happened here?

Well, every single person now has access to a cup of coffee at the price that they would be willing to pay. Not only that, but the shop has managed to increase it’s profit to £7.50: almost double what it could have made without price targeting.

Leakages

But there is a big problem with this plan which economists call “leakages”. How can the firm know exactly how much customers are willing to pay? They could ask the customers but everyone would say they were willing to pay the bare minimum figure: £1. Because who would pay more than they would have to for some coffee? So we end up with the following scenario where everybody ends up paying the bare minimum:

Everyone has access to a cup of coffee. But it costs £1 to make a cup of coffee and everybody pays £1: the shop owner makes no profit at all.

The problem with this form of price targeting is that people will find ways to abuse the system. Everybody will pay the bare minimum. This is why you won’t see it used this way in practice: when was the last time you sat down at a restaurant where you could pay however much or little as you wanted?

There are several ways that companies can implement price targeting without explicitly asking you how much you’d be willing to pay. I would like to argue that popcorn at the cinema is one example.

Popcorn as a form of price targeting

photo: Midnight-digital

At the start of this article, I said that popcorn was a form of price targeting. Why?

Everybody would love popcorn and a drink to go with a film. If you don’t believe me ask yourself the following question: if I was given a free popcorn and drink with my cinema ticket would I take it? For most people, the answer will be a resounding yes.

Let’s say it costs the cinema £5 to screen Indiana Jones. For £9 my local cinema could provide everyone with a film and a popcorn.  For every ticket sold, they make a profit of £4. But instead they offer two options:

£7 - Film Only
£10 - Film and Popcorn

Let us imagine a customer who is willing to pay £8 to see Indiana Jones. In the original scenario without price targeting, everybody is charged £9. Since he is only willing to pay £8, he won’t go to the cinema: it’s too expensive. But if the cinema offered a £7 option, he will now decide to go. The cinema will make a £2 profit.

Let us imagine another customer willing to pay £12. He will go for the “film and popcorn” option at £10. It’s essentially exactly the same product: the popcorn only costs pennies to produce. But there is sufficient difference between the two options that the customer won’t “leak” into the £7 group.

photo: DMBFreakNo41

Why aren’t you allowed to take your own food and drink into the cinema? Because that’d cause £10 customers to “leak” into the £7 group.

Conclusion

Popcorn is a form of price targeting: a way of charging people the amount they are willing to pay. I have shown that this not only leads to increased profits for the cinema chain, it also means the cinema is affordable to a lot more people. Of course popcorn doesn’t cost £3 to produce. But that expensive popcorn serves an important purpose in allowing price targeting to work. Ultimately, consumers benefit from great access to the cinema.

Based on research from an article at Physorg.

• Economics
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