Economics of Coupons

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In the research of Aviv Nevo and Catherine Wolfram, for example, it is shown that in case of static monopoly monopolist can profitably charge different prices for the markets with different elasticity. Thus, in this very case he will charge higher price for inelastic of the market. But then, using the example of breakfast cereals market, they prove that for this industry the shelf price would be lower while conducting coupon program.[6] The authors explain this result by the fact that cereal manufacturers are not the monopolist, so certain assumptions giving the opportunity to set higher price are not met.

The rule for maximizing profit with third-degree discrimination is:[pic 1]

where A and B are two groups with inelastic and elastic demand correspondingly. Marginal revenue, in turn, is a function of the price elasticity of demand, or

[pic 2], where [pic 3]is price elasticity of demand.

Customers from group A (inelastic demand) pay full price P, while customers from group B (elastic demand) use coupon and pay price (P-C). Then, maximizing formula for the company turns into that form: [pic 4]

,

where [pic 5]and [pic 6]are elasticities of demands of groups A and B correspondingly.

[pic 7]

In order to show why companies that issue coupons generally decrease the prices, we conducted a questionnaire of students. The aim of the questioner was to find out whether students would switch from general price of business-lunch to the coupon price. We want to know what new price, will maximize company’s revenue under new conditions (when most students began using coupons instead of paying initial full price).

Questionnaire

We decided to use practice to demonstrate theory and carried out survey. One of the most important things for students is to have good lunch. So, as we have a lot of students around, we decided to know about the views of the student concerning the price for the lunch. Our hypothesis is that students have high price-sensitivity and thus, the company should reduce the regular price while doing coupon program. Our questionaire looks like this:

New cafe, which serves a business lunch for 300 rubles, has been opened near the university.

- Would you buy a business lunch at this price?

- Imagine that you can get a coupon "Business lunch for 150 rubles" by cutting it out of the newspaper, which is distributed in the subway. Would you use this opportunity?

- At what price for a business lunch would you indifferent to buy it at that price or to take the time to cut the coupon? (Price is less than 300, but more than 150 rubles)

- Now imagine that you can get a coupon "Business lunch for 150 rubles" by printing it from the site of the cafe. Would you use this opportunity?

- At what price for a business lunch would you indifferent to buy it at that price or to take the time to print the coupon? (Price is less than 300, but more than 150 rubles)

- Coupon "Business lunch for 150 rubles" is handing out at the exit of the subway. Would you use this opportunity?

- At what price for a business lunch would you indifferent to buy it at that price or to use the coupon? (Price is less than 300, but more than 150 rubles)

By suggesting 3 variants of obtaining coupons, we tried to estimate the ‘hassle costs’ of the respondents. The logic is very simple: the more efforts needed to get the coupon the higher price student is ready to buy at with no coupon. And vice versa – if there is no effort in obtaining coupon (in our case, getting the coupon near the exit of the subway is zero-effort variant) then the student will be indifferent to buy at general price or to buy with coupon only if the coupon price is equal or just slightly smaller than the regular store price.

We got 63 responses. By default, the price of the business-lunch was 300 rubles while the coupons-price was 150 rubles. Only 27 of 63 students were ready to buy the lunch at this full price. It means that company’s total revenue in case of the absence of any coupons is 27*300=8100. Imagine for simplicity that there are no fixed cost. Let AC=MC=90 (as prime costs for producing one extra lunch is about 90 rubles). Then, the profit would be 8100-90*27 = 5670.

Then, when we suggest the coupons and in all 3 cases (cutting out from the newspaper, printing it or taking near the metro). It is not surprising that about 80% of “ready-to-pay” students went over to the group of people who would buy coupons. Thus, we conclude that students in our study are high price-elastic. It also should notice that 94% of students would use this coupon at least in one of the offered situation.

Under the first condition - when the coupons are available only in the magazines, the profit maximizing company should reduce regular price to 200 rubles per lunch while issuing the coupons ‘lunch for 150’. Then, the TR=43*200+20*150=11 600, where 43 – the number of students making a purchase at full price (200 rub) and 20 – the number of students using coupons. Then the profit of the company in this case will be equal to 5930. At the same time, if there was no price reduction, then the TR=44*150+6*300=10350 (only 6 students will continue to buy the lunch at full price) and the profit=3900.

Under the second condition of coupons available only on the company’s corporate site, the best way to maximize its profit is to set up the regular price equal to 200 rubles. Here, TR=34*200+38*150= 11 000 and profit=5420. If the company decided not to reduce price, but still use coupons, then TR would be 9150 and profit 4110 rubles.

In case if the coupons may be obtained only near the subway, the maximizing profit reduced price will be again 200 rubles. Then, TR=200*27+150*42 = 11700 and profit=5490. In case of the constant price equal to 300 the company would get TR = 10500 and Profit = 4560.

The results for the convenience are shown in the table below:

Not using coupons

Coupons in the newspaper

Prited coupons

Coupons are given near the metro

reduced price

without reducing price

reduced