What are we really saving?

As I am currently taking a graduate business degree, most of what I want to write about these days concerns economics – or rather, human behaviour. For example, I am constantly confounded by what I learn in marketing. Although the discipline is full of buzz words and applications of strategy, it all really boils down to observation of human behaviour. And there is something I really like about that. Whereas I used to believe that marketing was about changing behaviour (and, in a sense, it still is), what I am finding more and more is that we are simply there to observe and gather information and then try to make informed decisions. Certainly, there are influence techniques we study and tools we use to change buyer perception, but ultimately it is human behaviour that dictates what marketers call marketing strategy.

A pricing manager for one of the major oil companies came to speak to my class recently. One of the more interesting tidbits from the lecture was the way in which he dispelled the myth that collusion occurs among gas stations. To be sure, collusion is possible in pretty much any industry. But because of human behaviour – in this case, the price-elasticity of demand – the benefits of not colluding generally outweigh the benefits of collusion. It turns out that among consumers of gasoline identified as brand- or station-loyal (meaning they will almost always patronize a certain oil company or gas station), two-thirds would roll over on their favourite to save 0.5 cents per litre of gasoline. The effects of this are manifold: first, it means that we would expect long line-ups at a lower priced gas station when higher priced alternatives are nearby (which we do generally observe); second, and this is the part that I find quite fascinating, it means that we are willing to wait sometimes 20 minutes in order to save 25 cents on a 50 litre fill-up.

How is it that anyone can value their time at 75 cents per hour? Would you ever hire yourself out for any reason for 75 cents per hour? I should hope not. But I’m probably exaggerating slightly. So let’s say that, instead of 0.5 cents per liter, we’ll really save 2 cents per litre, and we’ll halve the waiting time. Now you’re choosing to wait ten minutes so you can keep a whole dollar in your pocket. If you own a vehicle, a dollar a week probably isn’t that much to you. Think about it for a minute. Which would you choose? $52 a year or nearly 9 hours of free time (assuming the 10 minute wait)? Of course, you’ll say those ten minutes you save cannot be condensed into one free day from work, and you would of course be right. But those ten minutes…what would you do with those? Maybe you would spend time with your spouse, maybe your kids, hell maybe you’d just take your shoes off and sit on your own front porch or balcony. But – and this is an important but – how often do you ever make a calculation like that? If you’re honest, the answer is probably almost never. Because we’re not trained to think like an economist, we don’t think like one. Instead, we strive to save money where we can, often in exchange for ridiculous amounts of time. And I am no different (to be fair, I’m not an economist either).

But it is because of this innate price sensitivity we all suffer from that it is nigh impossible for gas stations to collude on pricing. Even if a deal were struck between two gas stations, the gains to be made by abandoning collusion for one station are quite significant when you factor in the extra volume of gas you can sell by undercutting your competitor by half a penny (we expect far greater than 66% of drivers to switch to the lower priced alternative at that point). One of the pricing manager’s main job functions was to be ‘on call’ until 11 pm every evening simply to coordinate prices for all of his stations around the city and its environs to avoid any price discrepancies among them. Of course this isn’t the whole story – there are many other reasons collusion is impossible, chief among them the threat of government intervention (three studies in Canada in the last ten or so years all found no collusion). The manager we spoke with isn’t even allowed to so much as golf with anyone from a competing oil company.

Perhaps our price sensitivity is fueled by our outrage that gas prices should be so high. In the end, it doesn’t really matter. The supply and value chains of pulling a barrel of crude out of the ground and turning it into gasoline are very complex. I could go into more detail, but suffice it to say that there is pretty intense competition at each transaction level. The bottom line for retailers is that margins are low on their end product, which is why they charge exorbitant prices for bottled water and salty snacks at gas stations – it is all about getting us in the door, and it is quite obvious that we will go wherever the signs tell us that prices are lowest, even if it means a more expensive cola.

The point of all this? Well, when you’re thinking about saving money, think about how you’re spending your time (a very finite resource). Make sure it is making you happy. Imagine what you could do instead of driving across town to save $10 on an ipod, and then ask yourself, which would I rather have: $10 or an hour with my honey?