Quantity Rationing as Business Strategy: Furthering the Case for a General Theory of Pricing

Ration-Book

My last post on my attempts to create a general theory of prices met with some positive responses. I’m not hugely surprised. Any thinking person who has ever entered an undergraduate micro course has questioned the validity of what’s being taught. Although neat, it does seem to fly in the face of the economic realities encountered in the real-world.

One of the purposes of laying out a general theory of prices is to allow for a framework that can accommodate the massive variety of decisions undertaken by everyone from investors to firms to set prices in capitalist economies. The aim is to get rid of the notion that there is some sort of pre-determination to these decisions and that they can be modeled in some a priori manner.

Again, the idea is that in order to understand pricing in capitalist economies it is the responsibility of the economist to actually inquire into the reality of the price-setting process rather than just making up deductive arguments that are then projected onto the outside world. A general theory of pricing would provide a simplistic and highly flexible framework that can be used to discuss such empirical issues.

Here I would like to lay out a particularly unusual instance of price/quantity setting by a firm. The importance of the following example is not that it is general but rather that it is so particular. It is the unusualness of the following example that gives it the force of the exception that disproves any a priori rule.

Earlier this year the Abercrombie and Fitch CEO Mike Jeffries caused controversy when he said that he didn’t want overweight or unattractive people shopping for his brand. Jeffries also put his money where his mouth was in that the Abercrombie and Fitch shops were not stocking sizes that would accommodate overweight people.

Jeffries comments and Abercrombie and Fitch’s policies set off a firestorm of disgust at the elitist posturing of the company. Many even got a good laugh out of the fact that Jeffries… well, let’s just say he wouldn’t be featuring on any Abercrombie and Fitch billboards any time soon.

All these criticisms, however, missed the point. Jeffries is not an idiot. He knew exactly what he was doing. He knew that his comments would cause controversy but he also knew that they would play into Abercrombie and Fitch’s business strategy. As Forbes noted:

What Jeffries has done with years of obnoxious, exclusionary comments is sharpen the brand identity of A&F, and portray its customers as a select group – young, attractive, and popular. When he says he doesn’t want customers who don’t fit that image, he’s making his current customers more loyal and making the prospect of becoming a customer more attractive… Every time a critic trumpets, “Mike Jeffries is terrible for not wanting overweight or unattractive people in his stores,” they are propagating the exact branding message he’s trying to promote. Will A&F lose a few customers because of their obnoxious CEO and corporate ethos? Probably. But it will be no surprise if they end up adding new customers and increasing sales even as the controversy rages.

Exactly right. This was not some stupid gaffe on the part of Jeffries. No, this was a clever and calculated business strategy.

What is interesting about this example from the point-of-view of economic theory is that what Abercrombie and Fitch are doing is basically rationing. But they are not doing so to control price as in the typical economic theory of monopoly. Rather, by only stocking specific sizes in their shops Abercrombie and Fitch are bolstering the exclusivity of their product. This, perversely from the point-of-view of neoclassical theory, increases the quantity of goods sold and allows the company to increase its prices relative to its rivals due to the status of the product.

In terms of neoclassical price/quantity theory what Abercrombie and Fitch are doing is madness and makes no sense. But from a business point-of-view it is a genius move. Once again, the reason that the neoclassical theory fails when confronted with Abercrombie and Fitch’s strategy is because it assumes a fixed relation between supply and demand and between quantity and price. But these considerations have little sway in the real world and the Abercrombie and Fitch example merely highlights this is a particularly striking way.

A properly general theory of prices would accommodate such disparate and seemingly contradictory business strategies. It would not make any a priori judgements about how successful companies set their prices and ration their quantities. Instead it would provide a framework in which we can discuss such interesting particularities rather than one that needs to be twisted this way and that to accommodate them while immediately biasing the user as to the potential success of such strategies.

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About pilkingtonphil

Philip Pilkington is a London-based economist and member of the Political Economy Research Group (PERG) at Kingston University. You can follow him on Twitter at @pilkingtonphil.
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14 Responses to Quantity Rationing as Business Strategy: Furthering the Case for a General Theory of Pricing

  1. Lord Keynes says:

    Have linked to your posts on prices in an update here:

    http://socialdemocracy21stcentury.blogspot.com/2013/08/lees-post-keynesian-price-theory_17.html

    Regarding the “Teleology and Market Equilibrium” post, I am reminded of the the Oxford Economists’ Research Group in the 1930s when they actually asked businessmen people how prices were set:

    “In fact severe questioning by the Group failed to uncover any evidence that the businessmen paid any attention to marginal revenue or costs in the sense defined by economic theory, and that they had only the vaguest ideas about anything remotely resembling their price elasticities of demand. The Oxford economists were shocked, to say the least.” (Lee 1998: 89).

  2. Scott says:

    I wonder what neoclassical theory would think of marketing channels? I can remember a businessman in selective (a few stores, mid price) specialty books/coffee deciding to compete with a large intensive distribution (many stores, low price) book retailer by opening up nearby. He went broke because customers demanded the same lower price from him that they demanded from the large bookseller. A larger company can take advantage of a channel distribution strategy by selling generics at a lower price, selling a similar relabeled product for more elsewhere and having a exclusive relabeled product (one store or distributor, massive price) at a higher price. https://www.boundless.com/marketing/marketing-channels/marketing-channels-in-supply-chain/selecting-marketing-channels/

    • Neoclassicals would usually use monopoly/oligopoly models to explain this phenomenon. They can and do accommodate this, but in my opinion it begs many questions as to their over-arching theoretical framework.

  3. A very interesting juxtaposition of rationing and the free market, two concepts usually considered polar opposites.

  4. David says:

    You had me on the A&F strategy until you talked about increasing quantity sold. The A&F strategy seems more like market segmentation (like airline tickets) where the goal is not to increase quantity sold, but to support a higher price for a smaller portion of the market (i.e. harvesting some of the consumer surplus). For airlines charging higher prices for refundable coach tickets (aimed at business travelers), they don’t get increased coach sales, they get more money per sale. The issue of increased quantity seems secondary, if and only if, the extra prestige causes increased buying by current customers or an influence of prestige-seeking new customers.

  5. Forlorn Hope says:

    Ok, this kind of makes sense but I’m not sure how this contradicts neoclassical theory in the grand scheme of things. Nobody these days is claiming that economics exist in a vacuum. There are business decisions and there are economic decisions and the latter inform the former. A&F *business* strategy is not entirely unique (although their obnoxiousness rather is); Apple also follows a strategy of exclusivity. The economic theory of price setting would still be valid within the given framework of the constrictions in place. A&F are maximising utility for their given market. Their desire to differentiate themselves is a business decision while the pricing of their products would still follow the economic theory, otherwise their target market would be put off by the prices that are either too high or too low.
    Now, economics is a social science and A&F’s strategy is yet to be thoroughly time tested. Social pressure can be enough to poke some major holes in A&F’s plans. If their target market proves to not be strong enough to withstand outside societal pressure (unlikely in my humble opinion but still worth a mention), the neoclassical economic theory will get rammed into them pretty hard.

    • I think this is the point where qualifications begin getting made that begin to render the underlying theory meaningless. At one point in his paper “Noise” Fischer Black says something along the lines of “we don’t want to throw everything and anything into our utility functions”. I think he’s more fastidious than most neoclassicals, to be honest. The fact is that A&F are engaged in explicit rationing and this is not supposed to occur in markets according to neoclassical theory. Yes, you can bend the theory to accommodate this but then the question must be raised: at what point does bending the theory break it? At what point does twisting the theory to fit the facts render the theory useless?

      Obviously, I think that the point is reached here. If explicit rationing can lead to profit maximisation the theory has broken down.

      Further than this though, A&F as you say is not unique. We can find these practices all over the place. A&F is just a particularly interesting one. But such marketing strategies exist all over the place, really. Not quite as explicit in their rationing, but still undertaking it to some extent.

      Finally, I would add that if A&F change their strategy because of social pressure this says very little about the correctness of neoclassical theory. Rather it says a great deal about mobilised political action. (Personally I think that A&F can do what they want, but that’s just me.)

  6. Great read!
    Congrats on getting pressed!

  7. confessdeny says:

    U sure this Jeffries isn’t working both sides and bought shares in junk food too? Make us fatties all really depressed and we’ll eat more 😉

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