First published in Business Life magazine, February 2008
I recently saw a blast from the past: an independent coffee shop trying to charge an extra ten pence for a Fair Trade cappuccino. Fair Trade coffee is bought from certified coffee growers; they receive a premium, and a guaranteed minimum price. And so it might seem reasonable for a coffee shop to ask its customers to pay more for a Fair Trade cappuccino.
It isn’t, because there is very little coffee in a cappuccino – about seven grams of beans, or a quarter of an ounce. The Fair Trade premium, so important to a struggling grower in Kenya or Ecuador, is typically less than a penny when applied to such a small quantity of coffee. When a coffee shop charges ten pence extra for a Fair Trade cappuccino, the grower gets his due, but most of the mark-up is profit for the shop.
That sounds cynical, if unsurprising. But an alternative way of describing the same situation makes it seem much odder: the coffee shop is willing to slash prices and take a big hit to margins if you don’t buy fair trade coffee. Profiteering is one thing, actively working against fair trade is another. Why does it happen?
The coffee shop – like many businesses – faces a dilemma. Raise prices and it loses some customers; cut prices and it loses margins. Sometimes, however, it is possible simultaneously to raise prices to price-insensitive customers while cutting prices to the customers who are hungry for a bargain. Grown-up economists call this “price discrimination” – I call it “price targeting”.
Outside the bazaar or the used car forecourt, customers rarely accept the idea of haggling for a special price. So businesses work out their own methods of price targeting. The discount for students and pensioners? You might just as well call it a surcharge for people with a job. Kids eat for free in this family-friendly restaurant? Childless couples have cash to burn and can be offered a bit less for their money.
And in the coffee shop, fair trade coffee is a terrific marker for price-sensitivity. Anyone willing to pay ten pence extra for fair trade coffee is demonstrating that she doesn’t mind paying a bit extra.
The first rule of price targeting, though, is that it should never aggravate the customers. Economists started to point out what was happening, customers got cross, and the big chains now tend to offer fair-trade coffee without any mark-up.
That makes sense: they have plenty of other ways to identify price-insensitive customers, which is something to think about next time you pay thirty pence for a couple of marshmallows on the side.