Walmart, the largest American retailer, is set to introduce digital shelf price labels in 2300 stores, a move which has been causing some unrest. This technology can improve operational efficiency by replacing tedious, manual interventions to update shelf prices with a single mouse click, and in the process reduce the likelihood of errors or omissions. But some see it as a precursor to “Uber-style” surge pricing, which closely tracks the demand, raising the price of a ride when demand peaks occur. Is it likely supermarkets would follow suit, perhaps updating prices as frequently as six times per minute? And are prices that reflect actual supply and demand a bad thing?
Prices speak
The price of a good (or service) carries critical information for both consumers and producers. When supply and demand are fully balanced, everything that is offered is taken up, and everyone who needs something has their need satisfied. In economic language: the resources are allocated the most efficiently. The remarkable economic device that brings this optimum about is the price. In a free market, the price will tend to settle at a level where this equilibrium is reached. If, for some reason, the supply exceeds the demand, suppliers will compete to get rid of their excess inventory (or utilize their current excess service capacity) and lower the price. This will inform suppliers to produce less (or reduce their capacity), and tell potential buyers that they can get more for their money, thus both reducing supply and increasing demand, so equilibrium is restored. Conversely, if it is the demand that outstrips the supply, it is consumers who will compete for scarce products or services, prepared to offer a higher price. This will send a signal to suppliers to produce more (or increase their service capacity), and encourage consumers to reduce their consumption, thus both increasing supply and reducing demand and, again, restore the equilibrium.
It is intuitively clear that, to quickly reach an equilibrium where resources are allocated efficiently, prices need to be an up-to-date reflection of supply and demand. In financial and commodity markets, where prices are updated in real time, this is indeed the case, and traders can adjust their positions accordingly, often multiple times per day. However, while a single trade is unlikely to affect demand or supply enough to influence the price level, when prices are constantly adjusted, automated high frequency trading can lead to ‘flash crashes’, such as the one in 2010, when the Dow Jones Industrial Average index lost around 1,000 points (or 9%) in 10 minutes (though much of this was recovered by the end of the day).
But this is a long way from the retail market for groceries, where, unlike in financial markets, the roles of seller and buyer are clearly separated, and the buyers are consumers. Their demand is ultimately limited by what they can consume, and while that may fluctuate, for example seasonally or between days, depending on the weather, it is usually not remotely as volatile as demand in financial markets. On the supply side too, retailers’ input prices tend to be contractually agreed with their suppliers for relatively long periods of time. The resulting price stability and predictability is exactly what is appreciated by the consumer.
All is quiet on the grocery front…
All this suggests unexpected peaks and troughs in supply or demand are unlikely to happen, and so there is little need for surge pricing to even out a sudden imbalance. The notion of prices changing as frequently as six times per minute seems somewhat removed from reality: just imagine the logistical problems of customers having to pay a different price at the till than the one that was shown on the shelf. Systematic price changes on the fly while the store is open seems a definite non-starter, if only for practical reasons, and while in some European countries (notably France, Scandinavia and Belgium), digital price labels have been in use for some time, there have been no reports of surge pricing.
Nonetheless, just like prices themselves are a signal to producers and consumers to change their behaviour, talk about the adoption of electronic price labels seems to be a signal for some to grow suspicious of the retailers’ motives. They expect the technology will be used to take unfair advantage of the consumer. Some of this suspicion likely stems from cognitive biases. Even though dynamic pricing means prices will go up and down, depending on the supply/demand situation, consumers will experience price increases as a stronger negative effect than the positive effect of equivalent price drops (loss aversion), the more so as they will tend to take the lowest price as a benchmark (anchoring). This perception might fuel conspiracy thinking – retailers are colluding to overcharge their customers – especially among people who do not understand the market mechanisms of price setting. Anyone who was already suspicious of the purity of Big Retail’s motives is more likely to see such a disruptive change as a shady move.
But there are more sensible reasons to be circumspect. In principle, retailers might exploit their ability to update prices to protect or enhance their margins, or to make comparisons more difficult through constantly changing prices. Such practices might disproportionately hurt vulnerable people who are unable to track prices, or to shop at the most advantageous times. Ultimately, however, competition in the grocery market is focused primarily on low prices and trustworthiness (in both honest sales practices and product quality). Engaging in dynamic pricing that may be seen as unfair runs a significant risk of losing this trust, so it may simply not make economic sense for retailers to go there.
…except when it is not
One extraordinary situation where actual surge pricing might make sense in the grocery market is when there are sudden demand spikes, as we experienced during the COVID-19 pandemic. People began hoarding low-cost essentials like toilet paper and bottled water, leading to immediate shortages, and indeed altercations in the stores. While such conditions are uncommon, when panic buying is likely, manipulating the price ahead of the demand might well help stabilize things before they get out of hand. To avoid accusations of profiteering, the electronic labels could easily be used to warn customers that the opposite of “buy one, get one free” will be implemented: a second pack of toilet rolls will be charged at twice the price, to prevent hoarding.
The negative response in some quarters to the introduction of electronic price labels seems to be an overreaction. It is, of course, good to always be vigilant, but market mechanisms and long-term self-interest will keep retailers in check, should they become tempted to misuse the system to exploit their customers. The new technology will make it just that little bit easier to enable prices to influence – as they are supposed to do – the behaviour of the participants in the market to ensure optimum allocation of the available resources.