Describe an example of how prices are set, and quantities established, in some market that you know.

K.3.      Describe an example of how prices are set, and quantities established, in some market that you know.  You can use an example from work, or from a market where you are a consumer, or just an outside observer, but it should be a market personally known to you.  You should identify who (not by name!) makes the pricing decisions, what information they use to do so, and what sort of changes in their operating environment lead them to change prices or pricing strategies.   In this context, review Note 10 and describe any connections that you see to our pricing discussion and Note 10.

I am including an example below from my own experience; this is not a template, just an example.  (This may be a little dated; it’s based on some consulting work that I did more than a decade ago.)  Answers should be at least 500 words long; the following is around 750.

Example

I describe here the wholesale market for Washington state apples.  Orchards supply apples to packing houses – wholesalers –  on consignment; the packing houses pack, store and sell the apples.  Apples are sold by packing houses to customers such as supermarkets; the basic unit of measure is the 42-pound box.  The major packing houses have teams of sales people.  They typically work together in a single room, sometimes around a single table.  Each has a headset that allows him to talk to customers without his conversation interfering with the other conversations around him.  The sales people know the current and expected inventory of apples for their packing house and, in rough terms, the inventory positions of their competitors.  They typically deal with a limited range of customers that they know well.  One key to the operation is that the salesmen are continually exchanging information with each other; if a customer claims that a rival is offering a lower price, the sales person will ask the other sales people (muting his phone) what they have heard.  In this way the sales people try to have better information than their customers, allowing them to know when to adjust price.  The purchasers are typically large firms themselves and bargaining plays a central role.  The sales people have responsibility for setting price, but have incentives (commissions, job tenure) that encourage them to achieve the highest price possible.

Prices are affected on the demand side by economic cycles, opening of new markets, introduction of new apple varieties, and the changing brand identity for Washington state apples.   Branding in particular, and opening new markets to a lesser extent, raise issues of collective action and self-interest.  Washington state apples became a brand partly due to advertising by the state apple association, based on the red and golden delicious apples.  This was successful, moving the demand curve out, but it was funded by a mandatory fee on each box of apples sold.  This fee was overturned by the Washington State Supreme Court.  So now there is a considerable free rider problem, with some packing houses not contributing to funding the brand identity.  That said, Washington state apples maintain some product differentiation from apples from other sources, especially in international markets.  No individual packer or orchard has separated its brand significantly from its competitors that I know of. 

The chief factors affecting supply are the harvest and the time of year.  A large harvest creates greater pressure to move apples, and sales managers can authorize lower prices than normal as a result.  However, apples can be stored for several months, so another key supply feature is the length of time that the apples have been in inventory; as they near the end of their storable life, there is a greater pressure to sell them and lowered prices are more likely, since customers are fully aware of this.  Also, quality declines as time in inventory increases.

Importantly, the supply of apples to the wholesalers is not very sensitive to price in the short run.  It takes several years for an apple tree to reach maturity, so quantity cannot be increased rapidly as prices rise.  Weather is the most important supply determinant in any given year.  Once a given season’s crop is harvested, quantity is fixed.  Harvesting costs are significant, but the orchards still try to harvest their full crop even when prices are low to maintain the health of the orchards as well as earn some revenue.  Consequently, for a given year the quantity decisions are taken before prices are known with any accuracy.

That said, rising prices in recent years have brought smaller apples to market that previously would have been treated as “culls” for juicing or applesauce. 

The consignment structure matters: it means that the packing houses turn a profit even in times of weak demand.  Typically, they charge a fixed commission per box, with the orchards receiving the residual from the selling price less the commission.  However, packing houses compete for supply and so have a strong incentive to get the best prices possible to retain the loyalty of the orchards.  This is the chief strategic concern in pricing, although the quality grading of the incoming apples is also important.

The market displays several interesting pricing aspects, including trying to maintain bargaining power over time for a perishable product, the conflict between collective branding interests and self-interest, the impact of supply quantities, and the strategic impact of the consignment prices on relationships with the orchards.  To my knowledge, product pricing is simple and “linear”: customers negotiate for certain varieties and qualities on a per box basis, although quantity discounts play a role.  Reference prices play only the most informal and fluid role: every salesperson thinks that there is no real rival.