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Convenience of Money

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An interesting piece by Tim Harford, the author of The Underground Economist, appeared in Slate Magazine last year that discussed price rigidity, using a classic example. The price of a bottle of Coca-Cola remained at a nickel for over Glass Bottles Always Taste Betterseventy years, an incredible fact given the long-term inflation of so many other prices, including those of its main ingredients. Yet Coke was hard-pressed to raise the price in order to stabilize their margins because of the vast leap between a nickel and a dime. Indeed, the next-highest denomination resulted in a full doubling of the price of a bottle of the world’s favorite soft drink. In the 1950s, when a price change was absolutely necessitated, Harford tells us that the, “…boss of Coca-Cola wrote to his friend President Eisenhower in 1953 to suggest, in all seriousness, a 7-and-a-half cent coin.”

This may seem like a bit of a comical notion, but the lack of flexibility in US denominations did adversely hurt Coke, allowing its time-honored competitor Pepsi the chance to use their famous slogan, “Costs a nickel, worth a dime.” A similar situation faces soft drink bottlers and various other vendors today. Across the country, it appears that prices are being pushed past $1.00 for a 20 Oz. bottle and $0.50 for a can en masse. While prices obviously differ from place to place, the new ceiling for cans tends to be around a dollar, indeed a doubling in price.

No Coke, PepsiBut the fact that it costs twice as much isn’t the issue anymore. Indeed, even the poorest among us would rarely be found complaining about the average price of a can of pop/soda/insert-your-regional-slang-here. The problem now is what I call “convenience of money”. While $1.00 is a nice, round figure, bottles are left in an odd predicament. In most cases, $2.00 would be seen as too high of a price, and on an ounces-per-dollar basis would be less of a value than a dollar can. Prices for bottles have fidgeted often around the $1.25 point. Even though this is much more reasonable than $2, I would surmise that Pepsi and Coke’s sales don’t show as large of a difference between $2 and $1 as they show between $1 and $1.25 due to a demand curve bent as if by gravity to the easiest combinations of monetary denominations.

The problem is that blasted quarter. People just don’t carry change like they used to, and while there may be a few $1 bills in their wallets, the likelihood of being able to finish the transaction with a quarter is much smaller. Indeed, in this day and age, it is a $1.25 bill that Coke and Pepsi should request from the US Mint, rather than the 7 1/2 cent piece of old.

Broadly speaking, it might be even better for the soda companies if dollar bills were to simply be taken out of circulation, replaced with dollar coins entirely. The Mint has tried again and again to get people to switch over voluntarily to a higher-denomination coin. Yet the embattled green portrait of George Washington survives with nary a scratch.

Dollar-scanning machines tend to break down more often than their coin-only counterparts and can become an issue when dispensing return funds when more than one dollar bill has been submitted. Vending machines have already mostly been converted to accept dollar coins, whether they are of the Susan B. Anthony, Sacagawea or Presidential variants (all share the same size and weight). Coinage loves company, as well; having dollar coins on hand makes it more likely that smaller coins will again find their way to people’s pockets, making $1.25 not so awkward a price, after all.

Another tactic has been to switch to plastic: more and more machines include credit card swipers on the front, which allow consumers to either swipe their RFID-enabled card or their old-fashioned magnetic strip to purchase some edible goodies. Overseas, cell phones are often used for transactions, with the final tab simply added on to a phone subscriber’s bill at the end of the month. Both methods take the actual money out of the equation, leaving only the true price for customers to consider; having a quarter on hand isn’t a part of this purchasing decision. While these alternatives do carry transaction costs, a price point of, say, $1.35 for credit card purchases vs. $1.25 for cold, hard cash would not scare away many customers looking for a caffeine fix. Or, perhaps, not having to be as concerned about machine break-ins, drivers having to carry around so much coinage and cash and technicians having to fix the mechanical pieces required to process the money would present a large enough savings to vending companies to make the transaction costs a wash.

One caveat is that higher prices still carry a psychological barrier to customers. Especially in these smaller denominations, people have been taught to think in coins. Perhaps $1.35, then, is a larger leap for some people than it honestly should be. Certainly $1 seems like a much better value than $1.15 would be, for example. But alternative payment systems strip away the physical tie to this price psychology and affords companies more flexibility in adding more balance-sheet “bounce to the ounce”.

Written by caseyayers

8 October, 2008 at 4:00 pm