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

December 17th, 2015
in aa syndication

Fixing the Economist Article of the Week

by Philip Pilkington

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.

Follow up:

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.

Back in 2013 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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