Why Buy-One, Get-One-Free Offers Are More Complicated Than You Remember (maybe it is because of price discrimination)

Marketers’ race for data is leading to buy-one-get-one deals that make customers work a little bit harder

By Katie Deighton of The WSJ. Excerpts:

"Buy-one, get-one-free offers are evolving from one of marketers’ simplest and most alluring tools to…something more complicated. 

BOGOs, as they are called in the industry, once mostly existed to help companies clear out excess inventory, hit sales targets or go head-to-head with competitors at key moments. But marketers’ increasing obsession with data means many of their offers now come with red tape that is designed to either help collect information about their consumers or capitalize on a data-driven insight."

"Customers who order a Domino’s pizza online under the chain’s current “Emergency Pizza” promotion, for example, can’t get their promised free second pie at the same time. They have to collect that freebie in a subsequent online order. And they have to belong to the company’s loyalty program to participate at all.

The Emergency Pizza campaign has a goal beyond just moving pizzas, said Kate Trumbull, chief brand officer at Domino’s. It is also designed to drive memberships in Domino’s Rewards, Trumbull said. Such programs let businesses collect data on customer spending habits to better tailor their marketing and wider business strategies."

"At the heart of a complex BOGO deal is the economic principle of price discrimination, in which sellers try to keep deals and discounts away from “price insensitive” shoppers who would likely pay full price in any instance, said Scott Neslin, a marketing professor at Dartmouth College’s Tuck School of Business.

Making customers work a little harder for deals increases the chances that only price-sensitive consumers collect, thereby helping to protect a company’s margins, Neslin said.

“The complexity throws up a barrier that only the price sensitives are willing to transcend,” he said.

California Pizza Kitchen last month offered a BOGO with a similar twist to Domino’s, but tweaked the reward: Customers who ordered a cooked pizza at a restaurant were offered a free “Take and Bake” pizza to cook at home. The free, uncooked pie was only handed out when they returned to the restaurant."

Businesses can make more money if they charge different prices to different buyers instead of just one price to everyone.

Charging different prices to different groups of customers based on their ability and willingness to pay (a discount) is price discrimination. Buyers with a lower price elasticity of demand will be charged a higher price.

If the firm were to charge the same price to each group, they would actually make less profit since they would end up violating the rule which says "choose Q so that marginal revenue (MR) = marginal cost (MC)."

Suppose a firm has two groups of customers, A and B, shown below. Group A's demand is generally less elastic. The blue line is demand. Green is MR. The flat line is both MC and ATC (average total cost). Having ATC = MC is not realistic but it simplifies the explanation.

The darker red lines just show us how to find P and Q for each group. Profit is Q*(P - ATC).




Now group B


Group A profit) 8*(24 - 8) =128

Group B profit) 12*(20 - 8) = 144

Total profit = 128 + 144 = 272

What if they charge both groups 22?

Group A profit) 9*(22 - 8) =126  (at Q = 9, MR does not equal MC)

Group B profit) 10*(22 - 8) = 140 (at Q = 10, MR does not equal MC)

Total profit = 126 + 140 = 266

So there is less profit (266) if they charge the same price to each group than if the price discriminate (272).

Economist Robert P. Murphy gives an example of how there is nothing wrong with price discrimination:

"the granting of special pricing for certain groups need not harm the groups paying full freight.

For example, if a movie theater in a small town were barred from giving child, student, and senior discounts — and instead had to charge one ticket price for all customers — it might not be able to stay in business. It would hardly help the middle-aged adults to have a "fair" pricing policy with no theater in town. This example shows the pitfalls in thinking about "the cost" of providing a seat in a movie theater and deriving the "fair" price that a theater ought to charge all customers."

See The Economics of Coupons and Other Price Cuts

Also see Price Discrimination by Tejvan Pettinger. A key passage is:

"Price discrimination will enable some firms to stay in business who otherwise would have made a loss. For example price discrimination is important for train companies who offer different prices for peak and off-peak. Without price discrimination, they may go out of business or be unable to provide off-peak services."