Tuesday, February 5, 2008

Retail Markets - 6

We’ve talked about shopping as an information gathering activity---finding out about price, product availability, and product quality. There is another aspect of shopping ---purchase and transport from the store to the home. This part of shopping is also costly. One can focus on the explicit transportation costs. If an automobile is used that would be a function of the mileage and would include the implied gas, maintenance, and depreciation costs. If public transportation is used, there are charges for that. The opportunity cost of the buyer's time is probably the bigger component of the overall cost.

The critical point to observe is that to a good approximation these costs are independent of the amount purchased. You have to go to and from the store whether you buy a lot or a little. (Admittedly, time spent in the store as well as time spent loading and unloading the goods likely depends on volume of purchase. It is okay for our argument to have some of the time cost proportional to volume as long as there is another component of the time cost which is independent of volume). To economize on these transport costs, you shop and then store some of what you purchase rather than shop as the need arises.

When restocking their merchandise, retailers also face delivery costs that are independent of volume. This means the total cost of purchase per unit, which includes the delivery charges, is declining in volume whether there are explicit price discounts for volume purchase or not. Consequently, retailers have incentive to buy in bulk and sell off their inventory over time, quite apart from the incentive to hold inventory because demand is unpredictable. The result is a time pattern of inventory that shoots up at the moment of restocking and then gradually declines as a consequence of buyer purchases until the next moment of restocking.

Costs that don't depend on volume are termed fixed costs. Costs that increase with volume are termed variable costs. Because of fixed costs it often makes sense to do an activity at a sufficient volume or not at all rather than do it at a low level.

When you go to a store and see that there is little on the shelf of a particular item (or that the store is entirely out of that item) do you know the cause? That is, can you tell whether its because there was a run on that item at the particular store, or if there is excess demand for that item overall in the market, or that the firm is scheduled to have the item restocked very soon?

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