Why Do Companies Compete Harder on Black Friday?
The easy answer is because there is so much buying going on that day, companies do not want to miss out on their share. But that doesn’t feel very complete. Don’t companies care about winning business in March too? Yet they don’t compete as ferociously in March. Why not?
To be honest, I struggled with this question. For years I hadn’t had an explanation that felt right yet. Earlier this year I recorded a podcast with Rebecca called, Prisoner’s Dilemma (and what the heck it has to do with pricing).
I won’t go into a review of the prisoner’s dilemma, but here is a quick summary of the outcome. When companies compete, they each have an individual short term incentive to lower price to steal market share from the others. However, since the others would probably just lower their price too, nobody wins. Hence, companies tend to not price aggressively because they know it won’t really help them in the long run. This is called implicit collusion. When this breaks down, firms find themselves in price wars which destroy profits for the industry.
Rebecca, being the phenomenal podcast host that she is, asked for examples of when this breaks down. I obfuscated and said something brilliant yet evasive (like a politician). A few weeks later, it hit me: Black Friday. I so wanted to go back and re-record the podcast but alas that ship had sailed. So today seems like the best day to publish this addendum.
Think about Black Friday. If all companies kept their prices high, we would still probably go shopping and buy Christmas presents. All retail profits would probably be higher if nobody had sales between Thanksgiving and Christmas. Yet, if one retailer has a great sale, that company wins a much larger portion of the business.
If the prisoner’s dilemma solution was effective here, other retailers would “punish” that retailer by dramatically lowering prices, making it so nobody would earn much profit. The result being everyone would raise prices back up. This is what happens throughout the year. If only one retailer lowered their price in March, then in April all retailers would copy, “punishing” the first retailer, and eventually they would all bring their prices back up. This is one reason why retailers only have short term sales.
But this doesn’t work with Black Friday. Black Friday is a once a year event. Once the Christmas buying season is over, any punishment is so much smaller than the gains during this one time of year.
If retailers were very long term thinkers, they would realize that next year they could get punished for their behavior this year. But who believes anyone remembers what happened last year?
The reason companies compete harder on Black Friday is that:
- There is a huge increase in buying during the season
- There are huge gains to one retailer if it is the only one lowering prices
- There is not an effective punishment mechanism when one company lowers prices
Hence, all retailers have sales today, Friday November 24 2017 … Black Friday.
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