This September, a large international fair takes place in Frankfurt. Say you work at an airline company or manage a large hotel chain. Given the tremendous demand around the event, how high would you quote your prices? Would you keep raising them to maximize your profit? Or would you stop at some point and rather sell out all the available spots?
Now put yourself in the place of a customer to this fair. When you see a hotel room or an airline ticket that is 5-10x the price of what you would normally pay, how would you feel? How likely are you to opt for the same airline or the same hotel chain the next time?
Economic theory tells us that prices ought to rise or fall until supply meets demand. Several economists are likely to advice the hotel or the airline to raise prices until demand falls to meet the limited supply and profit is maximized. However, that doesn’t go down well with customers. Once the fair is done, they are unlikely to return to the group of hotels or the airline that fleeced them during a time of need. Most services companies understand this, and they cap off their prices at some point rather than squeeze the market for every bit of profit. By putting themselves in the place of their customers, the managers at these companies realize how raising prices could maximize profits in the short term, but could hurt profitability in the long term.
Every company juggles short-term profitability with long-term customer relationships. The decisions they make depend on how they see their customers – as a person who transacts with them just once or as one who would walk through their doors again and again.
Inspiration: Misbehaving – Richard Thaler