In this Edition
As I have done before on occasion, with this edition of the Amphora Report, I take a break from my usual doom and gloom and offer up an economic parable, this time for the summer holidays. I encourage interested readers to consider the morals of this story. There is more than one, including some that are rather subtle. Please feel free to contact me if you think you have uncovered one of these at: john.butler @ amphora-alpha.com
Commencement Day
As with many of his classmates, Jack arrived at his commencement day ceremony with a sense of forboding. Notwithstanding an honours degree in business studies, with a concentration in marketing, he had yet to land a job. Sure, there were some jobs out there, as the career office had advertised all year, but there was next to nothing in marketing.
Jack’s primary academic interest was literature. He loved to read stories as a young child‑ somewhat rare for a boy‑and as he entered his teenage years he was reading classics old and new. He was especially fond of fantasy novels, such as the Harry Potter series and the Northern Lights and Lord of the Rings trilogies. At 13, he had even read his first Philip Dick novel, Total Recall, although at that young age he found it tough going.
One of the great joys of literature is discovering how similar themes arise in widely different works, presented in different ways, offering contrasting interpretations of their meaning and stimulating original thought on the part of the reader. For example, in all of the works listed above, things are rarely as they seem. Sure, there is a protagonist (or small group of protagonists) at the centre, with a steady moral compass, yet nearly all other characters, major and minor, hold deep, esoteric secrets, and their occasional revelations represent key turning points in the plot.
On entering the state university four years prior, Jack’s intent was to major in English Literature with a concentration in modern fiction. However, by late 2008, the rarefied academic atmosphere of the campus had become polluted with the effluvial news of the escalating financial crisis. The possible collapse of the financial system, of the economy, and what this implied for students, many of whom were taking on debt to obtain their degrees, became a topic of daily conversation.
But it was not until commencement day 2009 that reality hit the campus hard. The proportion of graduates that had landed jobs had fallen sharply, to a record low, and Jack and fellow students in his year, 2012, were well aware of this frightening fact.
Jack was not alone when he began to consider changing his major to something more practical, which still drew on his literary skills and interests, but with a business orientation. Early in his sophomore year, he settled on business studies, in part because his university had such a highly regarded departmental faculty, including several who had actually worked as marketing executives at major firms. The faculty had consistently placed graduates at those firms where they had worked and also others. What could be a more practical course of study than one with a built-in jobs placement agency?
Jack excelled at his studies, which led to his earning an honours degree, one of only two awarded in the department that year. He was consistently on the Dean’s List, wrote a prize-winning thesis on rhetorical techniques for social media marketing, landed a sweet summer intership and, in his senior year, had multiple members of the departmental faculty arrange for interviews with senior executives of potential employers. Yet he received not a single offer. Nor did any student in the entire department.
And so it was. Jack and his fellow students marched despondently into the stadium that commencement day, not at all certain what was commencing, only that the relative security of academic life was ending.
Back in high school, Jack had worked summers at a pie shop down by the lake. It was a popular hangout for those who kept boats, or who came to jet-ski or windsurf, and they always needed extra staff in the high season. By his third summer, Jack had mastered the pie-makers art, producing pies of the highest quality. Mr Rechnen, shop owner, manager and head pie-maker, made Jack an offer to stay on following graduation and to start as a full-time assistant manager, with an attractive salary for anyone without a college degree, especially an eighteen year old.
It was tempting, to be sure. Jack was still living at home at the time and the salary, combined with low expenses, would allow him to save enough money to be able to purchase a simple home within just three years. He often dreamed of having a home on a particular hill above the lake, with a fantastic aspect and quiet surroundings. It was an ideal location to start a family. But that was all for later. The priority was to get the best job possible. That meant going to university, where he had already been accepted.
Sure, he would run up some student debt in doing so, rather than earning and saving money working in the shop, but long-term he assumed, as did his classmates and parents, that the benefits of a university degree far outweighed the costs.
But now, on that commencement day four years hence, Jack felt as if he had made a horrible mistake. Rather than graduating with a degree but no job, and with a pile of student debt, he could have saved enough to buy that house. He might even have been promoted to manager when Mr Rechnen decided to step back a bit from the business last year. He would be debt free with the exception of a low-interest mortgage on his property. His property!
Along with a handful of his better friends, after the pomp and circumstance of the commencement ceremony, he went down to the local pub to do his best to celebrate his achievement. No doubt it was an achievement: An honours degree from a respected department at a respected public university was nothing to sneeze at. But his academic pride failed to fully offset his fear of what lie ahead.
“Hey Dan,” he said to his best friend, raising his 10oz glass of IPA beer, “Here’s to our degrees.” As with Jack, Dan had no job lined up.
“Cheers, Jack.” He replied. They both drank.
“Jack?”
“Yeah man?”
“What are we going to do? I mean, are we going to just move back in with our parents? Get basic jobs and wait out the weak economy?”
“I don’t know. I suppose so. What other options are there? Enlist?” The expression on his face showed he wasn’t entirely serious about that option.
“I can’t go back home,” Dan replied. I will feel like a failure.”
“Now look. We are not in this predicament because we failed. We are in it because the economy has failed us. Don’t forget that.”
“Hey bartender,” Jack called to the young lady working the bar who seemed even prettier now than when he and his friends first arrived. “Another round of IPAs, please.”
Jack and Dan downed the dregs of the previous round just in time as the next arrived. “Hey,” Jack spontaneously asked the bartender, seeking female conversation, “Why do you serve these IPAs in 10oz glasses? The other beers here are all served in 12oz. What gives?”
“Well the IPA is more expensive beer. It is simpler to serve it in 10oz glasses and charge the same price for all beers. Rather than charge more and potentially muddle things up, you just reach for the specified glass and pour until full. Makes for quicker service, fewer mistakes making change and the customers don’t seem to mind.”
As the bartender made her way back down the bar to a waving patron’s hand, a light went on in Jack’s mind. He was suddenly somewhere else, staring off into space.
“Jack?” asked Dan. “Are you still with us?”
“That’s it!” Jack exclaimed. “That’s it!”
“What? What are you on about? Sure, she’s pretty, but…”
“No, no, not her! Not anything to do with– Dan, get this. I just figured out how to make Shoreline Pies a more successful business!”
“Huh? What’s that got to do–“ Jack cut him off.
“All the pies could be the same price! Don’t you see, it is so simple! Everyone would know exactly how much all the pies cost. One price only! So the decision about which pie to order comes down to what the customer is in the mood for. Price is no object to the decision, as it were. If you’re hungry, you order a basic pie with cheap fillings, but it’s a larger size. If you want a gourmet pie, like the smoked duck and asparagus, my favourite creation, well it’s smaller, sure, but you pay the same price and get what you want. Brilliant! I never knew why they served IPA in 10oz glasses. Now I do. That is possibly why this is the most successful pub near campus. This is marketing!” he exclaimed, pointing at the glass for emphasis, “This is marketing!”
“Uh, OK.” Dan responded, quite obviously less consumed by Jack’s epiphany than Jack was.
“Cheers!” Jack said, as he raised his glass again.
A Visit to the Pie Shop
The next day, Jack, Dan and a few other friends drove down to the lake. It was a beautiful summer day, there were many boats out, and the parking lots were nearly full.
While the others went down to their favourite beach spot, Jack went to Shoreline Pies, where the morning baking cycle was just finishing up. “Good morning, Mr Rechnen. How are things?” he said in greeting.
“Jack! Congratulations are in order I believe.”
“Well yes I suppose. Thank you sir,” said Jack in a somewhat unenthusiastic voice.
“Jack, what is it? Something got you down?”
“I don’t have a job. A degree, but no job. And I’ve got debt. No savings. It’s not a pretty picture.”
“No, I suppose not. But then that’s this economy for you. Things here are tough too. It is high season now, so business is OK, but I’m worried about the off-season. Very worried. I might have to shut down.”
“No! Shoreline Pies shut down? Never!” Jack knew that business had been poor for some time. But he had no idea things had got so bad.
“Businesses sometimes come up against a wall Jack. Shoreline Pies is no different. The last three years have been tough. I’m not sure I can make it through another. Lake traffic is strong, yes, as folks favour local recreation and vacation rather than distant, more expensive travel. But do you have any idea how much the cost of my baking ingredients is going up? Margins are getting squeezed, but I’m concerned that if I raise prices in a weak economy, I will just see business go elsewhere.”
He pointed out the window and continued, “There is that new burger joint opposite the lake. Opened last year you know, part of a big chain. They can afford to undercut Shoreline Pies no problem. If I raise prices, patrons can just cross the lake. So I’m stuck with low margins. I could cut pay I suppose, but then I risk losing experienced staff. What I really need is a way to maintain sales, stabilise margins and keep my experienced staff happy. But if I can’t do that I may have to close.”
To be sure, there was plenty of economic misery to go around. Shoreline Pies was an institution. It was part of his life. Even it was now in danger. He felt bad for Mr Rechnen. But then Jack realised he had a perfect opening for sharing his recent brainstorm.
“Mr Rechnen, I may have an idea for you.”
“Yes Jack? Another new idea for a pie? I must say your smoked duck and asparagus pie was a huge hit a few years back. Unfortunately it now sells far less than it used to. Too expensive perhaps for tough times.”
“No, that’s not it, sir. It’s something completely different. Let me explain. Have you ever thought to price all your pies the same?”
“What, how could that work? I’d make money on some pies but lose some on others. Or I would have to drop the gourmet pies entirely. No, that wouldn’t work; the gourmet pies are profitable, if less so than they were.”
“No, I don’t mean that. You could make the same margin on each pie, basic or gourmet. But rather than vary the prices of the pies, vary their sizes instead. Match the pie volume to the cost of the ingredients. This way, you simplify choice. You also speed up transactions—hugely important at peak times—and you make fewer mistakes handing change. You can then adopt a new marketing campaign to attract new business: Many great pies, one low price!”
Mr Rechnen thought for a moment, then said approvingly, “Jack, that is a fantastic idea! It would greatly simplify business. And you’re right, it might be a great way to attract new business too. That chain burger joint across the way, have you seen how complex their menus are? Customers, especially the less familiar, walk in and just stare at the lighted boards. There must be a hundred prices for different things at different sizes. It’s confusing. It makes it difficult for customers to make up their minds. They wait in line; the lines get longer. It is not efficient. We could do precisely the opposite and use it as the basis for a positive marketing campaign. I like it!”
A huge smile appeared on Jack’s face. Perhaps his degree was worth something after all. He might never have had his epiphany had he not spent some time learning to think like a marketer, like a businessman, rather than merely reading novels. But then maybe the reading had played its part as well.
“Oh Jack,” continued Mr Rechnen, “There was something I wanted to ask you.”
“Yes sir?”
“I’m sure you have bigger plans for the future, but if you were interested, I could use someone with your experience this summer. A shift manager role. Peak times. Also some early morning baking work. Part time only, no benefits, but if you’re still in with your parents you might not need benefits anyway. And if you don’t mind, you can help me roll out the new pricing and marketing strategy. What do you say?”
“What do I say?” Jack responded with no hesitation, “I say you’re on!”
The Leaves Begin to Change
It was only early September but for whatever reason the Aspen leaves were already beginning to turn. “Never mind,” thought Jack, “What a summer!”
Yes, what a summer it had been. Jack worked with Mr Rechnen to rework the pie pricing, figuring out exactly how much the ingredients cost for each pie, gourmet or basic, and how to resize the pies to ensure that the margin on each pie was the same, and was enough, at conservative volumes, to ensure a reasonable peak-season profit for Shoreline Pies. In practice, this meant downsizing the gourmet pies, as otherwise the sizes and prices of the basic pies would have had to increase. They settled on $5 a pie.
“It’s a perfect price,” Jack explained to Mr Rechnen. “It’s a nice round number for handling transactions, allows for the basic pies to be quite large and filling, and is high enough to allow for even our most gourmet pies to be of an acceptable size so that they don’t seem skimpy. However, we can also turn some of the smaller pie sizes to our advantage: We can offer a new line of obviously smaller ‘diet pies’ at the same price, with somewhat healthier ingredients and a side salad thrown in to compensate and fill the box. As you know, we sometimes felt that Shoreline Pies saw too little of the ladies’ business, with many of them preferring to patron Fiona’s Sandwich and Salad. Well, this is an effective strategy to grab more of that business too.”
While Jack was working on resizing the pies, he also engaged a local sign company to design a new sign, “Shoreline Pies: Many Great Pies, One Low Price!” The website was also redesigned and rebranded in this way, as were the pie menus.
The basic hope was that these measures would be sufficient to see Shoreline Pies through the off-season and avoid losing market share to the new burger joint across the lake. The more optimistic hope was that this would lead to a substantial increase in business, as customers rewarded Shoreline Pies’ simplified pricing and new ‘diet pie’ line with additional, more frequent business.
As the summer weeks went by, turnover rose and rose, exceeding the most optimistic of projections. Not only was there a substantial increase in patronage; what Jack and Mr Rechnen discovered was that it became more common for customers to show up on their own, purchasing three, four or more pies at a go, in order to feed an entire group. It was so easy given the one price formula: Everyone in a group could just hand one person a fiver and specify a pie choice; there was no need to make calculations. A quick run to Shoreline Pies was far simpler and thus quicker than a comparable run to either the new burger joint or Fiona’s S+S, leaving more time available to be out on the lake, or for whatever.
Jack was proud of the results. He had a job. He had helped to rebrand and improve a business. High season might now be over, and he was no closer to finding a permanent job than before, but then he hadn’t really been looking. As he was finishing up the accounts late one Sunday afternoon, Mr Rechnen walked in and asked, “How did it go this week Jack?”
“Looks OK, we beat this week from last year by nearly 20%. The season may be trailing off but we appear to have firmly increased market share. Just for fun, I’m extrapolating the trend through the entire off season, week by week, and I’ve got some indicative figures for you.” Mr Rechnen had a look.
As a broad smile emerged on Jack’s face, Mr Rechnen exclaimed, “You’ve done it Jack! You’ve done it! We can remain profitable even in the off season! Well done!” Jack had never seen Mr Rechnen so pleased, and he was a jovial fellow.
“Jack, I don’t know how the job search is going, but I want to encourage you to stay. You have done a fantastic job. As far as I’m concerned you are a marketing genius. These numbers make it possible for me to bring you on full time and finance a major expansion. With such a successful formula now established, I think we should open another franchise at Willow Creek, near the boathouse. Maybe another in the town centre. What do you say? How about it? Care to be a franchise manager and, more importantly, the Head of Marketing for a growing chain of Shoreline Pies?”
Jack couldn’t believe it. Apparently he had not only turned around a struggling business; he had given it the skills and confidence to expand, even amidst a weak economy, into new locations.
Not waiting to hear any details of the offer, Jack quickly and enthusiastically accepted. “Yes! You’re on! When do we start?”
A Letter Arrives from the Department of Commerce
The following year, while working out the pricing and pie sizing formula for the coming high season, Jack noticed a letter from the Commerce Department requesting that the Shoreline Pies chain begin to provide information on how its product prices changed month to month. According to the letter, this information was going to be used to help compile the prepared food sub-index for Consumer Price Inflation, or CPI.
While Jack felt he had better things to do, he realised quickly that filling out this form was going to be rather simple. After all, the prices of the pies were all $5. They had all been $5 since the prior June and, notwithstanding somewhat higher ingredient costs this year, he and Mr Rechnen had decided to maintain the $5 price. Profitability could remain the same because they now enjoyed some economies of scale, in particular in the area of staffing, as staff could rotate between stores and shifts. For example, at the town centre location, business was far busier during the week, particularly at lunchtime. Down by the lake or at Willow Creek, things were often busier on weekends or the evenings. Staff could be shuffled accordingly. And so Jack went ahead and filled out the form, indicating no change in prices, placed it in the enclosed return-postage-paid envelope and, on leaving the office, popped it in a post box.
Jack had never really followed economic statistics before, with the exception of a one-term course in macroeconomics early in the course of his business studies degree. But when he returned home to his home above the lake that evening, out of curiosity he went online, to the Commerce Department’s website, to see what had been happening with the Consumer Price Index in recent years. What he saw surprised him: While crude foodstuff price inflation had been quite high on average, at about 10%, this was not at all true of prepared food, which closely tracked the overall index, at around 2-3%. He wondered why for a moment, but then smiled. “Genius!” He said aloud to himself, “Genius!”
Crude vs. Prepared Food Price Components of the CPI: 2007-Present
(For those curious, my previous economic parables include The Tale of André Prenner: A Parable for Our Times, Amphora Report vol 1 (November 2010), available here; and Mr Mizuno Retires, Amphora Report vol 2 (January 2011), available here. Both are intended, as with this edition, to illuminate some of the more subtle and human aspects of our economic predicament.)
Resources
[1] Guess What’s Coming to Dinner: Inflation! Amphora Report vol 1 (October 2010). The link is here.
[2] For a more detailed discussion of what constitutes a debt trap and how the US has fallen into one, see Reinhart and Rogoff, This Time is Different. Or, for a more contemporary discussion courtesy of a Paul Krugman v Ron Paul debate, see The Invisible Red Line, Amphora Report vol 3 (May 2012). The link to the latter is here.
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Source: Amphora Report
