James K. Binkley and John Bejnarowicz

The level of consumer price awareness in food markets is an important issue to those involved in the industry. While few believe that price knowledge is perfect, research has indicated that both academics and industry personnel overestimate its extent. As a consequence, pricing decisions and market research may be based on an erroneous assumption. It is an understandable error, for the possibility that consumers might fall considerably short of full price knowledge seems inconsistent with the fact that such knowledge is needed for them to make the best use of their limited budgets. However, the acquisition of price information requires time and effort. This is especially the case in the supermarket, where a shopper is confronted with many products, most of which make a very small demand on the household budget, which limits the gains from price knowledge.

That information has cost is a tenet of information economics and was first articulated by Stigler (1961). He proposed that information gathering and price search continue only as long as benefits exceed costs. Hence, unless search costs are zero, price information will generally be incomplete for consumers.

In this study we test the validity of this theory in a new context by studying consumer response to quantity surcharges. A quantity surcharge exists when there is a higher unit price for a larger size than for a smaller size of the same branded item. Surcharges lend themselves to studying price sensitivity because the items differ only in package size, which most consumers are likely to regard as a trivial difference. Because, larger sizes usually have lower unit prices, many observers believe that some consumers use a "discount heuristic" as a shopping rule. While this reduces the need for price comparisons and lowers information costs, it sometimes results in a quantity surcharge.

In the study we use 1990 market level data for 54 grocery regions, data provided by a leading product tracking firm, and examine consumer purchasing patterns in the face of a quantity surcharge. We consider a single commodity, chunk light tuna. Most tuna is sold in a six ounce can, but there are also considerable sales in a twelve ounce size, which consistently sells for a higher unit price. In our data the average surcharge across the US was 30 percent; later surveys have shown it to be higher.

Using a regression model, we studied the role of prices and market demographics in determining variation in the share of tuna sales in the smaller, more economical package across the 54 markets. The demographics were selected as proxy measures for information costs. Key among these were income and female labor participation rates as measures of time cost; education and lack of facility with English as measures of ease of information processing; and market quantity of tuna sold as a measure of shopping experience and information value. Also included were household size and extent of single family housing, which account for differences in disposition to large sizes.

Our results suggest a strong role for information costs in determining purchase patterns and, by inference, in explaining why many consumers do not bother to collect all needed prices. Information measures explain a substantial portion of the difference in the small can's share across the markets; the prices of the two sizes had virtually no importance. We found evidence that sales of surcharged tuna are higher in markets with higher average incomes, and lower when the market has a higher level of education, and in markets where tuna is a larger component of the food basket. This is what we expect if information is costly.

We further address the question of the persistence of surcharges, and why canned tuna is such a consist target. We believe that surcharges arise at the manufacturer level, and in part reflect a price discrimination strategy involving producing different sizes and then pricing them with different markups. For cost considerations, usually a larger size receives a smaller markup and attracts the more price aware, price sensitive buyers. This opens the way for the firm to increase the markup on the standard size, since most price sensitive consumers no longer buy it. Hence we have the phenomenon of "economy" sizes, which, among other things, provide a means of price discrimination.

However, if price sensitive buyers resist the large size, this discrimination strategy will not work. Resistance is more likely for commodities that, once opened, are subject to rapid quality loss, so they must be used at once. This is true of tuna. Unless a large quantity is needed in the first place, the excess may be of little value, less than the savings from the discount, so the price sensitive consumers continue buying the smaller size.

Under this condition, the best option for the firm may be to price the large size with a higher markup, that is, a surcharge. Price sensitive large size buyers are unlikely to resist multiples of the smaller size if it has the smaller markup, leaving at least some buyers, non-searchers who buy the large size, paying a premium price. If those buying the surcharged item are mainly non-searchers, a firm trying to increase its market share with a price cut will be met with little response and probably lost revenues. Thus, surcharges can persist.