How does Family Video charge such unbelievably low prices?

I hold a seasonal position as a sales clerk at Family Video when I’m not studying here at Carleton. For those who might be unfamiliar with Family Video—it’s a chain movie rental store like Blockbuster or Hollywood Video, though you rarely see those around anymore. Unbelievably, there are currently over 755 Family Video stores in the United States and Canada, which seems like a size disproportionate to what I would estimate as people’s demand to rent movies outside of more convenient options like Netflix or On Demand. Nevertheless, Family Video is popular because it charges unbelievably low prices. People often come in and rent a stack of 16 movies for just $8 for five nights. I’m not sure what it costs to rent a movie from your television at home, but $8 would probably only get you two to three movie rentals at best. I’ve worked at Family Video seasonally for over a year now, and their profit margin still continues to baffle me, but maybe there are more tricks to the trade than I realize.

So when I said people could rent 16 movies for $8, I wasn’t lying, but there is a catch. You can only rent non-new release movies so cheaply, but even so the “2 For $1” section of older movies spans for aisles and includes thousands of movie rental options. But how does Family Video make money? My guess is that they make their real profit in renting out new release movies and not older movies. New release movies cost (this depends on the location, but I’ll just give you Waukegan, IL store prices since that’s where I work) $2.60 per night for the first two weeks. After those first two weeks there is an option to rent for five nights for $3.10, and two weeks after that, all month-old new releases cost a steady price of $2.60 for five nights for the remainder of their stay on the new release wall. $2.60 is a considerable mark-up from the $0.50 movies I mentioned earlier. Plus movies don’t have a brief stay on the new release wall. Some movies are considered new releases even six to nine months after their DVD release date.

Based on my research, the cost of buying a newly released DVD is about $19.99. I’m not sure what Family Video pays per movie because they buy in bulk, which brings costs down, but on average I’d say Family Video buys about 50 copies (give or take) of any given new movie for maybe $15 each. To cover this variable cost alone, each individual copy of this particular new release needs to rent out at least six times. All together for a movie Family Video purchases 50 copies of, 300 movies need to rent out to meet variable costs alone. This leads to the part I don’t really know. I’m not sure how many people rent out the really popular movies, but I would estimate somewhere between 500 and 700 rentals for really popular new releases, so Family Video makes revenue that way. Yet, you also have to consider the movies that tank. There are times when brand new new releases sit on the wall for weeks on end, and in those cases the extra revenue brought in on the popular movies only barely makes up for those that don’t rent very well at all.

So, again, where’s the profit? How does Family Video meet not only its variable and fixed costs, but make money as well? Based on my reasoning above, the money Family Video makes on new release rentals only meets the variable cost of the price of the movies themselves. So a new hypothesis is in order: Family Video meets its other costs and makes profit primarily on overdue movie fines. The dreaded fines! Yes, of course! I have, and again I would never lie to you, seen time and again upwards of $200 worth of fines on any given account. But again, there’s a catch. Family Video’s policy states that no amount of the fine needs to be paid to rent out new movies. Yes, that is correct. People with $200 fines often come in and rent movies without paying a cent in overdue charges, but they’re in the minority. The majority of people take responsibility for their late charges—even if they have to pay between $10 and $20 of late fees each time they rent. Now part of the reason late fees exist is purely logistical—there can be a steep opportunity cost to not having that movie up on the racks, particularly if it is popular. On a popular movie that is three days late, it makes sense to charge $7.80 ($2.60 fee each night for three nights) in late fees, because it may well have rented out to three different customers on those nights it wasn’t sitting on the shelf. On the other hand, some new releases might have sat on the shelves collecting dust in the store rather than sit in someone’s house for three days. This means that all the late fees coming in for that late movie are pure profit, or at least revenue above the variable cost, of that movie for Family Video. Under the assumption that these late fees are charged on what is probably every other customer, it begins to make sense how Family Video makes money.

Family Video’s late fees must be the reason I have a job, because they’re the only way the store revenue really surpasses its total costs to make a profit. And when you think about it, it makes sense: your TV can’t charge you late fees when you rent a movie for 24 hours on On Demand. After 24 hours, you just simply can no longer access the movie. In this sense, you pay more to rent for the convenience of renting on your TV because On Demand can’t make profit by you failing to turn the movie in on time. On the surface, Family Video seems so much cheaper. $2.60 for a new release for a night is undoubtedly an excellent price, but only if you return the movie on time. If you do, then great, you have rented a movie at a discounted price. The majority of people, though, lead crazy and forgetful lives, and when they rack up overdue rental fees, the “cheap” price they pay to rent at Family Video ends up costing just as much if not more than the expensive On Demand rental option. This system in which more diligent and responsible customers pay less than those who aren’t so timely is representative of price discrimination. This price discrimination actually works really well for people; those who can’t afford the fees might go out of their way to turn movies in on time and pay a cheaper price than those who can spare a few dollars in late fees. People pay at the price they are willing to pay based on the amount of late fees they accrue, which maximizes Family Video’s profits and keeps market prices down for those seeking the cheapest rental options. Ultimately, though, we’re all human, and most people are bound to pay some late fees. And, lo and behold, Family Video collects enough of those fees to put me to work for the summer! At least now I can rest easy and say that all 755+ Family Video stores out there in the world somehow make a profit. This is good news to me. Also, go rent movies!

I love coffee. Coffee fuels me when I can’t fuel myself, and for that I am entirely grateful. But I also (ashamedly—don’t judge me) love lattes. There is nothing better than a few shots of espresso in frothed milk, and if my coffee drinking habits came with an indifference curve, I’d probably be willing to give up upwards of three cups of regular coffee for a latte. Even so, regular coffee still means a lot to me, so I’m not willing to give up good ol’ coffee for any quality latte. The lattes from Sayles are sore excuses for lattes. Simply putting some coffee in a cup of milk does not cut it; this is a despicable practice. For a latte worth drinking, I have to travel from my cozy dorm all the way on the east side of campus to Blue Mondays in downtown Northfield to purchase a latte that lives up to its name.

As a busy college student, time is precious to me, and I am most inclined to drink coffee or travel to Blue Mondays during the days I have to study the hardest. This means that the thirty minute round trip journey to Blue Mondays comes with a pretty steep opportunity cost—not only do I have to pay for the $4 latte, but I give up thirty minutes of well spent studying regardless of if I choose to stay and work at BMs or not. Also on a -50 degree (with wind chill) day, the opportunity cost of traveling to BMs includes warmth and no chance of frostbite. If I choose not to go to BMs, I save a lot of money, because even though I don’t get the latte I prefer, I get free coffee in my personal giant mug from the dining hall, and then I just study in the warmth of my dorm without making the thirty minute trip. Think of how much econ studying I could do in those thirty minutes! I’d probably be real economist by now.

So the question is, then: Is a Blue Mondays latte worth it? I don’t know—my indifference curve and preference for lattes is pretty steep (three cups of coffee is a big deal to a caffeine addict). Even given this preference, though, my marginal utility per dollar is probably highest for regular coffee most of the time, since I enjoy it, and it’s free and convenient. Every once in awhile, though, I might want to venture to Blue Mondays to treat myself because I value it so much—especially if I have the time to spare. It’s worth it. After all, it’s economics.

http://www.marcgunther.com/behavioral-economics-at-starbucks/

Very few people, including me prior to reading this article, know of the 10¢ discount Starbucks offers every time you bring in your own coffee mug. Environmental activists suggest that if Starbucks were to charge 10¢ for a paper cup instead of offering a 10¢ discount for personal mug use, the vast amount of Starbucks waste would decrease because people are more motivated by avoiding cost than gaining profit. This article evaluates the behavioral economics behind why people are more inclined to bring their own mugs if they are presented with a 10¢ paper cup charge instead of the alternative 10¢ discount when using their own mug. Since economics is really the study of decision-making, this is a really interesting behavioral economic, or even psychological, evaluation of how the habits of people change when presented with a discount versus an additional charge.

As fascinating as this is, I would like to take this economic evaluation one step further. Behaviorally, yes, many people will probably go out of their way to avoid that charge if a charge were implemented instead of a discount. Others still might find personal motivation to reduce the vast amount of Starbucks paper and plastic cup waste that accumulates every day. However, I think it is also important to note that Starbucks is a luxury good—in other words, Starbucks can be easily substituted with other cheaper coffee brands. A cup of McDonald’s coffee is a good example of a far cheaper, yet similar product (a 24 ounce McDonald’s coffee is only $1.29, yet a 20 ounce Starbucks coffee is $2.25, and millions of people have yet to give up on Starbucks). If people were looking to cut coffee cost corners, they would probably avoid Starbucks altogether.

With this in mind, a Starbucks good is definitely elastic to some degree. A serious raise in price would probably lose quite a bit of Starbucks clientele, but a tiny price increase (or an apparent price increase of 10¢ that would occur instead of the discount) on an already luxury good probably, and I’m theorizing, won’t cause a great disturbance to the number of cups Starbucks sells. Plus, this is not even technically a price increase—people would just be charged an additional 10¢ for a paper cup, which means posted coffee prices would decrease. Ultimately, I’m not sure a 10¢ charge on paper cups would change consumer behavior as much as this article implies. People buy Starbucks in part for convenience, and bringing a mug from home just doesn’t fit that bill. I would think that the price difference would have to be more drastic to save the planet from Starbucks cup waste increase. People who can afford to buy from Starbucks regularly probably won’t jump into eco-friendly mode simply due to an imposed 10¢ paper cup charge instead of a 10¢ discount.