When Profit-Making Becomes Profiteering
A petrol station in Exeter in the South West of England has been accused of profiteering when it increased petrol and diesel prices from around the £1.30 per little to £1.99 per litre. The controversy has started me thinking about the question "When does profit-making become profiteering?"
The Situation
Shell tanker drivers are coming to the end of a four day strike which has stopped new supplies of petrol reaching garages although a second strike is scheduled to start at the weekend. This strike has caused some fuel service stations to run out of petrol and the situation is particularly bad in the South West of England in Devon and Cornwall which attracts many holiday-makers at this time of year.
Other local petrol stations ran dry so BWOC, the garage accused of profiteering was faced with a choice:
- Continue to sell at the existing price and quickly sell out its remaining stock
- Increase the price following the natural laws of supply and demand
- Introduce some form of rationing
Controlling Demand
In an article about the Beer Game I explained how sudden fluctuations in demand can cause massive consequences further along the supply.
The first thing that people hear when a product is short is "I had better buy some more. I don't want to run out."
People react selfishly to protect their own self interests.
In the petrol shortage, drivers want their fuel tanks to be full while during normal times, they may only buy half a tank's worth and effectively drive around about a quarter full.
But this selfish streak is no surprise. At the very heart of marketing is the basic question "What's in it for me? If I gain more than I lose, we may have a deal. If there is nothing in it for me, why should I bother?"
This idea of exchange - what you give me has more value than what I give you - is fundamental and nobody will pay more than the value they attribute to a product or service.
The Basic Laws Of Demand & Supply
Without going into a full economics lesson on supply and demand here are a few of the basic laws:
- As price reduces, demand increases.
People who wanted before but couldn't afford to buy, can do at a lower price and people who wanted to buy two rather than one will be more willing to do so. In terms of the value to price relationship, if the price is £10, then only those people who value it at £10 or more will be interested. If the price reduces to £8 then a new group of customers see the benefits of buying.
- As price increases, supply increases.
More people have an interest in supplying a product if prices are high and profits are good. This will attract opportunists into the market but also allow higher cost producers and suppliers to make money when they couldn't at lower prices. Take oil for example. It costs money to extract from the earth and each oil field will have different costs. Oil field one may cost $8 per barrel and is therefore always turned on. Oil field two costs $20 per barrel and is only operated when oil prices are above $20 per barrel on a sustainable basis.
- The market sets a natural price where demand equals supply.
- If the market is shocked out of equilibrium and supply rises above demand, prices are forced down.
- If demand rises above supply, prices increase.
This makes the product less desirable to some potential customers who decide they no longer want to buy and a new equilibrium price is set.
Returning to the petrol example, rising the price is a natural way to control demand.
Those who don't value the product at $1.99 per litre will not buy and those who have the time (and fuel) have the opportunity to drive outside of the local region and find new sources of supply.
But people are saying that this price rise isn't fair.
What Is Profiteering
My definition is:
Profiteering is taking unethical advantage of a supply shortage to make excessive profits.
It is a serious accusation and is particularly nasty in wartime where goods were diverted and sold on the black market.
But isn't the basic application of supply and demand applicable in just about any market.
My hero, Jay Abraham, has become famous for his $5,000, $20,000 and even $40,000 conferences. People went because they believed that they would receive more value from his advice than the price they paid.
But there is only one Jay Abraham so is Jay profiteering from making excess profits from the supply shortage?
The demand/supply basis is seen most clearly in auctions including eBay.
Item one is rare but few people want it so it is sold for a low price while item two is also rare but in high demand and sells for a much higher price.
Is the seller of item 2 profiteering?
Sugaring the Pill
To help compensate the drivers, the garage has been issuing discount vouchers worth £25 off an MOT (a compulsory safety test that all cars three years old or more have to pass each year to be considered roadworthy in the UK.)
This is a very interesting tactic, giving locals something of value and potentially cross-selling MOTs and vehicle services to people who haven't dealt with the garage before.
Would Rationing Have Worked Better?
Increasing the price gave drivers the free choice - buy the petrol at the high price or don't buy. Yes the garage gained but so did the customers who bought because they value the petrol higher than the price. The price rise meant that the petrol was saved for the people who had most value and reduced the desire for people to fill up their tanks "just in case."
The alternative would have been to ration supply.
Suppose the garage had imposed a £10 limit on supplies to make sure that everybody had a bit while stocks lasted.
People would still be eager to top up their tanks so many low mileage drivers would have petrol tanks full of fuel that wouldn't be used in the shortage.
People who need the extra fuel have a problem.
As it now takes over £50 to fill a car with petrol for even small family saloons, would these people be allowed to have five £10 transactions while waiting at the pump, going off and paying each time and causing greater transaction because of the increased time.
If not, would they be allowed to rejoin the back of the queue, again increasing congestion and providing further demonstration of the petrol shortages and increasing general panic buying?
Or will they be told that they can't buy any more fuel for two days regardless of their needs?
Conclusion
There are no easy answers when demand exceeds supply but the free market and the established laws of supply and demand provide a system that works.
It moves resources to those who are prepared to pay the most.
In some situations it's not ideal and that's why governments need to step in to make sure that human rights to food, water and health care are provided.
But for a petrol station in Exeter, increasing the price to control demand seems a reasonable action to me.
And besides, since when has making a profit been a bad thing?
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