Monday, February 28, 2011

Why Mohamed R. Khidr at a Mobil gas station in West Covina makes a lot of money

I have an undergraduate degree in economics. When I was taught economics, there were a lot of assumptions in what I was taught, including the assumption that people not only have access to perfect information, but also act rationally on that information. These actions represent the "invisible hand" that manage market prices.

Those are a lot of assumptions, and they don't hold up in the real world. Even when people have perfect information, they do not always act rationally.

I bought gas on Saturday, and paid $3.559 a gallon for it. (If Foursquare still allowed me to compete for mayorships, I would have shared this with you on Saturday.) This was at a Costco, where gas is usually priced more cheaply than it is at other gas stations.

This got me wondering - how much are people paying for gas at more expensive gas station chains, in more remote areas? Baker, California came to mind - it's on the main freeway between Los Angeles and Las Vegas, and there's not much around it, so gas prices usually tend to be high.

But when I checked the California Gas Prices web site on Sunday afternoon, it turned out that the most expensive gas in California wasn't in Baker. Instead, it was in the suburban city of West Covina, California.

My first thought when I saw this price - is this real? California Gas Prices is dependent upon people who submit price data, and I considered the possibility that someone erroneously listed a price for this gas station.

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But as I searched the web, I found a February 24 Pasadena Star-News article that indicated that the high price report at this Mobil station was probably accurate.

The article, written by James Figueroa, listed a February 24 price of $4.599 at the Mobil gas station at Azusa and Garvey, and included a picture of the price. So if they were charging $4.599 on the 24th, a price of $4.699 on the 27th wasn't all that surprising.

And this quote from the article obviously didn't surprise me:

Business at the Mobil appeared slower than other stations, however.

But what was surprising was this little tidbit in the article:

Across the street, a Shell station was selling regular for $3.75 a gallon.

Yes, that was (as of the 24th) an 85 cent per gallon difference between two gas stations right next to each other. Or, if you put twelve gallons of gas in your tank, a $10.20 total difference.

Yet people were willing to pay it - five people in one half-hour period surveyed by Figueroa.

Figueroa tried to reach station owner Mohamed Khidr, but he couldn't be reached.

Now invisible hand proponents would argue that it is impossible for someone like Khidr to exist, because people would rationally gravitate to the Shell across the street. And anti-libertarians would argue that "something should be done" about the gas station's price gouging.

But Khidr has apparently hit upon a successful way to make money. You can either sell things to a lot of people at a low price, or you can sell things to a few people at a high price. Kind of like what Apple used to do with its products, except that the gas at the West Covina Mobil station is just like all of the other gas sold in the area. (In fact, in late January, this article noted that a Mobil station in Bakersfield was selling gas for $2.999, while one in West Covina - possibly the one on Azusa and Garvey - was selling gas for $4.379.)

And as long as people continue to go to the West Covina Mobil station, why change the pricing strategy?

Years ago I read a parody music publication that claimed that the Eagles were pricing a record album at $5 million, rather than the then industry-standard price of less than $10. According to the parody publication, when the interviewer asked the Eagles how many people would buy such a high priced album, the band responded, "We only need one."

And yes, if you remember reading this story in an earlier post in this blog, then you realize that I'm making the same point again - if you price your goods as high as the market will bear, then you can't be criticized when people actually pay the price that you set. (Assuming that the marketer is not taking advantage of catastrophe, but in both the Mobil West Covina case and in the Mobile Industry Review case, customers could easily find alternatives to the high-priced items but chose not to do so.)

P.S. When I shared some of this story on Facebook, one of my Facebook friends told me that she was driving by this gas station last summer and the prices were $1 higher than average even then. This further substantiates that the station has hit on a winning business model.
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