Chapter Five, Part V

Convention may play an important role in everyday social life. But in theory it should be irrelevant to economic life and to the way companies do business. Corporations, after all, are supposed to be maximizing their profits. That means their business practices and their strategic choices should be rationally determined, not shaped by history or by unwritten cultural rules. And yet the odd thing is that convention has a profound effect on economic life and on the way companies do business. Convention helps explain why companies rarely cut wages during a recession (it violates workers’ expectations and hurts morale), preferring instead to lay people off. It explains why the vast majority of sharecropping contracts split the proceeds from the farm fifty-fifty, even though it would be logical to tailor the split to the quality of the farm and the soil. Convention has, as we’ve already seen, a profound effect on strategy and on player evaluation in professional sports. And it helps explain why every major car company releases its new models for the year in September, even though there would presumably be less competition if each company released its cars in different months.

Convention is especially powerful, in fact, in the one part of the economy that you might expect it to have little sway: pricing. Prices are, after all, the main vehicle by which information gets transmitted from buyers to sellers and vice versa, so you’d think companies would want prices to be as rational and as responsive to consumer demand as possible. More practically, getting the price right (at least for companies that aren’t in pure competitive markets) is obviously key to maximizing profits. But while some companies—like American Airlines, which it’s been said changes prices 500,000 times a day, and Wal-Mart, which has made steady price-cutting into a religion—have made intelligent pricing key to their businesses, many companies are positively cavalier about prices, setting them via guesswork or by following simple rules of thumb. in a fascinating study of the pricing history of thirty-five major American industries between 1958 and 1992, for instance, the economist Robert I-Ia1] found that there was essentially no connection between increases in demand and increases in price, which suggests that companies decided on the price they were going to charge and charged that price regardless of what happened. Clothing retailers, for instance, generally apply a simple mark-up rule: charge 50 percent more than the wholesale price (and then discount like mad if the items don’t sell). And until recently, the record industry blithely insisted that consumers were actually indifferent to prices, insisting that it sold as many CDs while charging $17 per disk as it would if it charged $12 or $13 a disk.

One of the more perplexing examples of the triumph of convention over rationality are movie theaters, where it costs you as much to see a total dog that’s limping its way through its last week of release as it does to see a hugely popular film on opening night. Most of us can’t remember when it was done differently, so the practice seems only natural. But from an economic perspective, it makes little sense. In any given week, some movies will be playing to packed houses, while others will be playing to vacant, theaters. Typically, when demand is high and supply is low, companies should raise prices, and when demand is low and supply is high, they should lower prices. But movie theaters just keep charging the same price for all of their products, no matter how popular or unpopular.

Now, there’s a good reason for theaters not to charge more for popular movies. Theaters actually make most of their money on concessions, so they want as many people as possible coming through the door.. The extra couple of dollars they’d make by charging $12.50 instead of $10 for the opening weekend of Spider Man 2 is probably not worth the risk of forgoing a sellout, especially since in the first few weeks of a movie’s run the theaters get to keep only 25 percent or so of the box-office revenue. (The movie studios claim the rest.) But the same can’t be said for charging’ less for movies that are less popular. After all, if theaters make most of their money on concessions, and their real imperative is to get people into the theater, then there’s no logic to charging someone $10 to see Cuba Gooding Jr. in Snow Dogs in its fifth week of release. Just as retail Stores mark down inventory to move it, theaters could mark down movies to lure more customers.

So why don’t they? Theaters offer a host of excuses. First, they insist (as the music industry once did) that moviegoers don’t care about price, so that slashing prices on less-popular films won’t bring in any more business. This is something you hear about cultural products in general but that is, on its face, untrue. It’s an especially strange argument to make about the movies, when we know that millions of Americans who won’t shell out $8 to see a • not-so-great flick in the theater will happily spend $3 or $4 to watch the same movie on their twenty-seven-inch TV. In 2002, Americans spent $1 billion more on video rentals than on movies in the theaters. That year, the most popular video rental in the country was Don’t Say a Word, a Michael Douglas thriller that earned a mediocre $55 million at the box office. Clearly, there were lots of people who thought Don’t Say a Word wasn’t worth $9 but was worth $4, which suggests that there is a lot of cash being spent at Blockbuster that theater owners could be claiming instead.

Theater owners also worry that marking down movies would confuse customers and alienate the movie studios, which don’t want their products priced as if they’re second-rate. Since theaters have to cut separate deals every time they want to show a movie, keeping the studios happy is important. But whether a studio is willing to admit that its movie is second-rate has no impact on its second-rateness. And if annoying a few studio execs is the price of innovation, one would think theater chains would be willing to pay it. After all, fashion designers are presumably annoyed when they see their suits and dresses marked down 50 percent during a Saks Fifth Avenue sale. But Saks still does it, as do Nordstrom and Barneys, and the designers still do business with them.

In the end, though, economic arguments may not be enough to get the theaters to abandon the one-price-fits-all model—a model that the theaters themselves discard when it comes to the difference between showing a movie during the day and seeing one at night (matinees are cheaper than evening shows), but that they cling to when it conies t the difference between Finding Nemo and Gigli (for which they charge the same price). The theaters’ unwillingness to change is not a well-considered approach to profit maximization and more a testament to the power of custom and convention. Prices are uniform today because that’s how they were done back in the days when Hollywood made two different kinds of movies: top-of- the-line features and B movies. Those films played in different kinds of theaters at different times, and where people lived and when they saw a movie affected how much they paid. But tickets to all A-list movies cost the same (with the occasional exception, actually, of a big event -film, like My Fair Lady, which played in theaters with reserved seating and cost more). Today, there are no B movies. Every film a studio puts out is considered top-of-the-line, so they’re all priced the same. It is true that this ensures customers remain unconfused. But as the economists Liran Einav and Barak Orbach have written, it also means that movie theaters “deny the law of supply and demand.” They’ve uncoordinated themselves with moviegoers.