Wednesday, 11 June 2008

Why popcorn costs so much at the movies

One of the great unanswered questions that has baffled economists for eons is Why does popcorn cost so much at the movies? A number of explanations have been offered, none entirely satisfactory.

One answer is that once you enter the theatre, the theatre owner has a monopoly and thus can charge a high price for his popcorn. But as Steven Landsburg has pointed out
Once you enter the theater, the owner has a monopoly on a lot of things. He is the only supplier of rest rooms, for example. Why doesn't he charge you a monopoly price to use the rest room? Why isn't there a monopoly price for the right to proceed from the box office to the outer lobby, another to proceed from the outer lobby to the inner lobby, another to pass through the double doors so that you can see the screen, and another to take a seat?

The answer, of course, is that a rest room fee would make the theater less attractive to moviegoers. To maintain his clientele, the owner would be forced to sell tickets at a lower price. What he collected at the rest room door would be lost at the box office. (Landsburg 1993: 158).
Another explanation is price discrimination. Expensive popcorn makes sense if popcorn lovers are really willing to pay more than other people for their time at the theatre. Everyone comes to the theatre because the ticket price is low but the popcorn lovers pay more for their entertainment by buying the expensive popcorn. Popcorn lovers value the trip to the theatre more than other people and thus, via the popcorn pricing strategy, they pay a higher price. Imagine there are two types of people who go to the movies, one group dislikes popcorn and is willing to pay $20 for the movie. The second group likes popcorn, and will pay $3 for it, and is willing to pay $23 in total - ticket price plus popcorn - for the movie. If the theatre charges $23 for the ticket, only group 2 goes and buys no popcorn. If they charge $20 and have no popcorn, both groups go to the movie but the theatre misses out on the extra $3 they could get from the group 2 types. If the theatre charges $20 for the ticket and has $3 popcorn both groups go to the movie and the theater gets the full $23 from the group 2 types.

The problem with this is, Why don't we see popcorn price wars? One theatre sells its popcorn for $3 so why doesn't some other theater sell theirs for, say, $2.50. The low price theatre could attract all the popcorn lovers and make up on volume what is lost by the price reduction. For the price discrimination story to work the theatre needs to be able to stop competitors from under cutting them, that is, they need monopoly power. But where is the monopoly power?

Landsburg points out another possible answer.
Economists Luis Locay and Alvaro Rodriguez recently gave an ingenious answer to this age-old question, and to me it has the ring of truth. People go to movies in groups. Popcorn lovers often travel with companions who eat no popcorn. The usual argument says that you cannot price discriminate against popcorn eaters without losing them to another theater. The Locay/Rodriguez response is that popcorn eaters cannot go to another theater without splitting up their social groups. If another theater offers cheap popcorn and high ticket prices, the nonsnackers in the group will vote to stay put. Locay and Rodriguez have constructed a complete argument demonstrating that under plausible hypotheses about the way groups make decisions, theater owners have a degree of monopoly power over popcorn lovers who travel with popcorn nonlovers, and can plausibly exploit this power by pricing popcorn high. (Landsburg 1993: 166-7).
The problem here is that the popcorn lover could offer the non-popcorn eaters a sidepayment to go to the low-priced popcorn theatre. A deal something along the lines of: Let's stick to theatres which offer low-priced popcorn, and I'll occasionally pay for your tickets.

Yet another answer is that the high price you pay for popcorn is a fee for cleaning up the mess popcorn eaters make. There may well be something to this.

In a new book Richard McKenzie offers another solution to the problem. McKenzie points out that something has been missed in the explanations given above. He argues that theatres have an incentive to lower the ticket price and increase the popcorn price built into the contracts they have for the movies that they show. These contracts are like a share-cropping type arrangement. McKenzie explains
Theaters often bid for movies in terms of the percentage of their box-office receipts. Theaters regularly bid 70% of their box-office receipts-with their bids sometimes reaching 95% of their box-office receipts-for the rights to show a movie. Theaters could, and have, bid a fixed amount-say, $ioo,ooo-for the rights to show a movie for a multiple-week.engagement. However, because, as entertainment economist Arthur De Vany has argued, the success of a movie is very unpredictable (even when a movie has star power and is a sequel to a successful movie), a fixed amount bid means that the theaters would assume a great deal of risk, which explains why fixed bids alone are rarely used in contracts negotiated between theaters and studios. (McKenzie 2008: 91.)
The relevant point of this contract for popcorn pricing is that theatres have a built in incentive to keep their ticket prices low in order to increase the price of popcorn. If a theatre were to cut their ticket price by, say, $1, they will reduce their ticket receipts by less than $1, may be 30 cents (or in some cases only 5 cents). But they can also raise the price of popcorn by $1, and still keep the total price of their entertainment bundle constant. This strategy means they increase the number of tickets sold, since they cost less, and they get to keep all the additional profits on the extra popcorn sold due to the increase in ticket sales. The profit margin on the extra popcorn sold is greater than the loss, say 30 cents, on ticket sales due to the price reduction.

Eric Crampton when he read this asked: Why don’t film distributors write contracts demanding a share of ticket revenues and a pro rata share of popcorn revenues? He went on to point out that
Right now, the theatre (agent) has an incentive to chisel down the part of the revenues that can be appropriated by the principal and supplant them with non-appropriable revenues. If the distributor instead wrote a contract comprising revenues over both elements, he'd have to do better. Charge a slightly lower rate on ticket revenues and a higher rate on popcorn such that the theatre is indifferent between shunting between different portions of the income stream except to the extent that doing so increases total revenues for both principal and agent.
The distributor would be better off, the theatre indifferent but what happens to the price of tickets and popcorn relative to the McKenzie case? The lower percentage take on the tickets would increase the cost of ticket price reductions to the theatre and the increased percentage take on popcorn would reduce the gain to increasing the price of popcorn. Thus would we see a higher ticket price and a lower popcorn price.
  • Landsbury, Steven E. (1993). The Armchair Economist: Economics and Everyday Life. New York: The Free Press.
  • McKenzie, Richard B. (2008). Why Popcorn Costs So Much at the Movies: And Other Pricing Puzzles. New York: Copernicus Books.


Anonymous said...

Another option is to start with the assumption that most people like popcorn, but that popcorn is seen as an "optional extra" - most people can go to the movies without eating popcorn.

The challenge for the movie theatre is to charge the minimum possible to those who are price sensitive (to get them in the door), but still find a way to take more money off those who are not price sensitive.

Under the popcorn pricing strategy, those people who are price sensitive will go to the movies and not buy popcorn. Those who are not price sensitive will buy the popcorn, in so doing basically establishing their willingness to pay more than $20 for a movie ticket.

It is similar to the Stabucks pricing model - the small coffees are cheap, the larger ones expensive, despite having largely the same amount of coffee beans in them. Your willingness to buy a large coffee despite the inflated price is a way to charge price insensitive customers more.

unaha-closp said...

Concerning Monopoly:

"Why doesn't he charge you a monopoly price to use the rest room? Why isn't there a monopoly price for the right to proceed from the box office to the outer lobby, another to proceed from the outer lobby to the inner lobby, another to pass through the double doors so that you can see the screen, and another to take a seat?"

He does all these things, by selling a ticket. All of the above are offered in a single option purchase along with the right to watch the movie.

jeremy said...

So why doesn't someone set up a stall on the kerb beside the theatre and sell pop corn at $2.50 to the people on their way in? What's happened to efficient markets then!!!!!

Anonymous said...

How about this? My local movie theatre charges a regular price for a comfortable seat, restrooms and the option of purchasing light refreshments before entering the seated area, and also charges a premium price for a much more comfortable seat, access to different restrooms, entrance to the seated areas by separate doors, all-you-can-consume of popcorn and standard soft drinks plus the option of purchasing other, more luxurious refreshments during the movie screening by waited service (yes, someone will bring you an overpriced macchiato at 30 mins into the screening if that's what you want). I do not drink Coke, Sprite, or Fanta, but I can make use of the club soda. I don't usually have popcorn. So guess which one I buy?

The premium, every time.

Anonymous said...

Been a long time since the last post, but I have to assume SOMEONE will see this.

At the movie theater, you aren't buying a drink or a popcorn. Literally, you are buying the container the drink or the corn comes in. No-one inventories the product, only the container.

But the real bonus goes to the people buying the ticket and not the popcorn. Those who purchase snacks pay for most of the cost of operating the theater, just like those who purchase items inside a gas station (in the US) pay to keep the business open. Gas stations don't make money by selling gas. They get a few pennies per gallon. Most of their revenue comes from selling snacks, drinks, overpriced quarts of oil, etc.

Same thing in the theaters. Theaters don't stay solvent by selling tickets. They remain open by selling extra products to people who want to have popcorn and such.