Who do hotels rip you off?

Okay - I was down in Wellington on Wednesday, and staying overnight, so as to go to the Budget analysts' lock-up on the Thursday morning. As I was checking in at the hotel - not where I usually stay, since Wellington accommodation was apparently nearly all taken up, maybe because of the Budget, and I had to take what I could get - I happened to notice a sign at the counter, advertising the exchange rates the hotel used to convert US dollars or Aussie dollars into Kiwi. In both cases, the hotel offered a ludicrous rip-off exchange rate. According to the hotel, a Kiwi dollar would cost you US$1.05 or A$1.05, where in reality it actually costs more like 83 or 84 Aussie or US cents, if you were to buy it at a bank.

Why do hotels do this?

As I was thinking about it, it reminded me that I'd read something once, about a similar phenomenon - why does popcorn cost so much more at the cinema than it does in the supermarket? It took me a while to track it down, but it was a chapter in Steven Landsburg's wonderful book, The Armchair Economist: Economics & Everyday Life (The Free Press, 1994). One reviewer, by the way, described this book as "An ingenious and highly original presentation of some central principles of economics for the proverbial Everyman. Its breezy tone conceals the subtlety of the analysis. Guaranteed to puncture some illusions and to make you think", which you might think is nice but no more than the usual puffery of a new book, until you notice that the reviewer was Milton Friedman.

I'd like to be able to tell you that Landsburg had the definitive knock-out answer, but he didn't. He dismisses, for a variety of reasons, what you might call the layman's explanation, which is that the hotel guest, or the moviegoer, is the temporary captive of a monopoly seller. I didn't think that could be the answer, either: if there's workable competition in the hotel (or movie) market, and there likely is, then a hotel or cinema shouldn't be able to get away with it, since the hotel or cinema around the corner would scoop all the business at a better exchange rate.

The best Landsburg could come up with (and I haven't advanced the thinking much, either) is that the hotelier or cinema owner is pursuing some sort of price discrimination strategy in a world where willingness to pay for popcorn and willingness to pay for cinema tickets varies across cinemagoers, and that could explain why all the other hotels and cinemas do it, too. He may not have had a clearcut answer to what's going on here, but even so read the chapter. It's an excellent explanation of price discrimination, and the rest of the book is equally informative and entertaining.

What bothered me about this price discrimination explanation, if that's what's actually happening, is that it clearly has the capacity to backfire in a highly embarrassing way. Prices that consumers know are exorbitantly above cost have a number of unpleasant consequences for the companies that charge them. For one thing, consumers are likely to think: if they're ripping me off on popcorn, they're probably ripping me off on everything else. They'll start thinking: why pay to go to the cinema at all? If they're ripping me off, I'll rip them off: I'll download the film for nothing over the Internet. Or, in another context, one consumer making a huge song and dance in the newspapers about the $2,000 bill for their smartphone roaming charges, probably puts off many hundreds of other consumers from turning their phones on in Sydney or London. If the cinema owner had a strategy of lower-than-otherwise movie tickets and higher-than-otherwise popcorn, now he's brassed off the popcorn eaters, and he's left with lower revenue from the ticket-only customers. And in areas where there may be some doubt about the degree of workable competition in the market, you're positively inviting in the prospect of regulation with open arms, mobile roaming being a classic example.

Maybe the silly popcorn price, and the silly exchange rate, are rational strategies from some perspective or other, but if they are, they still strike me as high-risk strategies to pursue. I wonder if there's something else going on?