The Price of Prets
Pret a Manger is one of my very favourite shops: delicious food and coffee with a great brand and a heart. Prior to the pandemic it was enormously successful, particularly in the south of England, with 237 shops in London alone and plans for further expansion.
Of course the pandemic has put an end to that and many stores have now closed. Some stores were quite possibly superfluous and they had over stretched their mark but with London a ghost town for 9 months now, the commuter spend on lattes and delicious sandwiches has crashed.
But Prets has always been innovative and in September 2020 they launched Pret Barista. A subscription based coffee service that costs £20 per month, it allows for 5 hot drinks per day — this is a very substantial discount on a £2.50 coffee x 5 per day x 5 days per week (assuming you drink that much of course!).
The subscription model is of course part of the success of Spotify, Peloton, Headspace and so many more online purchases. Of Spotify’s 157 million users, 71 million pay a monthly fee to subscribe. Freemium/Premium models allow for free access — at the cost of adverts — versus a monthly subscription which is ad free and good quality.
And there’s the difference — Prets is not of course an online purchase. It’s coffee. Purchased on the high street. And they don’t have the ability to entice you up to the premium model by annoying you with adverts (as Spotify or YouTube do).
So why offer such heavily discounted premium coffee?
First, the pandemic caused sales to crash: on a simple demand and supply diagram we can see that the fall in demand caused sales to crash to Q2 and thus prices to fall to P2. (In August 2020, Pret announced 2,800 job losses in the UK, around a third of its workforce, and revealed sales remained 60% lower year-on-year due to coronavirus disruption).
So in some ways they had no choice but to offer cheaper coffee — there simply was not the demand in their city centre locations to pay for the higher priced offerings. (This is in contrast of course to local independent coffee shops in the suburbs which have been doing very well).
But even more importantly a fixed price — and thus fixed monthly revenue for Prets — allows Prets to be more certain of covering their fixed costs. This is crucial to allowing a business to stay open in the longer term .
A fixed cost is a cost that does not change with the number of coffees sold. Rent on the city centre locations will be the main fixed cost that cannot be covered as shops are shut and commuters stay away. This subscription gives a guaranteed income regardless of lockdowns. And it was a popular move — 16,500 people took up the coffee subscriptions on day 1. And they don’t make it easy to leave!
The model has further benefits which will allow Prets to emerge from the pandemic in a stronger position than its rivals. Once you have the subscription, will you really go to another coffee shop? That would be a little odd. So they have locked you in. And while you are there, you may as well buy your (perhaps slightly over priced) lunch too — and thus the sales of what Economists call complementary goods will soar too. So, Prets may emerge slightly smaller, but stronger. This is potentially a game changer in a crowded market of city centre eateries and cafes.
Finally the subscription allows for some pretty effective price discrimination. Whilst that sounds horrid, you will have been the beneficiary of price discrimination when you travel (peak/off peak), go to the cinema (student Wednesdays? OAP Mondays?), buy a seat on a low cost airline (do you mind where you sit?). Price discrimination is the sale of the same good (a tube journey into London) at different prices (peak/off peak). This allows the provider to extract from different consumer groups much more of what they are willing to pay.
For example, if I am very thirsty, I might be willing to pay £3.50 for my coffee. But the majority of people are willing to pay only, say, £2.50. And we know that when you go into a coffee shop, prices are fixed — there is a uniform price.
If Prets could find a way of charging different consumer groups, different prices, then the overall income they receive increases. Why charge everyone £2.50 when some people are willing to pay more? If we have a way of separating the groups of customers into those who are willing to pay more (thirsty impulse buyers), and those who are not willing to pay quite so much, then we can charge appropriately and increase overall revenue and profits.
The diagram here shows the impact of (third degree) price discrimination. Those who go into Prets on a Monday morning are charged P1 for their coffee. Their demand curve is Inelastic — they are thirsty and hurrying to work and have little chance to shop around, so their demand for coffee varies little with price, so Prets can charge them a higher price P1. Demand at P1 is Q1 and thus the total revenue from these sales is the area P1 x Q1. Subscribers are willing to pay less per coffee though if price falls they might be tempted to buy Prets coffee more often. Hence to tap this more flexible market Prets charges a lower price, P2. The total revenue earned from them is P2 x Q2. Adding these two together, the total revenue is greater than charging all customers the same price of P0.
And once you’re all subscribed, Prets can start selling to you, via the app and adverts, all their other lovely cookies and shakes.
