It’s a question many of us are asking ourselves as we stare at our grocery receipts: why are prices still so high, even when we hear about companies cutting costs?
Remember the early days of the pandemic? Airline tickets and hotel rooms were practically given away because nobody was traveling. And then there were the used cars, fetching prices far above their usual value, largely thanks to those tangled supply chains that made everything, especially food, more expensive. Most of those wild price swings have calmed down, but our grocery bills? They seem to have a mind of their own, stubbornly refusing to budge downwards.
It’s not just a feeling. A recent congressional watchdog report highlighted that retail food prices jumped a staggering 11 percent between 2021 and 2022 – the biggest annual leap in four decades. What’s even more curious is that shoppers, despite these sticker shocks, aren't exactly pinching pennies like they used to. We're seeing less comparison shopping, fewer coupons being clipped. It seems like a subtle, yet significant, shift in how we buy things has been brewing since around 2006.
This shift, according to research from Harvard Business School, has allowed businesses to pocket savings from cost reductions rather than passing them on to us, the consumers who, it appears, have simply gotten used to paying more.
I had a chance to chat with Alexander MacKay, an assistant professor of business administration at Harvard Business School and one of the authors of this fascinating research. He’s been digging into what’s really going on with these price increases.
Digging into the Markups
MacKay and his colleagues examined the markups on everyday products – think cereal, shampoo, cold medicine – sold in grocery stores, drugstores, and mass merchandisers from 2006 to 2019. Using sophisticated econometric models, they estimated the markups consumers were facing. What they found was surprising: over this period, markups actually increased by about 30 percent.
Now, here’s the kicker: the actual prices of these products didn't skyrocket. They mostly tracked inflation, rising by about 2 percent annually. So, if prices weren't going up much, how could markups increase so dramatically? The answer, MacKay explained, lies in the falling costs of these products. When you adjust for inflation, the real costs of producing these goods were actually decreasing.
What Exactly is a Markup?
It’s easy to confuse a price increase with a markup, but they’re not quite the same. In simple terms, a markup is the profit margin a company makes on a product. It’s the difference between the selling price and the cost to the company, often expressed as a percentage of the price. So, if a product has a higher markup, it means the company is making more profit on each unit sold, even if the price tag looks familiar.
The Falling Costs Conundrum
So, why were markups climbing even before the pandemic, driven by falling costs? MacKay’s team explored various explanations, like increased market concentration through mergers or changes in household demographics. But these factors didn't fully explain the trend.
Instead, two key elements emerged. First, in markets that aren't perfectly competitive, companies don't always pass on cost changes one-to-one. If costs go up by a dollar, prices might only rise by, say, 60 cents. Conversely, if costs drop by a dollar, prices might only fall by 60 cents. In that second scenario, the company’s margin grows by 40 cents, leading to a bigger markup. This is generally seen as a good thing – efficiency gains should ideally lead to lower prices for consumers.
If this were the whole story, we’d all be better off: lower production costs, lower prices, happy consumers, and happy companies making a bit more profit. But that wasn't the complete picture. Prices weren't falling; they were inching up. This is where the second, crucial part of the story comes in – and it circles back to us, the consumers.
