How Do Retail Stores Profit From Black Friday Sales?

What are the economics behind the Black Friday sales?: originally appeared on Quora: The best answer to any question. Ask a question, get a great answer. Learn from experts and access insider knowledge. You can follow Quora on Twitter, Facebook, and Google+.

Answer by Eric Mayefsky, PhD in Economics, Stanford

I'll take a little more of an abstract take on this since I know some behavioral economics but am not a retail insider.

Question 1: How do the stores actually make money on this?

Loss leaders are a really fun economic concept Dan and Ross both covered well in their answers. In short, the retailer can lose money on items being put on sale (either in the sense of a price below the cost of the item or in comparison to the price they might be able to get you to pay if they didn't put the item on sale) and come out ahead if they increase the probability of getting you to buy other things that day in the store or entering into a profitable future relationship with you (via brand affinity or things like warranties and replacement plans) by enough. I've always heard that extended warranties are sucker bets, as one example--don't buy the extended warranty unless it's a purchase so large and important that you feel like you need to actually buy insurance on it the way you think about insurance on your house or car.

In-store sales, like coupons and other similar concepts, are a form of price discrimination which can allow a business to make substantially more money. 'Discrimination' here doesn't mean prejudice based on sex, race, etc. but just refers to this idea that different people are willing to pay different amounts of money for the same thing and the efforts that businesses make to charge more to people who are willing to pay more. For example, say you're trying to sell a TV to two different people. One has a part time job and doesn't make a ton of money, but he does like watching TV so he's willing to pay $500 for a new TV. Another is an investment banker with a wife and two kids who makes a ton of money and would pay $2500 for the same TV but for whom the day after Thanksgiving constitutes about half of the free time he has to spend with his kids all year. A retailer could offer an outrageously large Black Friday discount for the TV and the I-Banker is not going to fight the crowds at the mall. So if your entire target market consisted of these two types of people, you could make the most money by having the TV sell for $2500 in general but be only $500 if you're at the store at 5am on Black Friday or something like that. The obnoxiousness of claiming the discount is key here -- being able to price discriminate successfully requires either being able to formally filter people by status (e.g. senior discounts at the movies), filter them based on their time/taste preferences in the buying process (e.g. the above example, coupons, etc.), or by creating two different versions of the underlying product (iPhone 5s/5c, etc.). All these types can reduce total economic surplus as the business has an incentive to make life more annoying for certain customers or make a lower-performing version of a product, even if there's no cost reduction to them when they do so. (The most often cited example of this in academic economics is when Intel sold a budget version of an early processor by using the same creation process as their top of the line processor and then destroying/disabling the math coprocessor on the chip afterward.)

Question 2: If it makes money, why not have Black Friday more often?

I think the biggest reason is that retailers don't have ultimate control over cultural norms. For example, there are really no other days in the US where a large portion of the population has the day off from work/school but the day itself has no other purpose or predetermined cultural significance. Some stores do run major sales on other three day weekends but would probably face backlash if incredibly over-the-top efforts were made to commercialize Memorial Day, Martin Luther King Day, etc. Additionally, retailers can't just create new needs for purchases from scratch, and the proximity to the winter holidays plays a major role in the purchasing frenzy that would not be present in a springtime Black Friday equivalent. (Note that the retail industry definitely has _some_ control over how commercialized things get and there are many giving pastimes that seem to have been brought about by clever marketing rather than purely cultural grass roots, but that is done through advertising and gradual psychological influence over time, not by fiat.)

Even setting aside culture and seasonality in people's need to buy stuff, adding more Black Fridays would have very diminishing marginal returns for a few reasons: limits in total budgets of consumers, the psychological impact of the scarcity of discounts (if I don't buy this now, it may not be this cheap again for a whole year), and then the actual benefits of it being annoying/difficult to get the lower price (see the price discrimination discussion above).

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