Enjoy that glass of teh tarik now

Remember the sudden 78 sen spike in pump prices in June 2008? That shocking increase took everyone by surprise. Consumers and businesses alike were left wondering how to cope with the sudden spike in the cost of living.

The impact was significant not only on bottom lines, but also on behaviour — I remember that it felt weird driving around KL without the usual traffic snarl in the weeks following the announcement.

Now, fast-forward to 2010. This time around, the good news is that subsidy rationalisation in the form of an increase in petrol prices has been much smaller.

Now, breathe easy. The price of RON 95 was raised by only five sen a litre, while for those who can afford the premium RON97, they will have to pay prevailing market prices. Even this is not too bad, at a time when the global crude oil price is hovering around US$77 (RM244.86) per barrel.

Now, let’s get to the crux of the issue — the impact of the fuel hike on prices of typical consumer goods. We know consultants and economists are good at deriving hypothetical pricing for goods, given the recent increase in fuel costs.

Putting the numbers in nice linear equations — well, non-linears are sometimes used to show how sophisticated they are — they come up with the estimated new prices of goods. It might appear credible, but it may also sound a little unrealistic to consumers who tend to go with their gut feel that the price increase would be sharper. I’ve seen some of the estimated numbers. The prices of roti canai, nasi lemak, mee goreng and teh tarik will probably increase by one sen. Meat and chicken will see their prices go up a bit more.

Consumers may believe they are going to pay a bit more than this, but try asking them why. They probably wouldn’t be able to pinpoint the reasons. “It’s just through past experience,” they may say.

Now, allow me to try and explain. First, there is what I call a concept of “rounding up”. We all know that we hardly see one sen increases in our teh tarik or roti canai. The process of rounding up to the nearest decimal point will take place.

But during price increases, people do not round them up to the nearest decimal. If the current price is RM1.20, a glass of teh tarik, which is now supposed to go up by one sen, will go up by five sen. That’s not to the nearest decimal point, if I can recall my maths correctly, but that is what usually happens.

Now, my second theory can be called an “easy change” concept. What I mean is this. Try looking for coins in your pocket. Chances are you will only grab the 10 or 20 sen coins. For some reason, it is quite difficult to find that tiny five sen coin in our pockets.

So, consumers will find it hard to come up with exact change when prices are in the multiples of five sen.

Similarly, sellers will find it irritating to look for a five sen coin to return to consumers. So, the end result? Sellers will round the transaction up for the second time to arrive at a 10 sen increase. Okay, now, a glass of teh tarik will be RM1.30 instead of RM1.21 as estimated by economists.

My third theory goes like this — brilliant business people will look around and say, “Look, we are smart people — we consider business costs from every single aspect. Prices of teh tarik are affected by different factors — fuel, sugar, and so forth. That one sen estimated increase is only due to an increase in fuel prices. We have not factored in the impact of high sugar prices.”

I will name this as a concept of “rational business decision”. So, the price of a glass of teh tarik will now be slightly higher than RM1.30.
One final theory is what I call an “expectation-induced business decision”.

A smart seller will argue the following: “If prices of fuel go up twice a year, I have to charge higher prices to my consumers every six months. But that’s not a good strategy, as I will be seen as somebody who pushes up prices too frequently. So what I will do is price in the whole year’s increase in fuel prices in my goods now, so that I won’t have to raise them in the next 12 months.”

The result?  Probably another five sen increase. So you see, a glass of teh tarik may end up costing RM1.40.

It is not my intention to condone this practice of profiteering. Not at all! In fact, this is exactly what the government is trying to prevent from happening.

It is an unethical practice, no doubt. However, this is probably part of the explanation why an increase in the price of certain goods does not tally with the adjustment in prices of other goods. So, better enjoy that glass of teh tarik before its price starts to climb!
 

Written by Commentary by Nor Zahidi Alias

Nor Zahidi Alias is chief economist, Malaysian Rating Corp Bhd
This article appeared in The Edge Financial Daily, August 2, 2010.