Which Price is Right?

For our original company, asks Monroe, "what becomes the best-seller? Why, the $18.95 version, of course."

It's a small story, but it's true. In fact, you can feel how right Monroe is. "The point," he says, "is that economic theory says that can't happen. But it does."

The neat curves and crisp laws of supply and demand, elasticity, and rational behavior that everyone learns in microeconomics class don't work in the real world.

Business is at the start of a new era of pricing. This era is being shaped by a new set of insights into business strategy and human behavior, and these insights are turbocharged with software, mathematics, and rapid experimentation. The result is what might be called "scientific pricing." There is even a blossoming industry of a dozen companies that offer scientific-pricing services.

Changes in pricing will alter every part of the economy. The way that business gets done will change, and companies will flourish or be crushed based in part on their ability to grasp and master the new science of pricing. Among those already using the new techniques are Best Buy, DHL, Ford Motor Co., the Home Depot, JC Penney, Safeway, Saks, Staples, UPS, and Winn-Dixie. General Electric, perhaps taking Jack Welch's warnings to heart, is not only working with at least two different pricing companies -- it has also invested in one.

PRICE CHECK (I): BEFORE THE BAR CODE

The oldest records of prices ever found are clay tablets with pictographic symbols found in a town known as Uruk, in what was ancient Sumer and what is now southern Iraq. These price records are from 3300 BC -- they've survived 5,300 years. The documents -- records of payment for barley and wheat, for sheep, and for beer -- are really receipts. "Uruk was a large city, at a minimum 40,000 people," says UCLA professor Robert Englund, one of the few experts on the Uruk documents. "So some of the quantities are very high -- hundreds of thousands of pounds of barley, for instance."

But here's the really remarkable thing. The earliest Uruk tablets aren't just the oldest pricing records ever found. They are the oldest examples of human writing yet discovered. In other words, when humans first took stylus to wet clay, the first thing that they were compelled to record was . . . prices.

INSIDE A PERMANENT PRICE WAR: "YOU'RE ONLY AS SMART AS YOUR DUMBEST COMPETITOR"

If there are pioneers in the world of scientific pricing, they are the airlines. In the 25 years since deregulation, the airlines have honed an obsession with prices -- their own and each other's -- that is legendary. We all live with the seemingly bizarre inconsistencies that result, such as two people on the same plane, sitting across the aisle from each other, one of whom paid $290 to fly from New York to Miami, one of whom paid $1,290. We also benefit from the pricing obsession: With just a little bit of planning, you can fly for the same price today that you did in 1980.

The airlines know full well that we are puzzled by the frantic pricing and repricing that they do -- puzzled, that is, when we aren't infuriated. Jim Compton, senior vice president of pricing and revenue management at Continental Airlines, not only wasn't scared of going to jail if he talked about prices, he was happy to pull back the curtain, to show fliers what he and his 150-person staff are up against. "I do not set the prices," says Compton, a patient, thoughtful man. "The market sets prices." That's point one. Point two: "I have a really perishable product. It's gone when the door of the plane closes. An empty seat is lost revenue."

But here's the first of many oddities of airline pricing. Most other perishable products -- milk, bananas, trendy sweaters -- get cheaper the closer they are to being "expired." Airline seats get more valuable the closer they get to being "expired." The most valuable airline seat is the one that somebody must have an hour before takeoff and is willing to pay almost any price for. Unlike a banana, an airline seat gets more profitable with time -- right up to the moment it goes from being worth $1,000 one-way to being worth $0.

Here's how Compton and his colleagues think about this: You always want that seat available to sell at full price -- just in case someone wants it. You want to sell every seat on the plane, except that you also want to have a handful left at the very end, for your most profitable (not to mention most grateful) customers.

The airlines could easily sell out every seat, every flight, every day. They'd price 'em pretty low, book 'em up, and wait for takeoff. But that would mean there'd never be any seats available two or three weeks before a flight took off. How exasperated are we to call and find no seats three days out? What if there were no seats three weeks out?