Using Cost Argument For Price Increases – A Redux

The latest article in the, “Ask the Expert“, series featured a detailed and well researched article written exclusively for this blog by William Poundstone.  In that article, Mr. Poundstone answered the question whether businesses can use cost increase as an excuse to push through price increases. The article generated two very well reasoned responses. Here I will address the questions and qualifiers raised in the two responses.

Before I get to that, let me clarify one aspect that is most likely already clear to the regular readers.

Costs have nothing to do with pricing. Effective pricing is about finding what is relevant to each segment and targeting them with a version at a price they are willing to pay.

The question Mr. Poundstone answered was whether cost increase can be a good excuse for pushing price increase (not setting the original price). I have answered the same question in a previous post with similar response:

if the price increase were justified with a reason, a greater number of customers will accept it. In their paper titled,Perceptions of Price Fairness, researchers Gielissen, Dutilh,and Graafland  validated the hypothesis that price increases justified with cost arguments were perceived to be fair by customers.

Ellen Langer’s work, quoted by Cialdini, point to another possible reason for customer acceptance of higher prices – it is not the justification itself but the mere presence of one.  This opens up opportunities for both B2C and B2B marketers to re-price their offering or capture greater value without turning away customers – just give a reason, any reason.

Now to the two responses.

  1. What about inflationary conditions? Leo Piccioli from Argentina raises the point about conditions where the monthly inflation rate is 2%. He writes

    Under an inflationary context (understanding it as a general increase in prices along the market, or, in other words a reduction in the value of money) “fairness” seems to be a bit easier: people know prices go up all the time and do not have the time to validate each increase (the cost of checking it out is higher than the benefit). Therefore, I would recommend constant small increases instead of periodic large ones.

    It is very true for such macro-economic conditions and across cultural boundaries the research I quoted and that quoted by Poundstone may not be relevant. Inflation is in the minds of the customers, it is their expectation that prices will go up. Presence of such expectation gives marketers the freedom to push through multiple periodic price increases without worry.

  2. What about the cost of the messaging to justify price increases? John Balz who writes the NudegBlog, posted an article responding to Poundstone’s article:

    The basic point is that rather than having companies coordinate separate communication about commodity prices at moments of price hikes, wouldn’t a better strategy be to integrate market commodity costs into a communication strategy more generally?

    Yes there are costs to a marketer in running these campaigns but a constant and steady message on costs has the danger of converting the pricing into cost driven one and letting the customers demand a price that is only marginally more than cost. For the extreme example, see my Coffee shop example,  do customers come into a coffee shop to offset your different costs or get their daily caffeine fix.
    Or take the case of Apple’s 3G iPad and compare that to of Kindle 3G. Both have the same radio parts but the price of 3G iPad is $130 more than iPad Wifi while Kindle 3G is only $50 more than Kindle Wifi. Clearly, Apple is pricing based on value to customer.

The net is, pricing has nothing to do with cost and we should not be talking about it at all. When the original price is wrong or misaligned, cost increases can be used as an excuse for better price realization without much customer backlash. Otherwise, let us not bother our customers with the cost of sending our children to daycare so we can deliver the product to them.

2 thoughts on “Using Cost Argument For Price Increases – A Redux

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