If we always made rational decisions that is based only on economic reasons the price we pay for products and services we buy should leave us feeling that these are worth more than it cost them. At the very least these two should match. The difference we perceive, between what the product is really worth to us and the price we paid is called the consumer surplus. But the problem with this is we are not all economists or rational number crunchers. I am going to exclude emotional decision making for this post and focus simply on our quantitative ability or the lack of it.
I do not mean our capabilities with numbers but our ability to assign a dollar figure to the value we derive from products and services. Imagine you have an hand held device that can read bar code and an LCD display. You read the bar codes of any product and it displays the value you will get. Then you look at the price and decide whether this leaves you a positive consumer surplus or not and decide whether or not to buy it. The value we get is our Willingness to Pay. We should be willing to pay any price up that and not more than that.
Unfortunately we do not have a device and even if there is one the device must not only work differently for each person since the value you get is different from mine and from everyone else but also work differently for the same person based on time and context.
There is no such device. So how do we know whether are not a product is worth the price we paid for it? We never will for sure. I have heard a simpler and better definition for consumer surplus, ” it is the size of the smile on our face after we buy the product”. If we kick ourselves for buying at a price obviously it means we paid too much.
The story does not end there, there are complexities like reference price, how marketing can increase our willingness to pay, how lack of value information (with no magic barcode reader) can artificially suppress our willingness to pay. There are emotional purchases in which we convince ourselves of higher willingness to pay or adjust our willingness to pay post-purchase to assuage our concerns of overpaying.
Now you know why microeconomics alone is not enough to define pricing strategies for marketers and the need for behavioral economics and behavioral pricing. I look forward to writing a few articles in behavioral pricing in the coming weeks.
I received somewhat surprisingly high number of views on How to price your garage sale article I wrote. I think people are searching online because of the time of the year for tips on pricing their garage sale. The article I wrote was probably not suited for the most common garage sales that sells many items for less than $5. Here is a set of 4 things to consider before your sale:
- Is it worth it?: Think of the opportunity cost of time spent categorizing, labeling, advertising and finally spending 3-4 hours manning the shop. Suppose your time is worth $50/hour, would you make more than $250 from your garage sale? If not, is it worth doing? Frugal families blog says, “anything under $2 sells fast”. That means you need 125 such items just to break even (after the opportunity cost). Note that you value your junk, err treasures, more than your potential buyers would due to endowment effect. Don’t overestimate the total sales to justify the effort.
- Alternatives?: Are there alternatives to garage sale like giving the items away to local charity and claiming tax deduction? If you do not itemize your taxes this does not help you. But think of the time saved and the general euphoria, however fleeting, from donating things?
- It is sunk, now keep moving: You might have bought your item at a higher price or you might have spent considerable effort building or improving it. Do the money and time spent in the past justify additional time and money for holding a garage sale? No, what you spent in the past is sunk. You should only consider the effort not spent and pick the best among the alternatives.
- Doing it for the experience: May be you do value the experience more: If you really think that the experience of holding a garage sale means something to you, be it a lesson in negotiation or just a way to meet the neighbors then by all means do it. However see (2) again.
With Borders shutting down stores and facing declining profits, Barnes & Noble remains the only strong brick and mortar bookstore. While it faces strong competition from discounters like Amazon, WalMart and Costco, its new threat comes from the change in consumer preference from paper books to eBooks. While there were other eBook formats and readers, the threat was not credible until Amazon entered the market with its own Kindle eBook reader.
The real threat is not from the device but from Amazon’s strategy to own the distribution through its Kindle store. Amazon is more than a bookseller, it is a Platform company (Mr. Jeff Bezos once described Amazon as the Ideas company). It has the wherewithal to develop a home grown distribution platform, build an ecosystem around it and quickly gain control of the ecosystem. But B&N does not have the technology and a strong R&D team.
Clearly B&N knows this weakness and sees the threat posed by Amazon’s Kindle store. It however can acquire the technology to fast-track its eBook strategy and it did exactly that. B&N is set to answer Amazon with its own eBook store with its acquisition of FictionWise an eBook retailer.
Stated in the same report is that B&N is going to develop its own eBook reader, a competitor to Kindle if you will. This is not the right strategy for B&N. As I stated in my previous article the Kindle device is not the main focus of Amazon and it will gladly give that market to control the distribution value chain. B&N should not be distracted by the success of Kindle device. The war is about the control of distribution platform not handheld devices. It cannot dilute its scare resources by focusing on both the eBook distribution platform market and the devices market as this would only enable Amazon strengthen its platform leadership position.
Strategy is about making choices and allocating limited resources and not straddling. So forget going after Kindle device, it is a red herring. B&N’s strategy should be to become another platform option for publishers and authors who would not want to see just one strong player in the eBook market.
Back in July 2008 I wrote about Amazon’s Kindle Strategy. I said they are not in it to capture the devices market but rather win the distribution platform market.
It is driving the new format, reduce the value captured by publishers and position itself to be the distribution medium of choice. The goal is to capture the format market and control the value chain and not the devices market. Since no one else s making such devices amazon.com took this on itself.
There is news today from Amazon that signals the move in that direction. Amazon announced today that they will release a Kindle iPhone Application that lets iPhone and iPod Touch users read Kindle books on their devices instead of Kindle. This program is available for free, a right move that fits with the platform strategy to increase footprint. The Kindle App will be a bit with iPhone users and it will reach top 10 among most downloaded.
Is this program targeted at its existing Kindle customers or new customers? While Amazon says it is adding convenience to Kindle owners allowing them to read books while they are away from their Kindle device, it is directly targeted at converting new users and increasing Kindle format footprint. For the very near term (within days) even if 1% of 10 million (approximate) iPhone/Touch users bought just 1 book at $9.99, that is $1 million in new revenue. For the long term this translates into not only more revenue from repeat purchases and new customers but also delivers on Amazon’s goal to win he platform war.
Questions do arise on why Amazon introduced Kindle at all and why it did not go for iPhone application in the first place. I think Amazon’s strategy evolved since the introduction of Kindle. The biggest factor of Kindle device is the readability with its e-ink technology, there will always be a segment willing to buy this device for this factor alone. Techcrunch downloaded Kindle App for iPhone and reported they had same reading experience on iPhone as on Kindle. Amazon probably also wanted to be negotiating with Apple from a position of strength having a powerful BATNA (Best Alternative To Negotiated Agreement).
Other Winners and losers? By giving the program away for free Amazon denied any revenue to Apple. Authors and Publishers stand to gain more from increased book sales. Magazines and Newpapers that received subscription revenue from Kindle subcribers stand to lose any additional revenue from new subscribers. This is because iPhone readers can access the content using the browser and with existing online subscription instead of paying a separate subscription fee for reading on Kindle. To some extent Sprint Nextel that has the contract with Amazon to deliver books on-demand to Kindle devices stands to lose.
Overall, Amazon will win because of its clear strategy and flaw less execution.
In April 2008 I posed the question, Is Ruby Tuesday solving the right problem?. At that time Ruby Tuesday announced a $50 million restaurant and brand makeover. I did a simple estimate based on Ruby Tuesday’s own goal of increasing cash flow by 3% and did not include the economic problems. The quick analysis showed the investment to be net negative.
The fiscal second quarter results announced last week point to the restaurant’s woes stemming from the economic crisis. Ruby Tuesday suffered more than the restaurant groups due to its high makeover expense that did not payoff and due to fall in traffic to malls where many of its restaurants are located. The WSJ reports,
While most large restaurant chains are struggling, Ruby Tuesday has had a particularly difficult time. Since 2007, the company has invested heavily in a brand overhaul to make its food and atmosphere more contemporary, but the effort hasn’t reversed the slide in same-store sales. During the past year, its shares have fallen 82%.
The answer to the original question is an absolute No.
See this link for the Economist forum on Corporate Social Responsibility: Economist