You better not bake your costs into pricing

The Atlantic boldly declares, “prices are people”.

“Baked into the price of everything we buy is the rising cost of advertising, accounting, legal services, insurance, real estate, consulting, and the like — jobs performed by the high-wage workers of our modern economy,”

Quoting data on our food spending, they say increasing share of our spending goes to services (wages to people that is) while less and less goes to commodity producers. Hence their case, baked into price is people cost. They explain to us that is why hand-made handbags are more expensive than the mass-made.

Just think about the $629 you just paid for the new iPad 4G, 32 GB.  Was it priced high because it is made one at a time using US labor, costs Apple a lot to pay those high-wage geniuses who work at Apple stores or because of their rising cost of advertising?

You can see how naïve Atlantic’s argument is and that how it completely misses the mark on economics and marketing front.

First the economic point – customers are not going to keep buying products when the manufacturers keeps adding their rising cost to the price. Demand is a function of price. Not only demand moves with price, the entire demand curve may shift (as they do in case of economic shocks). On the flip side, look at the farmer’s share as the price they charge for the products they delivered. Their pricing power keeps going down because of excess supply and practically no product differentiation.

Next the marketing point – customers are not paying to offset your costs. They are paying to fulfill their needs –utilitarian or hedonistic. It does not matter to them what your costs are or how you are allocating them.  When was the last time you were at a coffee store and paid separately  for employee salary or the decorative lighting?

It is not the cost that comes first, it is the price that comes first. Apple and Starbucks don’t bake their cost into pricing. They find the price customers are willing to pay for the value they get and deliver the product at cost that is profitable to them. In case of Apple, insanely profitable prices and costs. There are many customers who are not willing to pay Apple prices, Apple simply chose not to target them.

Shoppers brandishing their newly purchased iPa...
(Photo credit: Wikipedia)

It is not the salaries of Apple Store Geniuses that is baked into each iPad. To target those customers who are willing to stand in line and hand over $499 to $799, Apple has to hire the Geniuses. The  experience is part of the product. Apple is willing to pay higher wages the Geniuses demand because, one they cannot deliver the same customer experience with someone willing to take lower wages and two it can still make profit at these wages.

Prices are not people. People costs do not determine prices.

Hope you are not taking economic insights or worse pricing advice from such articles.

Other readings:

  1. If you think organic produce is priced higher because of costs
  2. Why is iPad 3G priced $129 more than Wifi but Kindle 3G is only priced $50 more
  3. What is the difference between Apple and a drycleaner? (password: iPad2)

The Problem With Increasing Oil Supply Now

There is bound to be a bigger push on the Congress and the President to do something about the high oil prices. On an election year, the candidates wanting to show they care, get in the fray with their own recommendations like Gas Tax Holiday.

A common theme across all these plans is they either seek to increase supply or reduce total price.The supply increase is recommended through, more drilling in existing fields, open up new fields in protected areas, stop adding to strategic reserve.The price control methods are just that, seeking to introduce price control, windfall taxes and eliminate taxes.

The problem is the shock is demand induced and not a supply shock. The demand is global is nature and not limited to US. When the prices rose first, it was a shock. Now people, across the world, come to expect the higher prices are here to stay and are changing their behavior like using public transit, using cattle for plowing the field (India), or working from home one day a week.

Not everyone is doing this but enough to put a dent on the demand. If the lawmakers choose to address this demand side problem by increasing supply, the demand will only increase to absorb the added supply. The price of crude is at its market clearing price and not spiralling out of control because people can make behavioral adjustments.

Adding new supply will negate these and will keep the prices at their current levels or higher and not push them any further down.