Saturday, September 15, 2012

Pricing In The Market Place

It would really be great if companies could just charge whatever they thought was fair for their products, or services to cover their cost of doing business and earn a little profit.   Unfortunately, in a free market economy, that is not exactly how it works.  In fact, the market determines pricing, even more than company management, as a result of the competitive bidding process that is so prevalent today.   Most major firms looking to buy goods and services go out to bid to select a supplier.   Generally, 6 - 8 credible suppliers are "invited to bid" on a company's business through a major bidder process designed not only to select a quality supplier; but usually at the lowest cost. 

There is a presumption that most suppliers, providing a similar service, will have the same pricing factors.  To some degree that is true; but not always.  Cost of labor, revenue sources, business locations, tax domicile, automation and other factors can be very different, all of which can have a dramatic impact on pricing.   Seven years ago, this Blogger determined that the competitive forces we faced in the marketplace made it impossible for us to continue doing certain back office accounting functions in the United States any longer.  To the shock of our management group, I announced that we would move those functions to India to secure cost savings, two shifts a day to accommodate global time zones, higher productivity and quality services. 

As such, as a global company, we moved those back office accounting functions off shore, which did result in some job loss in the US.    However, the savings derived allowed our firm to hire more people in higher level jobs in the US, Europe and Asia Pacific to further expand our company around the world.   And, our college educated, Indian employees actually did a better job than our employees in the US, that often were under educated and actually hated the tedious work. 

Most important, had we not moved these functions to India to secure cost savings, when the Recession hit in 2008, our company would have been in a serious loss position that would have resulted in even more lay off's than were necessary because of the Recession.   Thankfully, that did not happen.  The lesson learned here is that the President of a company must always see the train coming to avoid being run over by it.   Moving these back office accounting functions to India was the right thing to do at the right time. 

Companies that attempt to price from their Operations out, rather than from the client, or customer back usually don't stay in business for long.  We have certainly seen this in our industry.  That is why so many companies come and go through mergers, acquisitions, or even bankruptcy. Pricing is ultimately about what the market will bear, not necessarily what the seller wants to charge. 

To illustrate this fact of life in the simplest way I know, as someone who has traveled five million air miles on business, I compare the price of a shoe shine at major airports.   At McCarren International Airport in Las Vegas, the price of a shoe shine is now $10 and the seats are empty.   The optimum price of a shoe shine, when the seats are constantly full, is $3 to $4 tops.   That price will usually result in a tip of a dollar or two, which tells me that the market (the price a willing buyer is willing to pay most frequently) for a shoe shine in the United States at major airports is around $5 tops.   Whenever I see prices above these amounts, the chairs go empty.  By the way, this is my price point, as well.   I walk away if I see prices above this amount. 

This premise is relevant to the purchase of all goods and services unless the item is scarce; like diamonds.   The higher the price for a commodity, the lower the amount of sales or volume.   Like in the shoe shine example, there is a point that will cause the buyer to walk away because ultimately value is determined by the buyer in the marketplace, not the seller.  And, it may not even be possible to charge higher prices for premium service because all buyers today expect premium service as the norm.

As such, management must assume that inflation adjusted pricing for the same product, or services will continue to go down over time rather than up, while higher quality is always expected by the buyer.   This means that the only way to succeed in business is to continuously find better, faster, cheaper ways of doing business.  The company that fails to do so will not be in business long. 

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