The Hindu Business Line : Price discovery & value

Continuing our value equation discussion we ask: If there are no visible or verifiable signs, what would the consumer do to find out the superiority in benefits of a product or service?

Think of a motorcar: you realise its fuel consumption economies or driving comfort for example, only months after buying it.

How would one work out in practice the Value = Benefit minus Price equation, a sound basis for laying out money on anything? Where would one go for information — apart from other users' opinions and advertisements which may not always be reliable or relevant from one's perspective?

What if it is a new service that can be experienced only after one has paid for it, a new airline, a new bank branch near your home, a new restaurant or hotel that has opened up? This is the type of situation where the price acts as a surrogate for value; and therefore "It is premium priced, must be good" is a very common reaction.

Yet pricing theory remains an area for rich detail and potential controversy, almost impossible to `teach' through formulae. For example, has it ever occurred to you that the right price is one of the few things in life that leaves both the buyer and seller simultaneously satisfied - and convinced that they have had a bargain?

It seems a bit of a miracle or optical illusion: how can two people, one wanting to buy another wanting to sell, the same asset, say an apartment, reach an agreement that looks a good deal if not a great one to both?

No more powerful example can be given to show that all value is in the eye of the beholder. This is also why the auction route is considered one of the most powerful tools of discovering the price of anything.

You the buyer stop just short of where you might have serious doubts whether it is worth buying the asset; and the other party goes down, right up to the price where it is still worthwhile for him to cash the asset, all other things considered.

This can be represented as a tacit sharing — by a verbal tug-of-war, if you will — of the seller's (or producer's) surplus and the consumer's surplus.

Consumer's surplus is defined remarkably well by the classical economist Alfred Marshall: the difference between what you actually pay for the good in question and what you would be willing to pay rather than go without.

Suppose this gap is a thousand rupees. So long as the price increases that you agree upon do not take you beyond a few hundred rupees from the starting point, you are fine. So is the seller, because he too has set himself a mental limit below which he would not budge.

In the middle ground (but not necessarily the exact centre) lies the scope for all negotiations. This is, however, not such a familiar experience for us in everyday consumption goods because we pretty much pay what the price is on the sticker. There is no scope for negotiation.

However, even in such instances the competitive promotional offers and discounts offered by the manufacturers and dealers can be thought of as signals to show how far they are willing to, or forced to, go down.

In good times, such as right now in the Indian economy, therefore everyone shows increases in top line but grumbles about falling margins or sticky profit numbers.

You can visualise this as the concerted effort of millions of consumers to browbeat the few sellers to lower the price and share their surplus. Exactly the same thing might be said about salary increases in the market for jobs.

Thus wherever one can discover the price by a mutual discussion, and both parties can think of alternative options, the economics of markets comes fully into play. If either side conceals or can't share some information with the buyer which is crucial to the decision, then, of course, there is an information asymmetry - which brings in a whole new set of problems.

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