The Hindu Business Line : Cost a fact, price a policy?

In the early days of our MBA, we were asked to comment on the statement, "Cost is a fact, price is a policy." As a class of young graduates from various disciplines, some far from economics or commerce, we saw this statement as abundantly logical.

After all, cost was in the past — we had already paid out in cash for something that we then wished to sell; or it was an accumulation of expenses incurred, while producing something for the market, whereas the price at which one sold it was in the future, yet to be determined; it could be anything one wished.

If you were in a great hurry, one might offer a huge discount to whoever paid cash and relieved one of the entire stock, conventionally referred to as the typical bulk or wholesale discount.

On the other hand, a cautious marketer might decide that she should make a clear margin of at least say, 50 per cent over costs and so announce a price accordingly — and see what happens.

If there were no takers, the price could drop later on or some device employed to lure the custom. The important point, so it seemed, was that the options were all yours, the manufacturer-marketer. How little we understood the real world!

In real life, few things are more riddled with the unknown as pricing. Whole textbooks are written on this but none can give a formula answer on what a specific price ought to be.

They talk about the strategies to be adopted, such as market-skimming, a high price that takes the most affluent or ready-to-pay; or deep discount price that undercuts everybody, drives out the weak players and expands primary demand, return-on-investment based that takes into account a measured amount of profitability to be the residue and so on.

price is always a guess

Experience has shown that price is nevertheless always a guess, a gamble in the literal sense. It is a bet not only on how the customer will see the price against the perceived value of the product; but it is also a judgement, which research can only partly help with, on how it measures up against the alternatives the market has to offer.

Very advanced statistical techniques have been employed such as conjoint analysis to tease out how a consumer weighs the worth of groups of attributes of the product (say mileage economy, speed, style, pick up, space, in a motor car) and equate these with elements of the price that he or she actually pays for the product.

Yet, in practice, managers use age-old rules of thumb, based on other comparable products and always see the new launch in terms of the brand that it might be expected to take business away from - and which in turn poses the highest threat to it. Try thinking of a product, any product that comes to mind and you will find it possible to recall some other option the customer might have thought of. For example, if you were to be the first ever marketer of iced tea, what would you price a packet of say, 100 grams.

Obviously, sooner or later, even allowing for all the novelty and different occasions when it is drunk, the taste and so on, the customer is bound to think of it as yet another refreshing beverage and what she would be prepared to pay for it would have some relationship to any other existing thirst-quenching beverage, and in the end, the price would be such that a glass of the drink must be somewhat in the same ballpark.

The truly new-to-the-world innovative products are rare and far between.

Many of us go through life without ever having been called upon to calculate the launch price of a new product such as a Post-It pad, an i-Pod, or a Windows office suite, all of which were truly without parallel, when they came on the market.

This is where all sorts of philosophies and theories might be bandied about, recommending market development or initial profits or image or whatever as the goal that determines the approach to pricing.

In all other cases, the price really is not in one's hands at all, but a mixture of chance, competition and consumer or market forces.

The worst self-deception would be for the manager to think that it can always be set at a cost-plus a certain percentage. If such days did exist, they have been a long while gone.