Pricing

A big challenge for anyone running their own business is determining the right price to charge.

There are all sorts of ideas that claim to give you the right price (such as the idealized “supply and demand” curve from economics), and all sorts of wacky exceptions (such as loss leaders at the grocery store).

Many technical people fall into a trap when they get into business.  An elderly professor I know who had tried to run his own business found this was the core of what limited his success.  Even after he warned me about it, I went and did the same thing when I started my business.

Techies seem to gravitate to the idea that the right way to price products or services is to add up the cost, add a reasonable profit margin on this, then sell it for that price.  If, after labour, materials and everything, widgets cost you $30 to make, selling them for $42 (a 40% markup) is clearly the answer.

The joke is, a widget might not be worth $42 to the buyer.  It may be worth $20 (in which case you’re a fool to make them), or $400 (in which case you’re a fool to sell them for $42).  The right price to charge for something is the highest price customers are willing to pay.

Commodities are the exception to this, as they get driven down to the price to bring them to market plus a small markup.  There’s no real difference between brands of salt, so manufacturers will keep undercutting each other until the price gets to the “techie ideal” of cost + markup.

Kenny Kramer (the real life basis for Cosmo Kramer) sold electronic jewelry during the disco years.  He was able to get them manufactured dirt cheap, then sell them for a super-high markup.  This allowed him to not work for a years, long after disco was dead (will disco ever REALLY be dead though?).

Guiness416 recently pointed us towards a great article about gourmet chocolate.  The punch line is they buy chocolate that’s available to anyone and sell it in smaller chunks for a 1,300% markup. I was horrified reading it, and it just seemed so scummy to me.  It’s probably good business.  People with too much money want to find something they feel is extra-special, and are delighted to pay an outrageous price for it (given that the company is still in business years after the article was published).  They aren’t selling chocolate.  They’re selling gifts that say to the recipient “this cost a lot of money”.

Everyone has heard that the fountain drinks you buy at the movie theater for $4 costs them $0.10 to provide.  Is a 4000% markup reasonable?  Is it reasonable if it subsidizes other parts of the theater experience?

Long time readers know Mike and I would never say a bad word about real estate agents.  However, a case recently came up in Australia where a real estate agent bought a house worth $300k, from a man in a retirement home, for $150k (good thing they have a duty to their clients, eh?).  In this case I think its clearly wrong because the seller had a diminished capacity and the agent took advantage of that.  The same thing happened to my grandfather:  a real estate agent bought a parcel of land off of him for $5k, then resold it 6 months later for $10k.  This was 40 or 50 years ago, so it was a significant amount of money at the time.  Heck, it even landed the agent in the Cheap clan’s “Big Book of Grudges”.

I find it hard to shake the feeling that this isn’t right (I sure wouldn’t be comfortable taking advantage of someone like that), but all evidence seems to tell me that I’ve got the wrong outlook on this issue.  Or at least I don’t have the right outlook if I want to be successful in business.

Is it wrong to charge far, far more for something than it cost you?  What are the limits to “looking out for your own interests” and at what point does it become unethical gouging?