Monday Mornings with Madison

The Price We Pay: Rethinking Price, Cost and Value

Nothing worth having is ever handed over for free.  Indeed, how much is paid for anything should factor in its perceived value, not just how much it costs to produce or how much a competitor is charging for it.  Really, that should be the last sentence in this article.  That is the take-away.  But, for many companies, value is not factored into the price.  That often means they leave money on the table.

To better understand the relationship of value, price and cost, let’s start by defining these terms.  Cost is the easiest to understand.  Cost is the aggregate monetary amount needed to produce and deliver a product or service.  It is the amount spent to make and provide goods or assistance.  Cost is a numerical calculation determined by the producer based on what is paid for materials, labor and overhead.  So cost is what the company pays in order to create.  For example, an architecture firm pays for the time, expertise and equipment of the architects employed to design structures, as well as the office space, benefits, ongoing training, etc.  Those are the hard and soft costs related to designing a building.

Price is the amount paid by a buyer in exchange for a product or service provided by the seller.  It is also a numerical figure determined by the seller.  It is what the company charges.  The price is what the architecture firm charges a builder / developer / company for the ideas, design and ultimately the blueprints that the architect creates.  But if those were the only factors that go into pricing, most things would be priced about the same…. and they’re not.   That’s because price can also harvest value.

So what is value?  Most people understand cost and price because those are based on concrete mathematical calculations.  However, value is different.  Value is the utility or worth of a product or service to the consumer.  This is what the product or service brings to the consumer.  This is immeasurable because of how value is determined.

Value is determined based on:

  • 1. Individual Perception. A consumer’s perception of a product or service’s appeal, reliability, user-friendliness, appearance, customer support and technical assistance.  This varies from consumer to consumer.  The value of a product or service is different for different people.   For example, for people with myopia, corrective lenses have a much higher value than it would for those whose vision is 20/20.
  • 2. Public perception. A consumer’s value of a product or service’s appeal is deeply influenced by others’ perception of it.  When celebrities highly value a product or service, they are able to change how others value it.  This has always been true.  Consider Tulip Mania.  In 1636, the entirety of Dutch society went crazy over exotic tulips. Tulip prices spiked from December 1636 to February 1637 with some of the most prized bulbs, like the coveted Switzer, experiencing a 12-fold price jump. The most expensive tulips sold for as much as 5,000 guilders, the going rate for a nice house in 1637.The effect of public perception on value has increased exponentially thanks to social media.  Today, if Oprah puts a book on her Book-of-the-Month Club, it is an instant best-seller and the price for a hard cover of that book will increase accordingly.
  • 3. Timing. A consumer’s perception of value changes over time. For example, the value of the polio vaccination, for example, was far greater for children during the outbreak of that illness in the U.S. in 1949 and early 1950s than in 1980 after polio had been completely eradicated in the U.S.  

  • 4. Supply and Demand. The value of a product or service varies greatly based on supply of the product or service and demand for it by consumers.  When the Covid pandemic started last March, the value of Lysol wipes and Purell hand sanitizer increased exponentially when demand soared and production could not provide enough supply.  In the diamond market, companies deliberately keep supply of quality diamonds low to ensure that demand far outstrips availability.  This ensures that people are willing to pay more for diamonds than other precious stones.
  • 5. Location. The value of a product or service varies greatly based on location.  Consumers perceive the value of sunscreen as much higher in locations that are much closer geographically to the equator, as opposed to those who live in colder, less sunny climates.

For these reasons, value is not a mathematical calculation.  It is an emotional response that can be hard to qualify and even harder to quantify.  Why?  Because consumers associate the things they buy with status.  When a product triggers the value recognition mechanism that says “this is more than a product, this is an upgrade to my life”, that product or service gains more value in the consumer’s mind.  Therefore, the consumer will be willing to pay a higher price for it.

Case in point.  If we use the same example related to an architecture firm’s services to explain value, one would note that some architecture firms can and do charge substantially more to design a building than other firms.  San-Francisco based architectural firm Gensler — which has ranked first on Architectural Record’s roster of the Top 300 Firms in 2020 as well as the previous eight consecutive years – could and would likely charge a premium to design a hotel for Disney versus what other architectural firms might charge.  Gensler was ranked #1 in 2020 not only for overall architecture, but in the categories of Office, Hospitality, Reconstruction, Religious, Retail and Convention and Conference.

Major organizations and global corporations are willing to pay a premium to hire Gensler because they are known for pouring a great deal of time, money and expertise into funding the Gensler Research Institute which does proprietary, longitudinal research studies exploring the intersection of design, business, and the human experience.  Their researchers seek insights that inform their designers and help their clients to drive their businesses forward.  Through tailored webinars and virtual roundtables, unmatched thought leadership, in-depth publications, survey reports, and timely newsletters, they provide clients with the latest in design thinking and real-time strategies.  They hire top talent and keep that talent educated on how the world is changing and how to make buildings work best for that new world.  They are not just drawing blueprints.  They are designing iconic, inspiring structures.  For clients, there is a perceived value in hiring Gensler.  Gensler has a certain cache, and provides an upgraded experience.  For that, they are able to charge more.

As with Gensler, it is clear that value is also affected by brand and reputation.  Certain brands are perceived as a life upgrade.  For example, Rolls Royce is a car, but a 2021 Rolls Royce Ghost is $628,000.  Hermes makes women’s fashion accessories but a Hermes Shiny Niloticus Crocodile Horseshoe Birkin 30 Vert Purse in Emeraude Black is $72,500.

Charging Less is Counterintuitive

While many companies are inclined to lower their prices in order to sell more product or charge less for their services in order to do more work, charging less is often counterintuitive.  Consumers perceive something that is cheap as undesirable.  No one wants to buy a $2.00 steak.  But business owners often fail to understand this truth.  Business owners have limiting beliefs about money.

There are many great examples of this in business.  Take, for example, McDonald’s franchises.  When Ray Kroc first began selling McDonald’s franchises, the franchise fee was $1,000.  At the time, he got almost no takers.  However, in a moment of inspired wisdom, he increased the franchise fee to $10,000.  Immediately, the perception of potential franchisees changed.  It cost more, which to prospective franchisers meant it was worth more.  Suddenly demand soared!  The paradigm shifted from one in which Kroc was chasing buyers to one in which buyers were pursuing HIM.

The bottom line is that there is usually a deeper reason why people buy; a deeper emotion that creates demand.  Understanding and leveraging this is key to a business’ pricing and success. There is a need to couple a product’s pricing with how it is positioned, and tailoring it to the problems that the specific audience being served has.  Otherwise, when businesses price products or services based on what it cost or what competitors charge — ignoring its value and perception — they are likely leaving money on the table.

Quote of the Week
“Price is what you pay; value is what you get.” Benjamin Graham

 

© 2021, Written by Keren Peters-Atkinson, CMO, Madison Commercial Real Estate Services. All rights reserved.

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