What Makes a Brand Vulnerable?

I read, with growing contempt, a passage about the reasons that customers abandon a brand to which they have been loyal for years in favor of an “upstart” brand.  It was an extremely superficial and narrow-minded swipe that largely seemed to exonerate the brand for the very behavior that caused customers to abandon it.

The rationale for “customer abandonment” was that customers had no loyalty, they were unwilling to pay a higher price, the were unwilling to undertake additional difficulty to obtain and service the product, they were unwilling to compromise on their needs and accept a product that was functionally inferior to what competitors were offering, or in some other way to sacrifice their own welfare to support a brand that failed to serve their needs.

For each point in the brief list of reasons, I couldn’t help wondering why a brand should expect customers to remain loyal to the brand’s interests while the brand pointedly ignores the customer’s interests. After all, the only reason a person purchases a product is because they have a need to fulfill – and the only reason they purchase a given brand is that it is better than all the other options.  When another firm offers a better proposal, customers take it – and I don’t believe that should be seen as a failing of a customer, but as a failing of the brand to serve the needs of the customer.

The foremost complaint, as might be expected, is cost: customers abandon a favored brand for a lower-cost alternative.   But that begs the question: why does their favored brand cost more?   Is it because the brand is exploitative and charges an unreasonable markup?  Is it because the brand is inefficient and must charge more to cover its higher costs?   Is it because the brand includes unwanted features and services?   All of this is possible – but when a competing brand is able to sustain a lower price and customers who try it do not return, it becomes not only possible, but probable, that their previously favored brand is doing something wrong.

Another leading complaint is customization: customers abandon a favored brand for one that better suits their individual needs. Again, it begs the question: why does their favored brand fail to suit their needs?   Is it because they believe customers will accept a less suitable product for a lower price?   Is it because they believe that customers don’t really want the features and qualities the competitor offers?   Is it because they are unwilling to change their own product or processes when the needs of the market have changed?   When customers abandon, these are all possible causes.

Five or six other qualities were listed (some of them were redundant, others seem entirely frivolous) – but in each case the question is essentially the same: the firm is not delivering a solution of acceptable quality for an acceptable price, and customers who begrudgingly accepted it for lack of a better alternative abandon when that better alternative appears in the market.

So while I didn’t take much from the article itself, I did come away with a reinforced belief that a firm exists to serve its customers, and in order to attract and retain customers, a firm must serve its customers better than its competitors.   Nothing else matters, and nothing else should matter.

To suggest that customers accept a compromise when a better alternative is available is not only unreasonable, but also quite irrational.   And to cling to the belief that the brand is doing everything right and that something is wrong with the customers who abandon it leads to a suicidal level of complacency.

Fully Loaded Costs

The notion of "cost" is understood to entail more than the money-price of a good or service, but it seems to be only vaguely considered from the perspective of the customer.

When it comes to their own activities, businesses are diligent in determining the fully-loaded cost of any proposed activity.  That is, a business purchasing a machine will include not only the cost of the machine, but the cost of the power to run it, the salaries of the workers who operate and maintain it, and the cost to dispose of it when its useful life has ended.   Cost accountants can be quite clever in identifying all the cash outlays that must be made in order to gain the benefit of a purchase.

I have never seen the same exercise performed with the same punctiliousness for the customer's evaluation of the fully-loaded cost of ownership.   It's likely because the firm feels that it is the customer's problem, and the customer's task to determine how much he ought to pay for something - though for a business that means to sell something to that customer, it's very much their task to predict this with better accuracy.

It's not that non-price costs are entirely ignored, just that they are dealt with very sloppily.   A firm that is seeking a retail location will show great interest in the distance a person will drive to shop a a given store, and will create bulls-eye maps that overlay population grids to determine a profitable location.   But willingness to drive is a rather imprecise reflection of the factors that cause a person to be willing to drive a given distance.  Driving to a store requires money and time - and it's highly likely that these can be calculated with greater precision than they presently are.

I have to concede that time, particularly a consumers time, is far more difficult to quantify.   When it comes to employees, the cost of time is their wage: if you pay them twelve dollars an hour, a task that takes thirty minutes to complete costs six dollars.   But because you do not pay customers for their time, does this mean that their time has no value, that it is worthless or free?  Perhaps to you, but not to them, and if you fail to respect the value of a customer's time, you will certainly fail to obtain or retain their patronage.

In comparing prices in areas that use different locations, economists pay greater attention to the notion of the value of time.   It is not merely a matter of converting the price in foreign currency to a domestic one, though that little trick often gets a great deal of attention from the ignorant:  things seem to be much cheaper overseas if you pay attention to the price and ignore the amount of time it takes to earn the money to purchase it.

Considered in that manner, it might be better to price a product in terms of the time involved - that is, in minutes instead of dollars.  A product that costs six dollars has a time-price of 30 minutes to a worker who earns twelve dollars an hour.   If it requires 10 minutes of driving (each way) and 20 minutes in the store, the product now costs him 70 minutes.   Add in the cost of gasoline and the taxes on the purchase, and it is now a cost of about 80 minutes.   Remonetize that, and 80 minutes at $12 an hour means that the "six dollar" product costs him $15.60 to obtain.   So the same customer would be better off paying nine dollars to purchase the product online and have it delivered to his home than he would to buy it for six at a store ten minutes from his home.

And this pertains only to the cost of acquisition.  The cost of use is another matter, which is the reason that products that are more convenient to use are of greater value to consumers.   A tool that will last five years and reduce the time required to perform a task that is done once a day by one minute represents a savings of 1,826 minutes of about $365 to the person who values their time at twelve dollars an hour.

I have the sense that I have become tedious - but these examples should underscore the point with which I opened: that the cost of a product is more than the money price, and significantly more in many instances.   Were this accounted for with greater precision, producers would understand the true cost of their product to the consumer, and have a more reliable measurement of the value proposition their product presents.

Price, Savings, and the Ethics of Business Relationships

I find myself lately on the cusp of a moral quandary about the way that price and savings are presented to prospective customers.  Something just feels wrong, though I can't quite fathom the reason why - which signifies to me a need to jot down some notes in an attempt to sort it out.  

It's also worth noting that this simple issue spun up into a much larger consideration - so be prepared for a sharp turn about halfway through that leads into broader concerns.  (Such things happen in informal writing.)

The Situation

In a competitive environment, many suppliers offer exactly the same product.  For the purpose of argument, let's say there's a discount store and a department store who both buy shirts from the very same factory.   That is to say, the products are identical, no difference in quality.  The department store sells the shirt for $100 whereas the discount store sells it for $50.

The department store has a sales promotion in which loyal customers are offered a 40% discount on the shirt.   It sends out a promotion in which it is advertised "save $40" on this item - and even discloses the regular price, so that the customers are informed and aware that a shirt that normally sells for $100 can be had for $60 during this event.   It's right there in the copy.

The savvy consumer is well aware that the shirt can be had for less at the discount store - their regular price of $50 is still less than the promotional price of $60 being offered by the department store.   The department store marketer knows this, but believes that people like to feel like they are saving money, even though they are spending more.

To begin, the scenario above is not only plausible, but quite common - it happens so frequently in fact that marketing textbooks have a name for it (the "high-low" pricing strategy).   Just because "everyone does it" or "it's an industry standard practice" does not mean it is an ethical practice.

Clarification

Before tucking into this, I want to take a few distractions off of the table:

First, the department store promotion is not deceptive.   The shirt does in fact sell for $100 normally and is in fact discounted.   The promotion is not a lie because the customer will pay the "normal" price before and after the promotional event (the higher price is not falsely inflated).  So the promotion is entirely honest.

Second, a retailer bears no responsibility to promote its competition.   This may be subject to some debate - but it would be unreasonable to place upon a merchant the task of doing the research to find the best deals for a customer without compensation for the effort of doing so.  Some might argue this point, and they would be wrong for reasons that should be obvious.

The Moral Quandary

The moral quandary, as I see it, is that the department store is knowingly attempting to distract the customer from the high price by emphasizing the discount.  They are not concealing or misrepresenting the facts - but are attempting to draw attention away from something they do not wish the customer to consider:  no matter how much you are "saving" you are still paying $60 for the item.

Consider the stereotype of the person who returns from shopping with arms full of packages and announces to their spouse "I saved $500 at the store today" rather than saying "I spent $1000 at the store today."   The same principal applies: the shopper is being entirely honest, but attempting to get their spouse to ignore one fact (the amount spent) by presenting another (the amount saved).

This doesn't set well with me, and I'm not sure of the reasons it should be so.

Deliberation

I've mulled this over for some time, and the best way I've come up with is to consider the roles of the individuals (or organizations) involved.   Given the nature of the relationship, what does one party have the right to expect from the other - in a manner that is fair to both in the context of the relationship.

The role of a retailer (or any vendor) is to offer a product for a price, and in so doing to be honest about the nature of the product (such that the customer is not swindled into buying something that renders him no benefit) and the amount that he must give the retailer to take possession of the product (so that he is not told later he is obligated to pay more than he was led to expect to obtain the benefits he desired).

In this sense, the retailer has also disclosed all the facts germane to the transaction he is proposing to the customer.   The price of the item at another retailer is not related to the transaction he is proposing - that would be a different transaction, with a different vendor, and the responsibility cannot be assigned to the present vendor who would be a third party to that prospective transaction.   It is not his business, quite literally.

However, it seems to me that the ethics take a sinister turn when the same incident occurs in the situation of the shopper and their spouse - because their responsibility in the context of that relationship is to do what's in the best interest of the household in the long term, and this shopping incident is only one action in the context of an ongoing relationship in which there is, in fact, a duty to act in a way that ensures the resources (budget) of the household are used wisely.

But this can be spun back to the merchant-customer relationship if it is, in fact, perceived as a relationship and not an isolated transaction.   In the context of a one-time deal, the merchant accepts no responsibility for the welfare of a customer outside the context of the immediate transaction - but if it is a relationship, and if he portrays it as such, he must accept the moral obligation of considering the long-term welfare of his customer.   Ideally, he would offer fair pricing most of the time, but would be beholden to disclose when the customer can get a better price or a better product elsewhere - and also ideally, this qould be infrequent.

The Resolution

In the end, my sense is that much depends on the nature of the relationship between a retailer and a consumer - which can be very tricky in the present day, as some firms are evolving from being transactional companies (which view each sale as an isolated and independent event) to relationship companies (which view each sale as an event in the context of an ongoing relationship).

Simply stated, different ethical standards apply.

A transactional company can claim to be fulfilling the obligations of its role if it considers only the immediate transaction as an isolated event - but a relationship company cannot do so, particularly when it has attempted to convey to the customer that it considers their business to be a long-term relationship.  In doing so, it is obliged to consider the welfare of its customers in a broader sense and, on occasion, to send their customers to a different vendor - accepting that they will lose the profit of this transaction for the sake of maintaining a longer relationship.

Naturally, the problem is that a relationship company is a new concept for many retailers who are attempting to evolve from transactional models.   They may be unaware of the moral obligations they must accept to be regarded as a relationship company, and still doing business under the terms of a transactional company.   It is still a violation of moral obligations - but perhaps their ignorance makes the violation forgivable.

A more insidious moral problem is when a firm portrays itself as being interested in a relationship in order to get the customer to commit to giving them repeat business, but is not interested in doing what the customer expects (and has every right to expect) of a long-term partner in return.  That is clearly dishonest, deceptive, and morally reprehensible.

It may take quite some time for firms to fully make the transition, and fully embrace the moral and practical obligations of being a "relationship company" and putting to an end their transactional perspectives and the behaviors that were appropriate to the "old way" but inappropriate to the "new."

Epilogue

This note has meandered greatly from a simple consideration (the ethics of a pricing strategy) to a more complex one (the ethics of a relationship) - but my sense is that there is good value in this, and that there is likely a broader range of ethical differences between transactional firms and relationship firms ... which is grist for the mill.

Payday Price Discrimination

An accidental observation has got me thinking - or more aptly, it's got me nervous about what others might be thinking.   Specifically, a multivariate test of a design treatment that gave greater prominence to pricing and payment options had a drastically different conversion ratio during one week than the next.

Specifically, one week there was a large take-rate difference in the design option that made a favorable payment option more prominent, and the following week the take-rate difference was significantly less.   Someone instantly recognized that the second week was a pay week for people who are paid bimonthly, on the first and fifteenth, and reasoned that people are less attentive to cost or financing options when they are flush with cash.

It wasn't long before someone suggested that people might even be willing to pay more for a product after a recent payday than later in the month.   It was one of those things that's said with the kind of smile that suggests "if anyone questions the ethics of this I will play it off as being just a joke, but if nobody glares at me then let's give it serious consideration."  Fortunately, it was set aside, but I have the gnawing sense a seed has been planted.

Ethical Quagmire

There is likely some truth to the matter: that many people fail to budget personal expenses and spend more liberally when they have more money in their bank account.  And as such, it would likely be profitable to increase prices after paydays (as many companies issue paychecks on the first and fifteenth of the month, or every two weeks, it follows a fairly predictable pattern).  Especially in smaller towns with a few major employers who are all on the same pay schedule, local merchants are likely able to predict when they will get a rush of customers whose temporary wealth has put them in a spending mood.

But at the same time, I have the sense that the practice is ethically dodgy.   Payday price discrimination has nothing to do with the value of goods or the cost of supplying them or even the value that customers place on the benefits of ownership, but merely predicting when customers will be less mindful of their budget so that a merchant can take advantage of a moment in which they are cognitively vulnerable to making reckless spending decisions.  It seems to me in the nature of taking advantage of a customer who is drunk or mentally impaired, in that it has nothing to do with the value of the benefits being provided, merely exploiting a moment of inattentiveness for money.

It's particularly disturbing to me in the digital age because it is now much easier to raise or lower prices in an instant without any evidence of the price having been different just days or moments ago.   In the pre-digital world, items carried price tags and sales promotions were done with ink on paper, meaning it would represent considerable cost to change prices (to re-label merchandise in a store or print up a price list) such that there would be some hard evidence that something sketchy was done.   If products have no physical labels and prices are disclosed on a website, they can be changed with a click of the mouse, and unless customers undertake the effort to record price information, they will be unaware of the change or assume it's their own memory that is at fault for having imagined the price was lower yesterday than it is today.

The ability to instantly change prices is compounded by the ability to profile users as individuals, to track their online behavior and gather information from various sources in order to detect a single individual's price sensitivity and predict the moments in which their judgment may be impaired, such that a price may be instantly changed for one specific user, rather than all customers at once, such that the price that is offered to a specific shopper at a specific moment can be based on a very accurate prediction of their vulnerabilities.   To some in the marketing industry, that is highly interesting - but to the consumer, it is highly disturbing.

It's Already Being Done

There is the argument that such things are already being done - again facilitated by technology that reads demand of the moment and adjusts prices accordingly.  A CX practitioner who works for a rental car company openly admitted that his firm flexes the pricing of rental cars according to inbound flights - such that prices are higher at times when flights are arriving and travelers are likely to be in desperate need (anyone who failed to reserve a rental in advance, or whose plans have changed at the last minute, is going to get seriously gouged).  And I have personally experienced fluctuations in airline ticket prices - checking airfares during a break at work, returning home to purchase the ticket at a higher price, then checking the price the next morning to find the price had gone back down.

However, I don't have the sense that these vendors are adjusting price according to my failure to consider value, but merely adjusting to a perceived demand pattern without considering the reason for the pattern itself.   That is, the system that decides when to raise or lower prices is based on the demand of the moment but does not consider what is driving that demand.   That's pretty much how the stock market and commodities exchanges have always done business.   And it's often times done in slow motion - consider that a hotel at the beach does not generally change its prices by the moment, but it is certainly known (and accepted) that prices are higher in seasons when there is elevated demand.

The difference here is that reacting to demand in the market is different to exploiting moments of weakness in individual consumers.   To raise the prices of all automobiles for all consumers during the early months of the year because people often go car-shopping with their tax refund seems like a reasonable business practice - but to raise the price for a specific customer because she is female, uneducated, young, recently divorced, and just got paid last week seems highly questionable.

However, a practice is not to be deemed ethical simply because it's already being done or because people seem indifferent rather than outraged by it.   Common practice and emotional response are poor metrics for ethics.   Likewise, the covert nature of an action does not necessarily mean it is unethical, though such is often inferred.   If anything, the fact that sellers are more knowledgeable should translate into an ethical imperative for them to be more circumspect about their behavior, because they cannot claim ignorance.

***

Even having meditated on the matter, I am still of two minds about the ethics of payday price discrimination.  It seems to me a greasy practice, something that customers would strongly object to were they aware of it - and perhaps that is the more important consideration for customer experience.

Cost-Based Pricing

In a previous post I glossed over the costs of production, taking for granted that they are familiar to most people.  I've since come to realize that production cost is not so obvious a topic, so it merits some delineation.  So be warned that what follows is going to be very tedious and entirely unnecessary to anyone who's taken an accounting course, but possibly enlightening (though no less tedious) to anyone who hasn't.

Cost-Based Pricing Model

When a producer sets a price in the market, he must consider the cost of production in order to remain financially viable, which includes more than the obvious cost of fashioning raw materials into finished goods.   The total cost includes variable costs, overhead, and cost of capital.   A few other items, required return and risk, are also considered - though not strictly necessary for the sustenance of his operation, it is generally necessary for him to sustain his interest in sustaining his operation, and thus merits consideration.

Variable Costs

The variable costs of a product are mostly straightforward, and can largely be derived from considering the components that are assembled to create the final product, as well as to the labor involved in its creation.

A simple example is the bread produced by a baker: each loaf requires a certain amount of flour, yeast, salt, and water an the amount depends on output - you need twice as much material to make two loaves as one, and a thousand times as much material to make a thousand loaves.

Waste and spoilage are costs related to risk, which will be considered later, but they are strongly related to variable cost because waste often occurs per-unit and spoilage results from purchasing more materials than are needed.

Labor is also said to be a variable cost, but it is not as flexible and is more subject to waste: workers generally demand a fixed wage rather than being paid by piece-count and, while it's possible to release a worker on a full-day or half-day basis, maintaining a consistent labor supply often requires paying idle workers.   So while labor can in theory be accounted as a fixed cost, it is usually more in the nature of an overhead cost.

Overhead (fixed costs)

The overhead costs of a product pertain to any cost that does not change regardless of the number of units sold.   This generally involves any expense that involves an item that is not delivered to the customer as part of the product.

Back to the example, the baker's oven and utensils are overhead costs as is the rent of his shop: regardless of whether he bakes one or a thousand loaves, these costs are still accrued.

There is often an attempt to calculate overhead costs as fixed costs - per the previous example, the amount of labor to create a loaf is often considered a fixed cost, but because his employees' wages are based on the number of hours they work rather than the number of loaves they produce, the cost is not truly variable though it can be made to seem so by accounting.

There is likewise an attempt to make the cost of equipment into an fixed cost, figuring that a mixing bowl will wear out and break in a year, during which time a certain number of loaves will be produced, and therefore its cost can be apportioned per loaf.   This, too, is an artificial calculated value that is not strictly accurate in reality.

While overhead costs are not strictly related to the volume of output, volume is a driver.   That is to say that the capacity of an oven is not infinite, and it can produce only so many loaves even if it is operated around the clock, and that if the baker's volume increases beyond that point he will need to purchase a second oven.

There are various ways to flex overhead costs, but for the most part they recommend a long-term commitment: to buy and sell an oven based on whether it is needed on any given day is possible if the equipment can be rented on a per-day basis, but most equipment rental is longer term; and while a purchased item can in theory be sold and repurchased, this is also not a common practice that suppliers will accommodate.

Cost of Capital

Costs of capital pertains to the interest paid on loans, which must be repaid from the profit of any activity that the loan facilitated.  For example, if a baker who needed a second oven took out a loan to obtain it, his cost is not merely the cost of the oven but of the interest owed on the money borrowed to buy it.

It is a common mistake to consider, as a cost of capital, any interest that might have been earned on financial resources that are tied up in the business (such the amount of bank interest that could have been earned on the cash in the register) or the amount of profit that could be made by entering another line of business (a better return on equity by selling off the bakery and operating a butcher shop).

These are both important costs to consider when making an investment decision, such as which kind of business to open or whether to sell off one business and start another, but insofar as the operating costs of a business, they are irrelevant.

Required Return

Required return is the amount of profit that the owner of a business expects to make by operating it.   Strictly speaking, it is also an investment decision that is not germane to the operation of the business, but it does influence the price at which merchandise is sold, and merits consideration.

The required return is the most flexible part of pricing.   The owner must make enough to cover fixed, variable, and capital costs to avoid bankruptcy.  He would very much like to make a profit on his investment, but it is not strictly necessary for him to do so, and a business can run at break-even for an indefinite amount of time, though few would care to invest in such an enterprise.

The opportunity cost of investment elsewhere, as mentioned in the previous section, is generally a driver of required return.   That is to say given an opportunity to buy a second oven out of cash (rather than taking a loan) must consider other uses that could be made of the money.  If it would be more profitable in another investment, the wise decision is not to invest in the business.  Conversely, if the business needs the money to increase its volume, it must offer a return higher than competing alternatives.

Risk Margin

The risks involved in a business also impact the cost of the product, but it's a gangly topic that can make an already tedious meditation completely unbearable, so I will try to keep it short.   However, it's necessary to mention because too many arguments of price and cost suffer from the "perfect world" fallacy in which everything can be known and flawlessly predicted.

Risk in variable cost relates to waste and spoilage: a baker who expects to sell 500 loaves a day purchase enough material to make that many loaves.  If his prediction is too ambitious and he has more flour than he needs, it will eventually rot and his expense will be wasted.  If the baker spills a sack of flour, the cost is likewise wasted in that it will not be recovered by selling bread that might have been made of that loaf.

The risk in overhead costs is twofold: the gross profit (the difference between the revenue and cost of each unit) may be insufficient to cover overhead due to low sales volume, and things that are included in the overhead may have a shorter lifespan than expected.   The owner must also elevate the price to cover this risk.

The risk of cost of capital is generally mitigated by fixed-interest loans, that assure the borrower he will pay a certain amount of interest.  If the financing is not fixed-rate, such as an expense charged to a credit card with a floating rate or credit obtained by a short-term loans that rolls over upon itself, then there is some risk to be borne by the owner, and passed along to the customers in the price.

And while the required return does not entail any risk, all of the above factors constitute a risk that the required return will not be achieved.   And since the desired return is higher when the risk is higher, it will have an impact on cost.

Finally, there is a species of risk wholly unrelated to cost, such as disaster risk: it can be as devastating as the cart being run over by a bus, the vendor being robbed at gunpoint, or as minor as a wind that blows a stack of napkins into a puddle.

None of this changes the fundamental structure of the costs, but it does factor into the calculation of price.

Putting it All Together

I'm going to refrain from posting a spreadsheet that shows a tabular accounting of all of the costs of production - the excursion has been so tedious that I have bored even myself - the point being that in determining the minimum price at which a producer can offer his goods for sale, all of these factors (and possibly others I have  failed to consider) must be tabulated and broken down to the unit level, based on a projected volume of sales.

Price Sensitivity and Opportunity Cost

It's occurred to me that conversations and decisions on the topic of price sensitivity tend to neglect the notion of opportunity cost, and particularly in times of economic hardship, it is likely more influential to buyer behavior than it normally is ... though given that the present financial downturn has persisted for at least five years, we may need to revise our perception of "normal," as the lessons learned during the present slump and the behaviors to which consumers have become habituated will likely persist even after the storm has passed.

Cost of Production

The cost of production is relatively straightforward: the producer considers their variable costs, overhead, cost of capital, and required return in providing a good to the market, and the very least the customer can expect to pay is a price that covers those costs, which for some is the basis of their consideration of a fair price.

However, costs of production are very rarely considered by the customer, who are primarily concerned with their own needs rather than the needs of the producer.   It is especially rare in cultures that do not engage in haggling, but have the expectation that the price as marked is not negotiable.  For the majority of purchases in US markets, that is the case: we do not haggle with the grocer over the price of a melon, as is common in some eastern cultures, but take it or leave it based on the demanded price.

As an aside, I'm often surprised by the number of people who do not seem to recognize when haggling is appropriate.   People seem to take the price of items such as furniture or jewelry to be non-negotiable, and the only realm in which they feel haggling is possible is in the automotive sector or private sales.  Of course, there is another species of customer who seems to feel haggling is appropriate in venues where it is not, much to the chagrin of others who are waiting to be served while they waste time hectoring store clerks for a better deal.

And of course, all of this is a diversion, the point being that production costs are an indirect influence on the customer's assessment.

Need-Based Cost

Another common approach to evaluating prices is in the customers' assessment of their needs: whether worth the cost to satisfy a need, or whether the consequences of failing to fulfill the need necessitate paying the cost. It is essentially a binary decision - to buy or not to buy in a specific instance, not yet considering alternative methods for suiting a need (see next section).

It stands to note that vendors cannot accurately assess the needs of a customer and how much it is worth to have those needs fulfilled.   The customer knows these things with certainty, and the vendor can only guess.  They very often guess wrong, covetous of profit per sale and indifferent to sales volume.

Need-based pricing is a common consideration when a vendor that assumes the customer will not purchase in future if he does not do so immediately.   It's also a negotiation tactic used to place artificial pressure on the buyer to create the impression of a now-or-never (or "limited time only") deal when such is not the case.   When it works it can result in a good profit on a one-time sale, but when it fails it fails disastrously and devastates the potential lifetime value.  And from the consumer's standpoint, it can be quite amusing to see how a vendor who has pulled that trick squirms when you fail to react.

But again, I digress: needs-based considerations are generally a preliminary decision (the customer would not be in the market at all if his needs were inadequate to the price) under normal circumstances - and that it only takes precedence in the customer's assessment in certain instances by dismissing all other bases.

Alternative-Based Costs

Alternative-based costs derive from needs-based costs: in this instance the customer recognizes that the cost of neglecting the need is unacceptable, but is considering cost in a comparative versus binary manner: there are other alternative that can be chose to address the need, and the customer assesses whether one possible option is the most efficient use of his budget.

This may be a product-based decision (a customer needs to clean a floor but is choosing between a vacuum cleaner and a broom) or a brand-based decision (a customer has tentatively chosen a vacuum cleaner and is now choosing between a Hoover and an Oreck).  The binary test of whether the item is adequate to solve the problem has been satisfied, and the customer is considering more qualitative factors (how effective, how easy to use, etc.) in considering an option, mindful of his other options.

It seems to me that the alternative-based approach is grossly overemphasized by sellers, as evidenced by marketing messages and promotional tactics that present comparisons to similar brands and products.  That's not to say it's invalid, nor to say that buyers do not similarly overemphasize alternative-based criteria, but ultimately the price that a buyer is willing to pay is based on the fulfillment of need, and they can be very intelligent and diligent in identifying other options, outside of what a firm considers to be its competition.

However, success at alternative-based appeals relies on the premise that the customer is able to afford an array of equally satisfactory options.   Which is to say that it functions well under "normal" market conditions, but falters in times of financial hardship.

Opportunity Cost

The topic of opportunity cost is often pointedly ignored in discussions of price sensitivity, largely because it is very difficult to focus in a meaningful way.   It pertains less to the purchase of an item in question and more to the entire budget of a customer and a holistic consideration of needs.  That is to say that it asks the question "Would I rather have this product, or would I prefer to have something else I might obtain for the same amount of money?"

That "something else" opens up a universe of possibilities that cannot be conveniently discussed or considered - but is again fundamentally derived from the needs-based decision by broadening the consideration.  Whereas alternative-based cost considers other products that might be obtained to service a need, opportunity cost considers other needs that might be satisfied with a budget.  In times of hardship, opportunity costs tend to take precedence in buying decisions.  Lacking sufficient budget to fulfill their every desire, the customer is not choosing between products but between needs.

Most vendors are loath to consider opportunity costs.  For vendors of luxury goods, making a prospect aware of more pressing needs is a losing proposition.  But even when the product in question is a necessity, it is culturally inappropriate to intrude on another person's financial affairs.   It would be highly inappropriate for a salesman to ask a customer the questions necessary to demonstrate that if he drank one less cup of coffee a day and switched to a cheaper brand, that would enable him to afford a car payment that's $25/month higher.  Not to say that some won't try, but it's taking a risk of offending a potential customer.

Even so, it seems that opportunity costs are a significant factor in the customer's perspective on price in times of economic hardship, and there may be instances in which it is less offensive and even welcomed for a vendor to encroach on that territory.  Taking the same example, a customer who is negotiating an auto loan with a banker expects to be asked, in a general way, what their "other expenses" are each month, and may even be tolerant of a bit of intrusiveness if the banker might help them discover ways to be able to afford a higher loan.  However, this seems unusual: the perception of the consumer is that banker has less at stake in the decision, is in a position of greater power, and is providing a supporting service rather than selling a product.

To end with a digression, as it seems that's the way things are going, the customer perception of banking is entirely wrong: the banker's profit from the loan is at stake, he is not in a position of power given that there are other sources of a loan, and he is in fact selling a loan product.  Most people don't seem to recognize that, and assume an overly docile negotiating position, to their own detriment, when dealing with certain vendors.

Convergence and Conflict

The main thrust of this meditation is to propose that opportunity cost is woefully neglected in the present market - but I've also sensed that, aside of the obvious diversions, I'm touching on yet a different concept: that of the convergence and conflict among these various perspectives on pricing.

Arguments of whether a given product is worth the price are common.  Not only is it implicit in the setting and negotiation of prices, but it's also implicit in any product review, and often surfaces in casual discussions about products and brands.   The source of disagreement may be in whether a price is justified among two people who share the same perspective but it is also common, and perhaps even more common, in discussions or negotiations between people who are taking different perspectives.

That is, one person may conclude a product is worth its price based on production cost criteria, another may conclude it is not based on needs-based criteria, a third may feel it's a good deal based on a consideration of alternatives, and a fourth may disagree because he is considering opportunity costs.

As such, in negotiation and agreement, it's likely necessary to identify the perspective before debating the criteria that underlie a conclusion - or when the debate is entirely internal, to the mind of a buyer faced with a purchasing decision, to be more deliberate in considering the various perspectives.

Time: The Real Price of Things

This meditation is likely to be abstract, philosophic, and a bit weird - but I think I may be onto something that would render a more dependable and accurate assessment of the motivation of buyers and sellers in the marketplace: the substitution of time for money in our consideration of various factors.

In commercial considerations, money is the standard of measurement: every thing and every activity is reduced to a monetary value, entered into the accounting ledgers, and presumed to explain everything perfectly. Except it doesn't. Money is an abstract concept, and "a dollar" represents different things to different people on both the supply and demand side, across different locations, and across different times. It really is quite sloppy and leads to many misconceptions, contradictions, and paradoxes.

Instead, translate money into time. A thing costs a certain amount of money because a certain amount of labor goes into its fabrication and provisioning. Even when a producer buys a physical component to add to his product (flour), the supplier's cost of that component deals with his own labor costs (the labor to raise and harvest wheat, grind it to powder, package and deliver it), and any materials that supplier uses are representations of the labor costs of his own suppliers.

Perhaps it's easier to understand from the consumer's side: the money that a consumer uses to purchase items he wants and needs is gained by the time he has spent at his own work as a laborer. If a person earns $10 an hour, a $5 purchase represents 30 minutes of his time; if a person earns $30 an hour, it represents 5 minutes of his time. The money-price is the same, but the amount of time the money represents is different to each of those customers.

It is not that people with a lot of money spend it less discriminately or have different needs - its that the money-price represents a smaller amount of time. In that sense, the $30/hour worker considers a $5 item with the same lack of discretion that a $10/hour worker would regard an item that costs 83 cents. The price, in terms of time, is paltry.

This is likely where the convenience of obtaining an item enters into consideration - regardless of what they earn on the job, both individuals might spend an hour minutes to get to a store, buy an item, and return home. This levels the field a bit, because when convenience and cost are combined, the $10 worker must invest 90 minutes and the $30 worker must invest 65 minutes to obtain it (a difference of 72% is still significant, though less than the 300% difference when money-price is considered alone).

It also levels out differences between markets: an American worker who earns $10 an hour and pays $5 for a meal is spending more money, but the same amount of time as a third-world laborer who earns 50 cents and hour and pays 25 cents for the same meal in his locale. In that light, the histrionic objections to low wages in developing nations is entirely unwarranted.

The difficulty in chronitizing rather than monetizing costs is in the disparity in wages of the buyers. Our sense of equality and fairness is largely satisfied when all customers pay the same money price, regardless of what they earn - but again upset when we recognize that the same money price represents highly disproportionate time prices for different consumers.

It's also highly unlikely, given our cultural fixation on money, that accounting systems can be converted to a chronitized method of measurement. We really don't care that we earned a "profit" of ten minutes on the sale of an item, but want to know how much money we have made.

It does become significant in terms of personal finance: where a person is considering their budget and the price of things in terms of money rather than time. The explanation of why people with a lot of money buy more things and pay higher prices seems more logical when you recognize that they might be spending the same amount of time to buy a "luxury" version of an item that less wealthy individuals purchase an "economy" version.

It is not that having more money makes them regard the money itself as less valuable - it's that it takes them less time to earn more money. And when you consider time given rather than money, it works out that that the $30/hour worker exchanges an equal amount of his time (two hours) for a $60 shirt as the $10/hour worker exchanges for a $20 shirt.

This makes the consideration of price, in the retail sense, much less subject to seemingly unknown factors - but it does make the mathematics a great deal more complicated when price expressed in terms of time fluctuates according to the income and financial resources of each individual customer.

Don't mistake this for a revisionist consideration of pricing: it would be ludicrous for a retailer to ask each customer how much they earn in order to set a money-price for an item to be equal in terms of time for the individual shopper. But it would be (and is) quite natural for a consumer to consider what he spends as a percentage of his total income and select a retailer or an item that offers a price that represents roughly the same proportion of time.

That is, the $10/hour worker who seeks to spend 25% of his income on rent will seek an apartment that lets for $400/month whereas the $30/hour worker, seeking to spend the same 25%, seeks one that lets for $1,200/month. The same for the vehicle they drive, the clothing they wear, the food they eat, and any product or service they consume.

When retailers seek to supply a given market, they seek to satisfy a given price point to accommodate the capacity of a given income level. Each product is tailored to the purchasing capacity of a given income bracket - so that in aggregate, sellers provide range of choices to suit a range of incomes, resulting from a range of wages. That is, when a retailer decides to stock $20 shirts and $60 shirts to accommodate the price sensitivity of different shoppers, what he is really doing is providing each the ability to choose an item that represents an amount of time that is proportional to their income.

To focus only on money prices is to ignore a necessary relationship between money and time that has a significant impact on consumer behavior in terms of price sensitivity. Were the consideration more explicit, it would likely help clarify and add more certainty.

As such, a retailer who is seeking to price his merchandise in a given area has to consider the price sensitivity of customers in an area, and that is difficult to do based on the household income of customers in an area. If you translate cost into time, and determine that customers are willing to give about 20 minutes of their own labor in order to purchase a given item, then determining what price to charge can be done by considering their income in terms of time: if the ZIP code areas that a merchant wishes to serve though a given store average out to $15.87 per hour, then the proper price for an item that represents 20 minutes labor would be $5.29

My thoughts on this matter are beginning to unravel - too much at once to coordinate it all - and I likely need to break off typing and do some thinking to reorganize and reconsider them. But I have the sense I'm onto something here, and that chronitization can be useful in untangling some of the problems where monetization obscures the real cost of things.

Price Discrimination and Customization

It's likely important to prefix this meditation with a comment on the concept of discrimination - as the word itself is so closely linked to politically sensitive issues of race, gender, etc., that it's difficult to consider in its intended context without those issues intruding.    In short, "price discrimination" is an economic concept that pertains to charging different prices to different customers - and for the purpose of this piece, it is intended to deal with reasons for discrimination that can be objectively substantiated.

To further disambiguate, I'm setting aside price discrimination as a concept related to the goal of revenue maximization, which takes as its sole consideration the customer's willingness to pay and, in effect, seeks to inform the decision of the supplier toward the goal of asking as high a price as possible to fully absorb consumer surplus. That is the context in which it is most often considered, but the context least germane to my present train of thought, which focuses more on price discrimination as an effect of cost.

That said ...

Creating a product that is customized to the needs of a specific customer requires price discrimination in the highest degree. In part, it is a matter of financial necessity - where customization for the needs and desires of a specific individual require additional production cost, the additional cost must be borne by someone.  In another sense, it is a matter of ethics that the additional cost be borne by the very individual whose demands necessitated that they be expended.

Said another way, a customer who desires something extra should (and generally does) accept that the cost of the "something extra" is added to the price he is charged for having it. It's not really considered where the "extra" is a discreet product: a customer who wants shoes and a matching belt pays the cost of the belt in addition to the cost of the shoes, whereas another customer who simply wants the shoes does not pay for the belt (provided the two are not bundled by the retailer, such that he must purchase the belt to obtain the shoes).

It becomes slightly less straightforward when the purchase is perceived as a single product, especially a complex one, but my sense is that customers generally understand and accept the concept of additional features that add cost to a basic product: a vehicle with power windows costs more than a vehicle of the exact same type that does not have this added feature.  This comes as no surprise and raises no objection.

And the complexity becomes even greater when hidden factors create discriminate prices for the same good: a shirt costs far less at the factory store than in a department store in another state because of transportation costs; or the shirt costs more when purchased form a shop in a mall than it does from a strip mall because of the higher rent the shopkeeper must pay.

It was simple enough to understand before the Internet came about, but broad knowledge of market details (the price of goods in various places) and complete ignorance of others (the factors that cause the price to be different in various locations) led to something of a calamity: customers cried "unfair" when the same article had different prices in different locations, particularly when the locations were in the same general vicinity (the same item costs considerably more at two shops in the same town).

It's a bit ironic that the notion of "fairness" is raised at all. The alternative approach, to charge the same price in all locations, means that individuals who purchase the item in locations where it could be had for less (lower transportation cost, lower shop overhead, etc.) must now pay more than their fare share to subsidize the cost of making the item available in places where it costs more to provide it. It that sense, the objection to price differences is a demand for unfairness.

Dragging myself back to the notion of customization: the demand of a customer to have a product tailored to his specific needs and desires must necessarily be accompanied by a willingness to pay a price that covers the cost of tailoring it, as differentiated from other customers who accept the "standard" product or have a list of customizations all their own. This is true whether the differentiation is the result of differences in the physical product (an item with or without a given feature) or in the location (an item sold in one location or channel versus another).

This results in an increasing complexity in the structure of cost to produce and furnish a given item to a given customer. For a firm that chooses to customize, there can be no standard price, nor any way to give the customer an expectation of the price until there has been a long discussion of the variables involved.

This places a great deal of burden on the customer, such that many product decisions must be made and communicated to the vendor before a price can be given.  Pricing by feature is fairly standard practice in certain industries, generally those that provide high-cost items that are infrequently purchased: buying a car or having a house built is a very complex purchasing event and customers accept and expect that the price relies on the features chosen for their product. Buying a computer, with all the options and related costs, is likewise complex.

But the same level of complexity is involved in decisions of far lesser magnitude: ordering a hot dog from a street vendor requires the customer to make a set of decisions: what kind of sausage, what kind of bread, what additional toppings to include. However in this situation, the customer's options have no effect on the price of the item, and the vendor merely includes them - but they are not gratuitous: the cost of the most expensive options is borne even by customers who do not choose to have them. Their cost is so negligible that customers are largely indifferent to this fact, and may often be oblivious to it.

In that instance, it is largely a matter of magnitude - a customer doesn't demand a three-cent discount at a deli because he opted not to have mustard on his sandwich, but he might be outraged at a $20/night "resort fee" at a hotel to pay for a pool, sauna, and workout room that he never used during a week-long visit (which hotels get away with because of business travelers who expense their bill and don't pay much attention - another factor entirely).

But because of the freedom of information, customers are becoming increasingly aware of and concerned about price discrimination, and the vendor of a product that can be customized at all must be sensitive to the reaction the customer will have when every modification impacts the price, and especially where invisible factors cause price discrimination, they are increasingly intolerant of it.

And it does seem like a no-win situation: to offer the same product at the same price to all customers requires a great deal of coordination (and even collusion if the same manufactured item is sold through competing retailers), and customers who expect to get a better price for accepting a standard product are hostile to the notion of paying more to absorb the cost of serving more finicky customers.

The net result of this on customer experience is also conflicted, between the customer's desire to have a highly customized product, yet to be quoted a firm price in advance of providing any information whatsoever about the customizations the customer desires; and the vendor's desire to offer an attractive price for a product most people want, and yet be able to serve the demand for customization.

All things considered, it's a problem to which I can see no solution - and what's more, it is a dilemma that more and more industries will continue to face as customers become increasingly demanding of customization.