When Is The Price Right?

Much of conventional economic theory revolves around the assumption that an economy comprises rational actors seeking to maximize utility. One implication of this hypothesis is that, all else being equal, people will tend to favour a lower-priced product over a higher-priced alternative.

However, research by behavioural economists and psychologists—among them Daniel Kahneman of Princeton University—has cast significant doubt upon the thesis of Homo economicus. Contrary to the assertion that human beings tend to make rational decisions, scholars have consistently found that decision-making is influenced by cognitive biases, the perception of risk and reward, social pressures, oversimplified snap judgements or prejudices, and various other subjective factors that have very little to do with rationality.

This partly explains why many individuals choose higher-priced products, even when all else is apparently equal—the authentic Prada handbag versus a more affordable alternative; the glamorous Porsche, BMW, or Ferrari versus a high-quality, reliable vehicle for half the price; a painting by a famous artist for no reason other than its uniqueness and the renown of its creator.

In conclusion, trying to compete on price is not always an advisable strategy. But when can you reasonably expect that raising the price of an item will deliver higher revenue? When is it best to stay put or even go lower?

Subjective perceptions of price

I often pass by a restaurant that attracts long line-ups on the weekends, starting just before noon and continuing well into the evening. This establishment offers tasty Mediterranean-style comfort food, at a price that enables it to undercut its nearest competitors. Understandably, it is tremendously popular.

Yet even in this case, we can see less-than-rational economic behaviour at work. On rainy and chilly days, lengthy queues still form outside this restaurant—which suggests that in the name of a modest saving, customers gathered outside are willing to forgo both their physical comfort and their precious time. (Is it really worth it?) Adding to the complexity of the dilemma is the perception of sunk cost—the queuers may think to themselves “I’ve been standing here for half an hour already; I might as well stick it out to the end.”

On the other hand, in my neighbourhood there is a restaurant offering somewhat higher-quality Mediterranean fare for a higher price. This business has also enjoyed commercial success and recently expanded—but I have yet to encounter a line-up stretching out the door and halfway around the block.

Some customers may perceive products with higher prices to be superior, even if this is not necessarily the case. Do you want your enterprise to be perceived as a low-cost provider, a high-quality outfit that people will be willing to pay a little extra for, or somewhere in the middle? What value do you offer that others don’t? Answering those questions will help you not only formulate a pricing strategy, but more clearly define your brand identity too.

Merits of cost-plus and value-based pricing

As the name suggests, cost-plus pricing is based on tallying the fixed and variable costs that you incur to provide a good or service to your customers, and then adding a mark-up that enables you to turn a profit. On the other hand, value-based pricing is a reflection of what you believe customers are willing to pay for the product or service you offer.

Generally, cost-plus pricing is more apt for industries in which the items on offer are generic or easily substitutable, and there are many competitors. If your business is a convenience store, or sells items that are readily available elsewhere, you will probably need to maintain a cost-plus strategy and keep a watchful eye on local competitors’ prices.

Value-based pricing is better suited to industries in which the items on offer have some subjective quality—such as association with a particular brand or celebrity, atmosphere and ambience (as in a restaurant), or an inimitable experience or flavour. Businesses that deal in goods and services of this kind enjoy more pricing flexibility, and can often get away with raising prices gradually as their profile and reputation grow. On the negative side, this strategy can invite more competition, and complicates the task of establishing an appropriate price in the first place.

Determining the right price for your products is a challenge that doesn’t necessarily lend itself to a straigthtforward answer. Particularly in the early stages of a business, some trial and error may be necessary. Nonetheless, a coherent pricing strategy begins with defining the type of brand identity you want your business to embody.

Five Business and Economic Trends To Watch In 2016

Challenges and changes will be the hallmarks of 2016, but this year will also present great opportunities to far-sighted, innovative individuals and organizations.

1.  Economic headwinds intensify

Canada has been hit hard by the continued fall in the price of oil and other commodities, on which our economy depends heavily for investment and revenue. Not surprisingly, the province of Alberta has suffered disproportionately, with tens of thousands of jobs lost; the provincial government has also seen its tax and royalty revenues drop, inducing a large fiscal deficit. A lower loonie is the inevitable consequence of a fall in foreign investment to Canada’s extractive industries.

Of course, the global economy is highly integrated, and difficulties in one nation are usually indicative of broader trends. The weakening of commodities owes largely to a slowdown in the Chinese economy, due in part to persistent soft demand for Chinese manufactures in the most lucrative consumer markets: the U.S., the European Union, and Japan. China has managed to sustain a relatively high growth rate since the 2008 Great Recession with the help of public expenditures and private credit. But this tactic seems to be nearing the end of its rope, and investors are nervous about the implications—hence the volatile stock market.

All in all, 2016 is likely to be another year of economic uncertainty, and recession is a distinct possibility for many industrialized countries, China included.

2.  Millennials move up; Gen-Zers enter the workforce

It’s hard to believe that fears over “Y2K” came and went more than 16 years ago, yet here we are. In 2016 and in the years to follow, we will witness a major demographic shift in the workforce: Baby-boomers will continue to retire or cut back on their hours; Millennials will scale the professional ladder into positions of greater authority and prominence; and members of Generation Z—also called Post-Millenials or iGens, born in the era of boy bands and Spice Girls—will increasingly fill entry-level posts.

The visibility of this shift toward youth in business and politics will grow, as will its influence on consumer-market dynamics. Businesses that cater effectively to the preferences of the under-35 cohort by embracing mobile technology, values like social justice and environmental sustainability, and somewhat non-traditional work environments, will prosper.

3.  Departures from “business as usual”

Infused with youthful vigour and an innovative mindset, many organizations are adopting new ways of working.

Some workplaces have introduced elements of fun and relaxation into their office environments—like ping pong tables, recreation areas, and even dedicated spaces for taking naps. Others offer flexible work schedules, including unlimited vacation, conditional on employees completing all of their assigned tasks within a set timeframe. And last year, CEO Dan Price of Gravity Payments made headlines when he announced a minimum annual salary of $70,000 for workers at his business, and cut his own compensation by 90 percent.

With more young, socially conscientious individuals in the workforce and greater diversity in the executive suites, the trend away from traditional corporate structures and workplace dynamics will continue.

4.  Growth of the “gig economy”, and friction with the old order

The phrase “gig economy” is largely a misnomer, since a lot of “gigs” are really short-term employment stints, often in the service sector. For example, a customer who commissions a driver through a ride-sharing service is effectively hiring both the motorist and the company to provide transportation. But because of the informality of “gigs”, the temporary employer typically needn’t pay a minimum wage, or cover expenses like health insurance, workers’ compensation, payroll taxes, or job training. As a result, “gig” workers’ labour costs can undersell those of their counterparts in established industries by a wide margin.

In many major cities, taxi companies and drivers are lobbying municipal governments to either nullify certain regulations on the taxi industry to enable taxis to “compete” with ride sharing, or outlaw ride sharing altogether. Either way, the consequences for customers could be significant. Last year, the California Labor Commission ruled that an Uber driver was an employee rather than a contractor, and thus was entitled to claim certain out-of-pocket expenses. If this ruling encompassed all such drivers, ride sharing could lose a big chunk of its cost-competitive edge.

The inherent conflict between traditional work and “gigs” is far from settled.

5.  Opportunities in mobile services

Mobile technology has both greatly improved and become ubiquitous over the past decade, and accordingly, a healthy bottom line awaits companies that ride this wave successfully. A mobile-friendly web presence is more important than ever before, and businesses should strongly consider developing their own apps to facilitate access for customers with smartphones and tablets.