Thursday, April 07, 2011

Just got home from work.  Stayed late trying to wrap some things up before I take some vacation and then stopped to talk to our second shift chemist for a little while.

Just for the record, I currently (and God willing, not much longer--your prayers are greatly appreciated and fervently requested) work for a third-party lab.  In the broadest strokes, companies that manufacture things send some to us and say "tell us what's in it" or "certify that this will meet whatever requirements our customer has," so they can go to their customer and say "Hey, here's proof from an objective third party that we've got what you need."

In the days before my tenure here, the technical people handled almost every aspect of the job:  not just testing and sending reports, but interacting with the customer to make sure they were sending us what we'd need to give them the answers they needed, quoting prices for complex jobs, even doing troubleshooting.

The chemist was telling me about a strand of manager-types who are prone to making business decisions based largely on their uninformed gut instincts.  He once was given a project that involved some relatively complex testing; he managed to get it done in two days and wanted to charge the customer about $1k for labor and materials.  One of these seat-of-the-pants managers (I can't call them all managers; one currently supervises a single room and a single employee when he's not dealing with his non-leadership responsibilities) with no background in chemistry came through, looked at the chemist's paperwork, and said "That price seems too high."  She wanted to ask the customer just for a few c-notes.  Instead, the chemist suggested she ask for quotes for similar work from some of our competitors.  The one she called offered to do it for twice what our chemist figured and said it would take 2-4 weeks.  Two or three hundred bucks weren't going to cover our expenses, but it "seemed" more in line with...with what, I don't know; obviously not reality.

So that's heinous but it brings me to my main point.  You can't be a loss leader on everything.  Sam Walton knew he couldn't make Wal*Mart have the lowest prices on every item in the store, but he also knew that he'd make more money in the long run if he'd have enough inventory cheap enough to bring shoppers in who would decide to buy other things while they were there.

So, what motivates a shopper to go to store A instead of store B?  Let's keep things simple and say A and B are competitors in the same niche and the stores are next door neighbors, so except for shoppers with preexisting loyalty, there's no preference for one over the other.

Then B says "That hundred dollar item A sells?  We'll sell it to you for $90."  Okay, sounds good, right?
But then A says "That special-order item B sells that takes a week to deliver?  We'll overnight it to you for the same price."  Now things are getting interesting--both are attempting to provide more value for the dollar, one by reducing cost and the other by improving service.  To keep things from getting complicated again I'm going to treat all "improve value for the dollar" efforts as just lowering prices.

So B's got that one item at $90.  People tend to shop there to save ten bucks.  What if B had lowered its price to $80?  Would it bring even more shoppers?  Probably; most goods do have at least a little elasticity in their prices.  What if B cut the price in half?  It would probably bring in still more shoppers, but if the managers of B weren't asking economic questions before, they now had better start asking if they're bringing in enough customers to make up the difference.

The average customer knows he would be a fool to pass on such ridiculous prices, all things being equal.  The average customer may also wonder how long B was planning on running this half-price promotion or how much the prices of everything else were going to go up to compensate, or how long B's managers expected to stay in business if they continued to pursue business volume at the expense of profitability.  The average customer may wonder, if the heavily discounted item in question were perishable or not inherently valuable enough to come with a warranty, what was wrong with it that B's managers were trying so hard to unload their inventory.

You see it at grocery stores; a few months ago I even got half a gallon of milk at a "manager's special" sale price of $0.69 that was going to expire the next day.  Usually the price is somewhere well north of a dollar for that volume, but for that price I didn't care if it was going to go sour before I got halfway through it.  Ended up lasting nearly a week; go figure.  Another bottle was undrinkable a day before its expiration date.  Guess that's just one more thing that makes this universe an interesting place to live.

For things that aren't liable to going bad before being purchased, though, how does the customer respond to attempts to make a product or service more attractive?

At what price point, then, do patrons of store B start stepping back and saying "this looks too good to be true"?  After that, when business growth starts tapering off, where is the point where customers start saying "There's no way they can do the job right that inexpensively," and label B as merely a cheap store, inexpensive with quality to match, and start shopping elsewhere because they need a better product than B appears to sell?  Where is that point where lowering prices causes you to lose business because you are no longer competing in the market you had been in--in the market you think you're still in?

These questions are not purely rhetorical.  I'm sure some economist has done studies on this topic and I'd be interested in a treatment by a mind that was better informed, more well-versed, and clearer in these matters.  I'm actually wondering if there are usable rules of thumb or some more concrete formulations for roughing out a stable range of prices for goods or services offered; finding the range between where the marginal growth in business volume starts dropping and where it actually becomes negative.  Every situation is going to be different, but if someone asked me if a 70% discount "seemed" right, or if a 45% discount from the quoted price on top of a 40% discount from the quoted price (and that one I've seen happen) seemed like a smart way to draw business, it would I think be more diplomatic to say "Well, that seems like it wouldn't quite meet a first-order rendition of Markhov's 80-20 criterion; can you elaborate on your reasoning a little?" than it would be to apply a boot to the head and then ask how many boots to the head they received before they were able to demonstrate a toddler's level of business acumen like I had just witnessed

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