Monday, July 02, 2012

Profit = Market Price - Actual Cost or Price = Cost + Desired Profit

Comments on Google Nexus Q – Made in the USA

I agree with

"Deserved Profit = Market Price – Actual Cost"
"Price = Cost + Desired Profit."

But what I see glossed over by many lean folks when they present this is volume and the complexity involved.  The iPhone could sell 10,000 (say, or some number anyway) at $2,000 in addition to an carrier subsidy.  They can sell millions at a much lower price point.  Market price is a movable thing (depending on volume).

Also the 2nd formula is fine for deciding what products to build (theoretically - you have to be guessing at the values).  But it is totally fine to say we need a price of $350 for x product for us to decide to offer it.

The task is then to guess right.  If $350 is not going to work you give up - or more likely go back to the drawing board.  Can we make it better for just a bit more and then sell it for $400?  Can we re-engineer certain things and lower the price to $250 and even if that means we had to get rid of the ability to use wifi will that work in the market?

It definitely can be sensible to say we can't make x for less than $400 - we are not pricing it at $300.  It might mean we can only sell 10,000 instead of 30,000 if we priced it at $300.  But since at $300 we are losing $100 a unit high volume isn't great.

I think "If the market price for a device like this is $100, then you have to engineer the total product cost so it can be profitable at that price." is very well said.  Again volume is still a big issue.

Sometimes there are price cliff points - I can't imagine selling a tablet that isn't hugely better than the iPad on specs for more than the iPad price.  So above that level the volume may be miniscule.  But I think often there are not cliff points.

And the company does get to set the price.  The market then decides to buy or not, and buy in what numbers.  Apple would probably sell very few iPhones for $3,000 more than they cost today.  How many they would sell at $100 more or $100 less may change significantly but they would still be huge sellers at either of those prices.  So that "market sets the price" idea is not 100% accurate (I don't think anyway).  I do think the first formula is a better concept than the 2 formula.  But it is something that is maybe 80% accurate?  And the 2nd isn't totally worthless (it is just that it should be looked at more as a should we offer this product or not decision).

Pricing decisions also have big long term versus short term considerations.  Apple has started pricing many things in a way which makes it really hard for competitors to undercut them.  Apple, almost for sure could charge more for the laptops they sell and the iPad and iPhone.  But if they did they make it easier for a competitor to compete on price.  This pricing decision is an Apple decision not a market decision.  The market weighs in after Apple make the pricing decision.

But the price point for a kinda ok tablet at $199 - maybe will work?  Fire seems to be doing ok, for a pretty small, kinda lame, really cheap tablet.

Apple has done well create products for prices much above what people thought was market price.  It turned out people were willing to pay more for a great product.

You can notice that we are trying to sell this car for $35,000 and we are hardly selling any.  Ok, lets make it $30,000 and see what happens.

When setting what prices you will try to sell for, looking at your costs is a perfectly sensible thing to do.  Once the market tells you that you are off, you need to adapt to the market.  It isn't super easy though.  Often you can think the market failed to appreciate the value we offered because we messed up x feature and with y missing it was an issue and people will buy only black from Apple but they won't accept that from us (or whatever).  What we need to do is fix those mistakes.  The pricing given those mistakes the market sets below what we expected but that isn't really a pricing issue it is really a damaged offering issue.  Eventually mis-understanding pricing may become obvious, but it often isn't.

Anyway, my main point is just that the "market price" isn't some easy thing to know.  It isn't like looking up the freezing point of water.  I do agree with the "formula" I just think the way it is presented is often not as useful as it could be.

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