May 24, 1976 is a day that will forever live in infamy in France, for this was the day that the prestigious French wineries sparred with their Californian cousins and lost. Steven Spurrier, a 34 year old British wine merchant organized the event in order to capture some of the American fervor over the bicentennial. Spurrier invited some of the most prestigious wine tasters in all of France but in the haste of organizing the event was required to smuggle in the American wine bottles in the baggage of some tourists. No one thought the American wines had a chance, least of all Spurrier, who admitted, “I thought I had it rigged for the French wines to win.”
First up were the whites. Six Californian Chardonnays were pitted against four French Burgundies in a blind taste test. The American wines took the top three spots. Concerned with the results, Spurrier advised the judges that an American wine had taken the gold. In the next matchup, six bottles of Californian Cabernet competed against four bottles of French Bordeaux. In a result that shocked everyone in the room, the 1973 Cabernet from California’s Stag’s Leap Wine Cellars won the top honor with three French wines winding out the top four. The event marked the coming of age of American winemaking and separated a period of time when the Californian wine industry mainly produced cheap jug wines with one now that could produce world-class wine that commanded a premium. How could just one day transform the perception of Californian wine from being cheap to being desirable? What determines a fair price?
Value vs Cost
Many companies price their products or services by calculating the total cost and adding a target profit margin. While this formula remains relevant with commodities, its use can leave significant money on the table. Value-based pricing sets a price primarily on the perceived value by the customer instead of the actual production cost. McKinsey & Co., a consultancy, defines value as “the tradeoff between the benefits a customer receives from a product and the price he or she pays for it.” The key is recognizing that value is relative.
It is likely that you have different types of customers that purchase your products or services. Some customers might be extremely price sensitive, whereas others are not. Even price sensitive customers will attribute different levels of value to the same product depending upon the circumstances. Take water for instance. A price sensitive individual would likely laugh in my face if I were to knock on his door offering to sell a $3 bottle of water. That same individual might view that same bottle of water a bargain if he were sitting in bumper-to-bumper traffic on a hot summer day.
Value Perception is Dynamic
Value perception is dynamic depending upon the circumstances around us. Uber, the taxicab app, has a unique dynamic pricing model, which increases the cost of a ride up to 9x depending upon the demand on a particular street. While some view this as price gouging, in actuality it is incentifying more drivers to come into the area and more price-conscious riders to seek alternative transportation routes, thus normalizing demand relatively quickly.
A company’s own actions, changes to the competitive market and changes in a particular customer’s own reality can all cause the value equation to change for a customer. Amazon understands the dynamic nature of the market and changes their prices an amazing 2.5 million times each day compared to big box stores like Best Buy and Walmart that change prices just over 50,000 times in a month.
Pricing for Purpose
While more traditional business models use price fluctuations to achieve certain business objectives such as increasing market share, more and more business models are adding social objectives to the mix. India’s Aravind Eye Hospital has revolutionized cataract surgery with an innovative two tier model in which the vast majority of surgeries are conducted free of cost and subsidized by paying patients who are drawn to the hospital because of its world-renowned expertise. In my own experience, I’ve found very few social enterprises that are able to create scalable business models that are both profitable and able to meet social objectives. Aravind and others like d.light design prove it is possible, but believe me it is hard to do.
By in large, I believe that allowing the market to dictate the price of a product or service is entirely ethical, whether that means a supplier makes 5% or 150% margin. Whatever the profit margin, I believe we must be good stewards of the resources we are given. Pocketing 150% profit margin while our employees barely eke by is not ethical. Transferring a 40% profit margin exclusively to shareholders in the form of dividends can also be unethical. It’s not about a specific number or percentage, it’s about the way we steward the resources we have and are able to fully bless those around us.
Eventide Asset Management, a phenomenal Christian investment company who won the 2014 Lipper Fund Award for the Best Mid-Cap Growth Fund, has an innovative way to look at the value creation or destruction of a company. The Eventide Business 360 Assessment defines a company’s neighbors as the employees, customers, suppliers, community, society and environment that make up and surround a company. A company like Walmart, even though it provides incredibly low prices to its customers does so by squeezing its own employees and suppliers. The price is not right if only a few of a company’s neighbors are blessed by its presence.
Photo Credit: Graham