How to put a price tag on your goods
By TOM W. GLASER
© St. Petersburg Times, published April 12, 2001
In 1869, he repaired what was called a "gold price indicator" for an investment company. Seeing how he could make the machine better and more useful, he got a commission from Western Union to improve its stock ticker machine. A stock ticker was a form of telegraph that printed out the current prices of stocks as they changed. The prices were entered in Morse code but printed out in a readable form.
What Edison created was something entirely new, the Edison Universal Stock Printer. Having some idea of this invention's commercial possibilities, he took it to the board of directors of the New York Stock Exchange. He offered to sell them the rights to the machine, which meant that they would own the patents and be able to manufacture the machine. After some discussion, the board offered Edison $40,000, which was quite a lot of money in those days.
Edison accepted the offer, but when he reached the door as he was leaving, he felt a bit guilty. He stopped and turned to the board and said, "Gentlemen, I feel obliged to tell you that I would have taken $4,000 for my invention." The chairman of the board replied, "Mr. Edison, YOU should know that we were prepared to pay you $400,000."
The money he received gave Edison his start and allowed him to build a full-time research laboratory at Menlo Park, N.J. It also gave him a lesson he never forgot on underestimating the value of his inventions.
Have you ever wondered how companies and stores come up with the prices they charge? Have you ever thought that a price was too high or too low? The trick is that the companies don't come up with the price, the market does. If you thought a price was too high, you wouldn't buy, would you? Neither would most people who felt the same way, and the company would probably go out of business. By the same token, if the company priced its product too low, it would lose money on each sale and go out of business that way.
But those price tags get there somehow. This is in part a function of the supply and demand graph you've already seen. Where the supply curve meets the demand curve, price is discovered; everyone who wants to sell at that price will find a buyer, and everyone who wants to buy at that price will find a supplier. The market clears.
But you need a price to offer the good or service for sale in the first place, don't you? That initial price can be adjusted to meet the demands of the market, but there needs to a starting price. Where does that come from?
It really comes from two places, and often it is as much art as science to determine that first price. The first consideration is how much it costs to make the product or provide the service. Part of determining cost requires considerations not usually apparent to most people.
For example, there are hidden costs. Every product or service must be researched and developed, and not every experiment is successful. But every experiment does have costs that must be paid before it is known if it will be a success or a failure. The business must recapture those expenses, but often people will say, "It only costs a few pennies to make that. The company is gouging the public." These people aren't looking at all of the costs.
Other costs are pretty much common sense. There are fixed costs that don't change much from month to month. These might include payroll, taxes, rent, utilities, insurance, interest payments on loans and similar things.
Variable costs can change rapidly, often without warning. These might include the costs of meeting new government regulations, lawsuits and costs that change because other prices change. Some of the latter include the cost of shipping as gas prices rise, and the cost of certain components as higher prices are charged for raw materials, such as plastics manufactured from the same oil whose prices drove up the cost of transportation. Add in trying to anticipate inflation, and the process does look more like an art.
Another cost is marketing, which can be a riddle. It is a problem that seems to be without a solution, because you can't sell your product without marketing, but you can't do marketing without the money you get from the sales. This is answered by putting your company in debt from the beginning and borrowing money to do the marketing. You have to spend money to make money.
For example, when John Wanamaker opened his store in Philadelphia in 1861, he ended the day with this notation in his ledger book: "At the close of the first day the cash drawer revealed a total of $24.67. Of this sum, $24 was spent for advertising and 67 cents saved for making change next morning."
In addition to advertising to attract customers, marketing includes market research. Now that market research has given you an idea of what to make, it can also give you an idea of what to charge. Market research firms can now ask people how much they would pay for your product, but not in that way, of course. They would first ask, "Would you pay $X for this product/service?" They would then do that with more suggested prices and narrow down a range of prices the customers would probably pay.
Another consideration, but a very tricky one, is what your potential competitors charge for their product. You can't contact them to set a price, because that violates federal law. If you charge more, you could be considered to be gouging. If you charge less, you could be charged with unfair competitive practices. And if you charge the same, you could be charged with price fixing. You must be sure that you decide your price solely on your own.
Have the class research some of the costs that businesses incur. You might invite speakers from the community or even from your school system. Your principal can tell your students how much it costs to run a school, a non-profit organization. If your class has decided to offer a good or service, have it look specifically into how much costs might be and the prices of competing goods. The class might choose its best interviewers to canvass potential customers for price range. Also invite speakers from marketing and/or advertising agencies to speak on what they do, how they do it and what sort of costs are involved.
Useful Web sites
http://www.pricing-advisor.com -- the Professional Pricing Society.
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-- Tom W. Glaser is a high school teacher at the School for Advanced Studies at the Wolfson campus in Miami. He has won numerous national economic teaching awards and was named Florida Council on Economic Education Economic Educator of the Year in 1997.
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