Costs and Pricing Are Not As Closely Related As the World Thinks
Fixed costs never matter to pricing. Variable or incremental costs only matter to pricing in markets where we don’t negotiate.
If you’ve read or followed me for very long, these statements should be well ingrained in your mind.
How the World Relates to Costs and Pricing
However, you probably didn’t always believe this. At one point you thought prices and costs were very closely related. Here’s the thing. The whole world, except pricing people, believe that costs and prices are closely related.
I was reminded of that when my wife showed me an article about wine in the Costco magazine. The author, Annette Alvarez-Peters had over 36 years at Costco with 14 years overseeing the wine, beer and spirits program. If it wasn’t for her extensive experience, this wouldn’t even have raised her curiosity.
See the article for yourself here. Here is her first paragraph.
“Usually over a glass of wine, I have discussions with Costco members, friends and family about some pressing matters: Is a $150 bottle of wine really that superior to one costing $20? Can you detect the differences, and are they worth it?”
This is a fantastic set of questions that should tee up a brilliant conversation about value … but it didn’t. Instead, she went on to explain the costs of making and packaging different wines. Some of the key points included:
- Land in Napa Valley is much more expensive, so the grapes there cost $7,200 per ton while in Columbia Valley in Washington grapes only cost $1,500 per ton.
- Vintners who curtail their grape production per acre have lower yields, which they believe makes better fruit. The lower yield means the grapes are more expensive.
- Fermenting (and aging) in barrels is more expensive than stainless steel. Some barrels are more expensive than others.
- Some packaging and labeling is more expensive.
After spending the entire (short) article talking about the cost of production, she ends with a reasonable paragraph.
“So, to answer the original questions: It’s a personal choice. I think the best way to evaluate value is to try new wines from different regions and determine what you enjoy. Cheers!”
I am NOT making fun of the author in this blog. She is obviously very knowledgeable about her craft. She has expertise and knowledge I wish I had. Yet this is an extremely clear example of how the rest of the world views where prices come from.
So again, the main point here is that fixed costs don’t matter to pricing. Variable or incremental costs only matter to pricing in markets where we don’t negotiate.
The whole world, except pricing people, believe that costs and prices are tightly related. However it’s not our job to educate them. It’s hard enough to educate pricing people. 🙂
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Mark is a pricing expert who helps companies understand value, how to create it, communicate it and capture it. He has a PhD from U.C. Berkeley and an MBA from Santa Clara University, plus 25+ years pricing experience. As an educator, speaker and coach, Mark applies innovative, value-based pricing strategies to guide growth and increase profits for large and small companies.