The Price of Fish

Posted by on Oct 13, 2014 in Business Partnering | One Comment

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I recently was lucky to combine some work and pleasure on the north east coast of the USA indulging in my favourite food, lobster. As a result of me paying quite different prices for essentially the same size of lobster it got me thinking on how one goes about working out the price of something – sad I know!

In the last blog talked about how if we are to survive as accountants it is important that we can become more relevant to overall business decision making. One such area that would be helping the marketing function in their pricing decisions. I have seen this first hand in the motor industry where manufacturer has a portfolio of vehicles pitched at different types of customers e.g. small executive saloon, medium executive saloon, large executive saloon which, often due to economies of scale in manufacturing, have production costs which are very similar but have prices that can vary by more than £50k.  These price differentials are often the result of finance and marketing collaborating to make sure the business maximizes its return to shareholders. The prices chosen ensure there is no chance of customers substituting to a lower level model and maximizing the returns made.

Profits are maximized, as the small executive saloon will sell in much higher volumes but at a lower margin. In contrast the very expensive large saloon will have much lower sales but much higher margin and its high price is associated with greater prestige and quality and also incentivizes the consumer of the entry-level model to buy into the image.

Well, surprise surprise it would seem that the same issues occur when restaurants are trying to work out what to charge for a lobster. The price, which a fisherman receives for his lobster, has fallen significantly over the last five years with wholesale prices falling from $6 a pound five years ago to around $2 today. This is largely a result of supply and demand with many believing global warming contributing to bumper lobster harvests.

However despite the large fall in the wholesale price the price on the menu on restaurants has not fallen, and gone up if anything. One of the reasons for this is that most of us perceive lobster to be a luxury good and are therefore happy to pay a premium to enjoy it. Thus a pricing model based on a pure cost plus basis would be incorrect and the model adopted in this case is more of a psychological price as applied to the aforementioned luxury cars and designer handbags amongst others.

The psychological influence also results in people getting more pleasure from something when they pay more and to make the price lower could ruin the consumer experience. This can be complicated further by the perception that if the lobster is too cheap it may be because there something is wrong with it and therefore you avoid it on the menu. Another benefit to restaurants is that the highly priced lobster makes other seafood options appear to be good value.

What has any of this got to do with finance then? As you are an expert in financial modeling using spreadsheets and also having a sound knowledge of the profit impact of cost you are in an enviable position to help. However if you do not understand the fundamentals of marketing and are trusted by and able to work with marketing professionals you are unlikely to be of much use. Therefore to become a more valued partner the moral is; try and integrate with whatever departments are the value drivers in your organization to understand them and hence become the person people go to for help.

This is how finance will survive and continue its position at the heart of management decision-making.

1 Comment

  1. Dragan Ocokoljic
    October 20, 2014

    Sean, thanks for this interesting expert-view on such daily and simple example.

    One sentence is especially interesting: “The psychological influence also results in people getting more pleasure from something when they pay more and to make the price lower could ruin the consumer experience”

    The question in my mind is: Where is the limit of this kind of pricing strategy after which they will collapse? The experiment can be: increase the price until the consumer compare real quality and price. In one moment the consumer will understand that there is a big gap and he will become frustrated. Is this the end of this kind of pricing after which the product will never be in premium price segment? Maybe the best strategy is to be on the price edge and never go beyond. Just thinking.

    All the best,
    Dragan

    Reply

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