The Price of Fish
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 but we should always remain commercially curious!
Finance business partners need to become more relevant to overall business decision making. One such area would be helping the marketing function in their pricing decisions. I have seen this first hand in the motor industry where manufacturer have 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 decade due to abundant lobster harvest some put down to global warming.
Despite this restaurant menu prices remain similar. A reason 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 also 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 much use. Therefore, to become a more valued partner the moral then, is to 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.