CONTAMINANTES
Which Price is Right? Kent Monroe, a professor at the University of Illinois at Urbana-Champaign, is one of the deans of pricing. He's been teaching the subject for nearly 37 years, and he knows that sloppy thinking about pricing is widespread across the U.S. economy. Both consumers and businesspeople assume that price has everything to do with cost. Wrong. "You have to know the cost so that you can understand the profitability implications of price," says Monroe, "but not for the purpose of setting price." Businesspeople assume that if they are in a competitive situation, and prices drop, they have to match. Wrong. "The natural tendency to match is foolish," he says. Executives who are devoted to using "data" in all kinds of other arenas think it's perfectly acceptable to set prices based on "history" or "experience" or "instinct." Wrong again.
Monroe tells a pricing story that shows how even the simplest situation can confound accepted wisdom about prices. "A company is making two versions of the same product," says Monroe. "One has a little more gold and foil on it, but they're essentially the same. One is $14.95; the other is $18.95." Not surprisingly, the $14.95 item is selling better. It's also the lower-profit product.
"Then a competitor comes in with a third product. Again, it's essentially the same thing, but a fancier version. And it's much higher priced: $34.95."
For our original company, asks Monroe, "what becomes the best-seller? Why, the $18.95 version, of course."
It's a small story, but it's true. In fact, you can feel how right Monroe is. "The point," he says, "is that economic theory says that can't happen. But it does."
The neat curves and crisp laws of supply and demand, elasticity, and rational behavior that everyone learns in microeconomics class don't work in the real world.