Question:

Dear 80/20 Mentor,

Our supply chain is stabilizing, and costs are reducing slightly. Should I share some of that reduction with customers? Or, should I keep the margins and re-invest in the business for long-term growth? If I choose the latter, how can I position that with our customers?

Sincerely,

To Share or Not to Share

Answer:

Dear to Share or Not to Share,

Perhaps the most common error made in pricing is believing that cost and price are more related than they truly are. To be sure, the price vs cost delta determines the margin, and that's important. But to believe that the cost of a good should somehow determine the price of a good is to fall into a dangerous trap.

The price of a good is determined by two things, and two things only: what a customer is willing to pay for it, and what a competitor is willing to sell it for.

If it costs a dollar to make a good, and that good is something that EVERYBODY wants, it is a grievous error to charge merely two dollars for it. There is a story told about a person selling hot roast beef sandwiches at the very top of a snow ski run at lunchtime—one can only imagine how delicious the aroma was to the hungry, chilly skiers! The vendor was selling the roast beef sandwiches for $20; some customers noted that the same roast beef sandwich was available at the lodge for only $5. "Yes," said the vendor, "but it's an awfully long way back to the lodge." He sold out in under 45 minutes.

Similarly, if an item costs $100 to make, and there are no customers who have the slightest interest in the item, it won't matter if the price is $200 or $20 or $2...no one will buy it.

Hence: price and cost are unrelated.

To the question, certainly, when the pandemic hit and supply chains got stressed, everything got more expensive. It's the economic theory of supply and demand. Prices went up because consumers were willing to pay more to acquire the scarce supply of that which was needed. Only the foolish folks thought to hold prices in an effort to gain market share: they gained share short term while losing money, and then lost that share when their supplies ran out.

In the current situation, yes, supply chain is improving, and some costs are declining. This should not elicit a knee-jerk reaction to lower prices back to pre-pandemic levels. It is entirely possible that the higher price is the new normal—that the consumer is willing to continue to pay that price, and that competitors are not willing to sell it for less. If both are true, then the market has just been reset to a new, more profitable level, which the suppliers should enjoy.

Unfortunately, there is usually a competitor or two who "don't get it," and immediately do reduce prices, which in turn forces everyone to follow suit. This situation is the genesis for the saying "The market is always in the grip of its least intelligent competitor...so ensure that it isn't you!"

In short, then, SHOULD one lower prices when costs come down?

The answer: only if and when the market demands that this be done. Until then, hold prices, and pay attention.

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