Over- and under-pricing

Kelly Trimble put in some very wise and useful observation about pricing on an earlier post. I had sent it to my iPad to read in leisure, but it got lost in the crowd until now. I thought it was worth posting here. 

   Kelly Trimble wrote:
It’s a stormy Sunday night here in Missouri, so I am going to feel free to rant a little bit.


I'm gonna disagree just a little bit with your diagnosis of why people would pay a 300 % premium for the better regarded brand. There may be part of the market buying the Zeiss lens for the prestige, proving to other photographers that they can afford it, but I think what may be happening is that the buyers are treating lenses as Giffen goods rather than Veblen goods. The effect is much the same in that demand increases as price increaes, but the reasoning behind it is different, having to do with indifference curves, income effects, and substitution failures.

Another more interesting explaination, however, comes from the branch of economics known as 'property rights' which touches on the concepts of limits or impediments on information in the market. Most economic theories have as a basic assumption that all market participants are fully informed as to the utility of and substitutes for the entire vector of product choices in the market. That is not the case, so sometimes a poorly informed market participant will get his information as to the relative quality or utility of a product through the pricing mechanism, allowing better informed producers to manipulate their prices to influence behavior.

Here is an example. In our town, we have many live performance theaters. My family used to own one. Visitors to our tourist town did not have good information as to which live show was better without having first seen all of the shows. They got a lot of information from advertising, where the ads built desires for a particular entertainment product while giving the impression that the product was of a certain quality. They also got a lot of information from other consumers, but they learned quickly that the people who have seen a show are not always the best judges of the quality of a show because people's tastes vary so much. What we found was that consumers were getting their information as to the relative quality of live performance shows largely through ticket prices. If you are standing in front of two live performance theaters, one is showing the Baldknobbers Family Jamboree, the other showing The Shepherd of the Hills Outdoor Drama, you have money in your pocket, and your vacation ends tomorrow, and you have no other information on which to decide to see, but one is priced at $10.00 per ticket and the other is priced at $40.00 per ticket, as crazy as it sounds, most people will buy the $40.00 show, and most of the people who buy the $10.00 show will walk out of it wishing they had gone to the $40.00 show. And they are not being snobs-they simply assume that if people are willing to price their show that much higher, it must really be that much better.

Another factor to consider is that consumers often do not price individual product components when trying to obtain a certain level of utility. They will price an entire collection of components, and often will judge the purchase decision of an individual good based not on its individual price and utility, but on its marginal cost versus its marginal utility. Going back to the live performance theater example, we found that people were judging prices based on the entire cost of the experience. Somebody sitting in their home in Oklahoma City made a decision to come to Branson instead of Vegas or Austin or Myrtle Beach or whatever when they added up what it was going to cost to travel, how long the trip would take, how much gas they were going to burn, how much wear they were going to put on their car, the cost of every motel room, every on the road meal, how much shopping they were going to do, and everything else, and then added the cost of the theater ticket on top of all of that. A weekend trip to Branson from Oklahoma City for a group of four people could cost a thousand dollars. So the ten dollar show would cost them $ 1,040 and the forty dollar show would cost $ 1,120, or only seven or eight percent more, but the prices told them it was 300 % more show.

Every year we would look at the data, plot demand curves and project next year's prices, and the numbers would tell us that to maximize revenues we needed to increase ticket prices, and every time we increased ticket prices, attendance went up substantially.

Now here is another wrinkle to that model. People will value their own time at a certain price in the model. They don't do it explicitly, probably subconciously, but putting a value on the customer's time was the only way the arithmetic worked when doing these price models.

Relate that to the lens. They are not buying just a lens. By the time they have bought the lens, they have bought a camera that costs a few grand, a bunch of peripheral crap, such as batteries that fit only that camera, chargers, cards, photoshop/lightroom/etc., computers, a desk, monitors, a printer, tripods, a few grand worth of studio lights, probably several other lenses, and done several thousand experimentation shots involving hundreds of hours, maybe a college degree in photography, probably some $500 workshops involving $1,000 of travel, building to house a studio (owned or rented) a couple of ex-girlfriends and maybe a marriage or two. Back in the film days, it was said that a full professional studio photographer had spent as much on equipment as your average dentist, varying between $ 40,000 and $ 500,000, depending. Today that may be different, but still somebody shooting a high-end DSLR professionally has spent $ 15,000 to $ 30,000 on equipment and maybe more if you factor in all of the stuff associated with getting the person to a certain point in a career.

So let's assume that the guy has spent $40,000 on equipment and discovers that he needs a high-high end 50mm prime lens. Even a professional is not going to have enough information outside of brand names to judge the relative quality of the Sigma vs the Zeiss lens. He will get part of his information about relative quality from the fact that the Zeiss lens costs four times as much as the Sigma. With the sigma lens, his ability to take a certain shot costs $41,000-and it costs $44,000, or about seven and a half percent more, with the Zeiss lens.

They know that if they buy the cheaper lens, they might not get quite the results they were hoping for, and they know they are going to wish they had bought the more expensive lens; whereas if they buy the more expensive lens and they get shitty results, at least they know it wasn't the lens.

In my experience, when photographers buy expensive stuff, it isn't out of snobishness, like somebody buying a Rolls Royce to prove that they can buy a Rolls Royce, although there is some of that going on, particularly among wedding guys. I've had some photographers tell me that they will buy the more expensive stuff because they have customers come in that know a small amount about photography and it is easier to project to the customer that you are a true professional when you have high-dollar name brand lenses. Imagine your customer expecting you to explain why he is paying X-thousand bucks to shoot whatever and you are using some shitty Sigma lens??? But when a photographer buys expensive stuff, it's usually out of a quest for better quality and maybe a lack of confidence in their own abilities as a photographer. They don't know what level of quality they need for the work they are doing, so they bankrupt themselves buying the best quality gear they can get. And since they have imperfect information as to what the technical characteristics of the gear may be, they simply buy the most expensive. Such as the $4,000 Zeiss lens. And then they have to build the price of that expensive lens into the price of what they are doing for the customer (or 'client').

When I started in business, I found that there is such a thing as being 'over-capitalized'. As you proceed in business, you encounter a series of problems and challenges that you must overcome to obtain customers and to deliver a product to those customers. There are two ways of approaching each of these problems: you can grab a big wad of cash and throw it at the problem to make the problem go away or solve itself, or you can use some ingenuity, develop a new talent, or devise a whole new process using the resources you have to solve the problem or to develop the capability needed. If you have plenty of capital, you may not have much entrepreneurial time, so you will tend to throw money at the problem, you will buy more equipment, hire more staff, spend money on media advertising, or whatever. If you don't have the capital, then all you have is yourself, and you are forced to come up with a better solution than currently exists using your own time and effort to develop a new capability. When you spend money to solve a problem, that cost has to be built into the price of your product and eventually, even though you may have all the money in the world, you cannot compete with the guys that had no resources, but did a lot of DIY and creative stuff to deliver a product at a price (and sometimes quality) that the over-capitalized guy cannot match.