Who Drives the Price? Consumer or Customer?

In the lean community, many times we talk about how the consumer drives the price of  a product or service.  The price is not driven by some sense of entitlement we have to a certain profit margin.

Traditionally, the thought was:

Price = Cost + Profit

We find out what our cost is and add our profit to it and that will be the selling price.  Things have not sold because companies price things higher than what the consumer is willing to pay for it.

The lean mindset is:

Profit = Price – Cost

What’s implied is the consumer sets the price.  The company has a cost and can work to reduce the cost or leave it but that is what determines the company’s profit.

Over the last couple of weeks, I have worked with a large group of people on their innovation process.  How new ideas are presented to leadership and the decision making process on whether to proceed with the idea or not.

What I was pleased to hear was all the division agreeing that the consumer sets the price of the product.  Not what profit we want to make.  Finance to Supply Chain to the Creative directors and staff all agreed on this.  Yet, there were times when the decisions being made on a product were only pursued if the price could change or the cost cut more.  I understand wanting to hit a pre-determined profit margin but raising the price when the consumer is not willing to pay for it is just a waste of time.  It generates zero revenue if not sold no matter what the cost is.

All the divisions agreed with this but knew they needed to put it into practice.

There was an example that was tricky that came up.  In our business, we make consumer goods and then sell them through mass channels (CVS, Walgreens, Walmart, etc….).  Our research says the consumer is willing to pay price X for a product, so we design and innovate around that knowledge.  Then we show a retail partner, like Walmart, and the say they like the product but their customers will only pay Y which can be 50% less then what consumers told us directly.

So now what?  Sometimes that makes the product unfeasible to produce without losing the integrity of what the consumer insights have told us it is they love about the potential new product.  It can put us in a predicament because we can sell the product without Walmart but we feel we are losing revenue if we go by their insights.

All the divisions agree that we don’t get to set the price, but who does?  The consumer (person buying the product off the shelf)?  Or the customer (Walmart, CVS, Walgreens, etc…)?

What do you think?

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Posted on July 25, 2011, in Customer Focus, Innovation and tagged , , , . Bookmark the permalink. 1 Comment.

  1. Matt,

    Interesting post. Supply & demand are still king with the price. The buyer and seller influence the price and the buyer has the ultimate say as they can walk from any purchase with few exceptions. Wal Mart plays the role of buyer and seller in the consumer goods world and throws their weight as the largest retailer every chance they get. Retailers like WalMart may drive prices down to in competition but the consumer indicates what they are willing to pay when the market with less competition.

    Another point that is interesting is WalMart’s unprecedented influence on the supply chain. They seem to get whatever they want in the name of giving their customers lower prices. I’ve seen them back down a couple times though when someone calls their bluff. They started limiting the number of brands they carried for a while but backed off that when the consumer called their bluff and it hurt sales. They also tried to go to one brand for each food item at Sam’s Club. That meant that whoever won the ONE YEAR contract would have to add capacity to sell it at a lower price. They demanded that we all bid on the business by the end of the week. Many of us realized that we would be better off without making that kind of capital investment for such a one sided deal We were getting ready to say no thanks when they suddenly backed off the demand. It was quite apparent that they had many big players tell them no.

    Chris

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