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This is the price you pay

21/04/2015 15:39, author Mateusz Chołaściński

Most of our “bad” buying decisions are in fact not as bad as they seem if we take a closer look. It’s enough simply to consider the “alternative” no-buy scenario and attribute the right value to what we actually received for the money we paid. At the core of every decision is the input information we have at our disposal. The worst decisions are in fact only those where we failed to consider the input or ignored a significant, valuable factor. For example, a poor decision would be to buy a 12-pack of 40cl yoghurt pots for personal consumption only because they had been reduced by 50% (as the expiry date was imminent) whilst ignoring the fact that it's highly unlikely we would be able to consume them all within a couple of days. The input obviously not taken into consideration in this case is sheer common sense. On the other hand, it wouldn't be such a terrible decision if, feeling thirsty, we were to purchase a small bottle of water for 2EUR from a beach stand. It is possible to assume that a cheaper source is available nearby, where the price may be as low as 50 cents (a discount of 75%), but the buyer would then carry the cost of the search. However, in this particular situation the search itself would be extremely inconvenient, for every minute dedicated to comparing prices between stands costs a lot in terms of effort. Is an hour of thirst, spent walking from stand to stand instead of relaxing on the beach really worth 1.5 EUR? In this light, 2EUR does seem to be a fair deal after all.

I frequently hear complaints about poor buying decisions - the purchaser senses they have been overcharged and is left feeling dissatisfied. The bottle of water is a typical example. The high price is described as “unfair”, “outrageous”, “extortionate” and we wonder if we've been ripped off. Why is that? Well, perhaps we have misunderstood the concept of value and price.

Fair transactions happen when both sides receive satisfactory value. For a seller, this value is not just the cost of supply or production plus a margin to cover all other expenses. A seller also needs to prepare a sensible offer, search for customers, communicate the product merits, compete, innovate, and do all of this in a risky environment. This is the investment the seller makes in order to get a return. The seller naturally aims to generate as high a margin as possible, by selling at a price that the buyer is willing to pay. In the end, the tools a seller can apply to generate higher margins are product differentiation and the search for new markets (those not already held by competitors). The value is measurable. It equals the achieved transaction price. For the buyer, value is what they get in exchange for money. Easily said, but nobody really knows how to convert the benefits they receive into currency. Without a comparison, without a reference point, it’s simply not possible. There are two comparison criteria here that may prove useful:

  • First is the comparison of the goods we aim to buy against something else that we could buy instead for a similar price. Comparability here is completely arbitrary. Some people are willing to choose between one particular game console and a different console, while others ponder whether to select a game console or a bicycle (as they consider either will satisfy roughly the same needs).
  • The second is to compare the exact same product or service but from different sellers. And it is this comparison which delivers the ultimate perception of price fairness. Without it we are unable to reach a conclusion, especially in regard to products that cannot be replaced by other goods. Food here is a perfect example. In the US, in 2013, the average disposable income spent on food at home per capita was 5.6%, while back in 1963 it was as high as 12.5% (http://www.ers.usda.gov/data-products/food-expenditures.aspx). Compared to 50 years ago, it seems as though Americans have now been granted a never-ending BOGOF (buy one get one free) offer on their entire weekly food shop! That’s really quite something! What a bargain! Yet if some stores positioned themselves 20% above this average (i.e. accounting for 6.7% of annual disposable income) they would be called expensive, wouldn't they? Despite the fact that they would be still 46% below the 1963 level[1]. For the buyer it is only here and now that matters. But it is all relative.

In reality our choices are a mixture of the two criteria, so we do actually compare in all directions (see the “What is the right price for a 50 inch LED TV set?” example). The first comparison usually leads us to the (price-and-value-based) decision on what to buy, the second to the (rather price-based) decision on where and how to buy.

Unless we have been deceived[2], there is no unfair transaction price[3]. If the price does not seem right for either party involved in the transaction – purchase does not take place. If we decide to buy and then feel dissatisfied, we only have ourselves to blame for ignoring the input. To put it another way: feeling thirsty on the beach? This is the price you pay for being such a skinflint.

What is the right price for a 50 inch LED TV set?

10,000EUR? Sounds expensive, but acceptable. 1000EUR? Even better! 100EUR? That's more like it, I’ll take one. Each of these prices might make sense depending on the circumstances.

Imagine the year is 1990. A top innovative company has just announced they have developed a high quality blue LED, the missing element in white LED technology, and thus in the production of LED displays. A couple of months later they present the first LED TV set. A year later – a huge set with a 50 inch diagonal comes onto the market. Nobody else has anything like it. And everyone wants to get their hands on one. New entertainment quality and prestige. Science fiction in your own home. No other company is likely to catch up for a while. In the States, a CRT TV set (approx. 30 inches) costs over 2000USD (sorry, but the EURO wasn't around then), and pretty much everyone can afford one. 8000USD actually sounds quite fair. Considering the CPI in the US over the last 20 years and current EUR/USD rates, that would be the equivalent of around 10k now. I’d be delighted to have such a masterpiece, and I’d be more than happy to pay the price. Now back to 2014. A quick online search suggests offers around 1000EUR are available. So, why do I think this is okay? Because it’s something I assume to be the market price. But hang on a moment. What else can I have for 1000EUR? A bicycle, and a really decent one at that. After spending all day at the office sitting in front of the computer I might choose to get some fresh air instead, visit a park or two, go for a picnic. Work out, keep fit and feel better. Why would I select something that requires me to sit for hours more, something that would make me feel worse? To me, a TV set is worth around 100EUR as I’ll use it occasionally to watch carefully selected films. If nobody wants to sell one at that price now, I’ll wait. And in the meantime, I can always scan the Internet and look for the cheapest option.

[1] of course not literally. CPI and all other factors have been ignored here. I assume that food has roughly the same value, and the right price measure is how much effort is involved acquiring it

[2] i.e. the final transaction price is different to the one the buyer was expecting due to hidden fees or the seller simply cheats and charges a different price to the one agreed prior to purchase

[3] if we limit ourselves to consumer goods in the free market, so excluding e.g. life-saving medicines