## Monday, April 6, 2009

### The true worth of a product

Another trivial topic. More of a passing thought actually.

This morning while walking to office I see the shoes of a man walking in front of me and I think how much is this shoe worth of, I mean the correct appropriate worth of this shoe.

Take the case of the shoe manufacturing company. The company after having produced the shoe, decides on its price. Consider yourself to be the guy entrusted with the responsibility of determining the price of this shoe. What do you do? I’ll break it into components like the raw material, the number of sections the shoe undergoes in the factory, number of people involved with its production etc. Lets say the the raw materials cost 50 bucks. Lets say 10 people worked on it and each worked 1 hr and going through their wages I can know the money equivalent to their worth and say its 100 bucks. Now the company invested money in the heavy machines it installed for the purpose so the maintenance and cost of those machines has also to be accounted for so lets say the cost of a machine is some XYZ and its lifetime is say 10 yrs and likewise I can determine how many shoes it can produce in its lifetime. Based on that one can know the cost of running that machine per shoe manufactured and similarly do the math for all the machines involved. Lets say its 50 bucks. So now the bare minimum price that I can charge on the shoe is 200 bucks. Its not over yet.

The company does have other sections also, like finance, marketing, sales etc. The cost of those also needs to be accounted for. So now I’ll calculate how much does a sales guy, a marketing guy, a finance guy spends on a pair of shoe on an average. For that I will find out the total number of shoes I produce in a month and divide it with the guy’s monthly salary(please see the last para) or I can also find the per day salary of the sales guy and see how many shoes I produce in a day etc etc. The thing is I can know how much I am spending on a sales guy, on a marketing guy etc on a per shoe basis and say it all adds up to 50 bucks. So the shoe is worth 250 bucks. The shoe can be sold at 250 without incurring any loss.

Now comes the profit part. The CEO started the company to earn some money, right? Others who joined also had the same in mind. The profit margin is a big issue. How much profit should they derive? It shouldn’t be too high or else the shoe price will be out of the target customer’s reach and it shouldn’t be too low also because you & your family have to survive on it. The profit should be optimum. One has to determine how much profit should a sales guy derive, how much for a marketing etc and like wise for every employee. The profits will be shared according to the hierarchy and in that respect the CEO is expected to take a lion’s share. It shouldn’t be hard because after all, the shoe business was his idea and it is normal that there is a fraction of shoe price that a customer pays should go to the CEO for his idea. You can see, arriving at a profit margin must be a tough task and I don’t know but the current market situation must also play a role in it. So after a long hard day’s work the final price of the shoe is determined at say 350 bucks. The company marks it as the Maximum Retail Price (MRP) i.e the product is not worth more than this price.

So I guess this is how one determined the value of a product. But then again, if it’s the most appropriate price, why do people still bargain? So, isn’t bargaining signify that you completely reject all the price determining upheaval task that the company performs. Isn’t it like all those sessions about manufacturing cost, profit-loss margin, etc useless. Isn’t it like questioning a company’s hard work on the product’s price-tag.

The problem becomes grave when the same product is available in many price tags. Say for example if the vendor makes a profit of 20 bucks per shoe sold(he wouldn't disclose it), on the case of customer bargaining for a better price, some vendors may settle for 15 bucks profit and sell the shoe in 345, some may sell it in 340 and some in 335. It doesn’t stop here. The customer is all confused now. He buys it in 345 and thinks it’s a good price but next day his neighbor gets it in 340. In such cases the customer can even question the 340 being the right price because the maximum is 350, the minimum can be anything that’s less than 350. We as customer cannot know the true worth of a product, can we?

I think I have a solution for this. What if, the company redo its math, make some appropriate changes and come up with a Minimum Retail Price. What if every product sold is sold under Minimum Retail Price. This leaves the bargaining out of context because now the customer knows he cannot pay anything less than this price unless he wants to murder the company’s minimum profit. The customer always wants the best price for a product, the true worth the product carries. Minimum RP is the answer. A maximum quoted price leaves so many questions to one’s assumption which only adds to one’s confusion. When you buy a product on Minimum RP, you respect the many trouble and hardship the company has undergone to arrive at this price. One can feel the immense pain a company would take to come to this number. And you would know its worth, true worth, a number that is a result of many experts involved in the business and the biggest help to the customer that he no more needs to haggle. He can go home in peace knowing that he couldn’t have paid anything less than this and neither will his neighbor.

There is one other hitch. One can see that we are using the wages of the employees to arrive at a MRP but then again, how would one know whats the true worth of this particular employee, what should be his appropriate salary. Again one can see that we need to know how the company is performing and how are the shoes selling but that means you know the price of the shoe already. How did you arrive at the shoe price if you are not sure at the fitting salary of the employee and how would you determine an employee's salary (the true worth of it) if you don't know market performance of the product and hence the product price.

PS: The process of arriving at the MRP is completely the author's personal belief. There may be some business practice involved and the author may not be knowing it.