Pricing – or the street-value – often is still cost based, Apple being one of the rare examples of companies who understands that the cost of production is not related to the amount of money people are willing to spend. Cost is what you invest to create value. Sales-price is the value created in the eye of your customers). (production) Cost and (sales) price are not related.
A few years back I had the privilege to work for a major fashion company at one of the product development sites, driving innovation and coordinating a small innovation team as a internal service provider. The director at the time recognized employees working in operation capacities had little time to look beyond the immediate product and production needs. He initiated the innovation team, with the task to bridge operations with academies and institutions where new ideas are born and developed. Remember, this was the early 2000s, way ahead of the innovation curve.
Naturally, I could not help but do a few small experiments. Just to check if I was wrong. As it turned out, I was not. Well, not in this case.
Observing some of the product review meetings, what surprised me was the process of determining the price-tag; a multiple of the production cost. Pricing a product appeared to be mainly based on the raw material used, production costs; cost of goods, transport etc. Although these are important to consider since you do not want to sell at a loss, I wondered what they had to do with the sales price.
When Apple introduced a new gadget pro, I often was the first to spent whatever they were asking to have it. Production cost never entered the process, I did not care. The new gadget pro was beautiful, innovative and appealing and I just had to have it.
With some of the fashion products I had the same (with some shame I have to admit that I discovered a more than average interest in shoes). Knitwear was one of the products. Some sweaters just feel great, nice, comfortable. And some of these sweaters were priced very low, which I though was totally wrong.
The value of a product is in the eye of the customer. The customer judges the quality of a products, and – probably related – the value of the product. But they do this based on what they see and experience. This is very direct in the case of sweaters and other garments; customers value based on what they see and feel. Apple understand that in a good way, it is luxury – no dependency – and they manage to price their products at a level that people are willing to pay for it. The pharmaceutical industry also has understood this (see e.g. here), but maybe not in a good way as there may be life depending needs underlying the purchase intent. Nevertheless, they seem to target a pricing level they can get away with.
So, it the only thing that seems to count is the perceived value of products.
To evaluate this, I performed a small experiment. I would give a person a sweater and asked them to answer 3 simple questions (one a scale from one to five); do you like it, do you think it has quality and do you think it is expensive. For this experiment, I used twelve sweaters from the then current collection, randomly collected to cover the full range of price offerings. Participants were members of the companies, but not working in the knitwear area. Just to make sure they did not know or could not estimate the production costs. 7 persons participated.
A simple regression showed the relation between the 3 parameters (like, quality, cost). See images below. It suggests that people do not differentiate well between quality and expense, meaning, in the eye of the consumer, (perceived) quality and (expected) cost are the same. Most variation was found with like, suggesting subjects do know what they like, but that each person likes something different – as expected. More interestingly, like did not have a high correlation with quality. So, people seem to be able to recognize quality, even if they do not like it themselves personally.
Conclusions from this that the perceived quality is the main driver for the expected cost, and that both quality and expected expense appear independent from personal preference.
What does that mean for pricing? Yes, you should check cost of goods, but this basically just helps you to decide whether you should consider having the item in your catalogue/portfolio. It does not help to decide the price. To decide, just borrow the eyes of your customers and evaluate the (perceived) quality.