Adam Smith and David Ricardo argued that all value comes from labor, and the value of something is in the amount of labor it took to produce it.
But Henry George understood that this is backward. The value of something lies in how much labor we’re willing to exchange for it.
Too often, we’re tempted to price things based on what they cost us to make. It’s more useful to price things based on what they’re worth to those that might want to buy them.
This is a quote from Seth Godin’s blog. He is a very wise man.
How much ARE we willing to pay for things we want to buy? Look at shoes, for instance. There is, I suppose, a lot of effort in designing footwear for specific types of activities, specific types of feet, and specific design elements such as color and logo. What do they cost to make? What would you consider a fair mark-up for the profit over the cost of manufacturing?
Do you believe your every day, run-of-the-mill shoes are worth $165? If so, why do so many go to Walmart and PayLess to get cheaper versions of those shoes? What exactly are the shoes for? Protecting your feet from injury so you can run or walk longer without causing damage is the main use. We also buy shoes to correct arch problems. Some buy shoes with extra support for sporting activities. Others buy them to match the jacket and purse they’re wearing at the time. But if all they did was protect our feet from injury, who would pay $165 for a pair?
How much ARE we willing to pay for the convenience of not having to cook for ourselves? The average price we pay is between $4 and $7 per person. So for 4 hamburgers, 4 small fries and 4 drinks, we pay $16 to $28.
- $2.00 for a 2-liter bottle of soft drink.
- $2.00 for 8 hamburger buns.
- You can get 10 pounds of potatoes for $5.00.
- at $4.00/pound, you can get 2 pounds of hamburger
In other words, you could have enough ingredients to feed 8 people instead of 4. Our time for 20 minutes of prep and cooking is converted to, (and this is ironic), about $15/hour. But you must understand that fast food restaurants make all their profit on the drinks. They give us 12 oz. of soft drink in a glass 1/2- 2/3 full of ice. The biggest expense in the meal is the drink cup. Because they buy in bulk, their burgers and precut fries are much much cheaper than what an average person pays. The cost of the ingredients then is 1/4 the price they charge. Labor is about 1/3 of the cost, the profit margin is about 3-5%. The rest of the cost goes to fixed costs like building rent, franchise fees, insurance, and utilities. If all you wanted to do is eat, would it be worth the 20 min of prep time and cooking to save you 50% on your costs?
Now imagine you are sick. Is your health something that you price shop on? If you’re diabetic, what would you be willing to pay to stay healthy? We are willing to pay $600 for a dose of insulin that costs the company a miniscule percentage of that. The companies that manufacture this don’t care what the profit margin is. They charge that much for something people need that much because they CAN. They know people are willing to pay exorbitant amounts of money because we value our health and life as something essential. (Well, duh!) Should people decide they are NOT going to pay that much and refuse to buy it, they’ll die! That will show those heartless companies a thing or two. The concept of supply and demand has no meaning because reducing the demand doesn’t reduce the price. It is the same as allergy pens…epi pens. If you are allergic to bees and you get stung, are you going to haggle as to whether the shot should cost $50 and now costs $700 with no change in delivery system or contents? No?
If you look at all these examples, they obviously are NOT basing their prices on the costs of manufacturing plus a profit, but they are charging what they think the market can bear. They are pricing their items and services based on the value to the people that want to buy them.
They believe (and rightly so) that fashion and comfort are more important than just foot protection.
They believe that convenience is more important than nutrition.
They believe that living is more important than money and equal access.
This is where a high moral standard comes in. If you believe in a cost + a reasonable profit and price your goods and services in accordance with that principle, you will be in the minority. Then you have to ask yourself: Is profit more important than accessibility and common sense? You may undersell your competitors and come through with a modest profit, but will it allow you to buy that big house and nice car? Is that important? What is it worth, to you?