pricing

Value for Money?

Isaac Mostovicz writes...

Value for money is a well-known economic concept – but does it really reflect the reality of how people buy? Years ago, economists observed that individuals pay a price for service or a product. However, observing individuals was not very helpful for economists who always try to measure and quantify. So they exchanged individuals with “the market”, a virtual entity that is difficult to define. This allowed them to talk more generally about the exchange of money for products or services in a way that was detached from the human psyche and its motivations. Next, the principle of exchange was introduced. Economists argued that we determine the value of products and services by the amount of money we are willing to pay in exchange for them. Following this logic, economists claimed that a person will always try to pay the least amount of money possible for the goods or services that he desires. The term “value for money” (VFM) was born.

Exchange Value and Commodities

In this discussion I’m focusing on exchange value and how it relates to marketing. This term, widely used in political economy and especially in Marxian economics, is one of the four major attributes of commodity. Commodity is defined by its fungibility, or the ability for one unit of the commodity to be fully exchangeable with another unit of the same commodity. For example, a $10 bill can be exchanged with another $10 bill or one barrel of petrol can be exchanged for another one. However, would you exchange a $10 bill for a stack of quarters? Are all petrol barrels similar? Finally, did you notice that services were dropped out of my discussion?  Actually, whenever we exchange our money for goods they are always bundled with a service, whether it is in the form of who serves us, how easily we can obtain the goods, or something else. How do we factor service into the value of the “commodity”? We’d like to think we can talk about two items that cost the same or that are exchangeable having the same value, or being similar to commodities, but in reality it’s hard to find such items. Practically speaking, value is hard to quantify.

And yet, economists tend to relate to all products as commodities. From the buyer’s perspective, when we relate to an item as a commodity, we tend to feel that the supplier has no right to mark up the item by one cent. We should be able to pay the cheapest price available and nothing more. Think about exchanging money in the airport – who doesn’t resent have to pay a commission? Because money is a commodity, we don’t think anyone should be able to charge more than it’s worth.

Luxury – the Antithesis of VFM

Luxury is the antithesis of the value-for-money economic thinking. Luxury consumers are definitely not looking to maximize value by taking the cheapest offer. After all, the principle of luxury is needlessly overspending. Moreover, the element of paying in luxury is not just about exchanging a price for the goods or services received. Paying is an integral part of the luxury experience. Luxury can never be free and the more we pay, the stronger the luxury experience is.

A Different Principle: Value or Money

From my experience, value for money is an illusion based on only observing the act of exchange without really understanding the psychological dynamics behind it. I have found that economic exchanges are always about either value or money. When we focus on the value we’re getting, we do not think much about the price. Nobody chooses a dish in an expensive restaurant based on its value for money, (“I think the 250g entrecote is a better deal than the sea bream, price-wise”), unless he is an economist. We have a general idea how expensive the meal might cost and we simply select the dish according to our liking.  Likewise a person who values high quality, comfortable shoes does not fret over their expense, nor does he extensively weigh the value against the money he spends. Because he values the shoes enough, he regards the price as simply instrumental in getting the value.

By contrast, when we focus on the price of an item and not its value, we commoditize the item and start looking for the cheapest price possible. We will buy because an item is comparatively cheap or not buy because an item is comparatively expensive – and not really consider the value at all. We all know of items that we choose based on price. For some people maybe it’s napkins in the grocery store, for some maybe it’s movie tickets or a music album. Somewhere in our minds, the value of these items is unclear or appears insignificant. And the moment we disregard value, we tend to focus on price alone. “The supplier shouldn’t charge more than the bare minimum” is the mantra here. And if a person were to choose not to buy at all for this reason, often it is not be because he thinks the value and price are not commensurate. He doesn’t really think about the value, he only thinks that the offer is “too expensive,” a term that economists cannot live with because it is unquantifiable, subjective, and personal.

How We Feel About It

When we buy based on value we feel positively toward the offer and sense that we are getting something we need and desire. When we buy based on price, we feel hostile toward the offer, as if someone is demanding that we pay money that we would rather hold on to.

Price and value are not two sides of the same equation. We either purchase for value or we purchase based on price. Moreover, whether we relate to the price or the value of a product is psychologically determined, and is subjective, personal, and unquantifiable. I do not know what economists do, but as a marketer I know that by creating value my customers will recognize, I can always get a good price.

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Choosing your diamond part 3

Isaac Mostovicz writes...

Diamonds are truly priceless

It took me many years to understand how diamonds are priced and what a “good price” for luxury goods and diamonds really means. You will not find this information elsewhere as the subject was never researched and assumptions about pricing were never examined.

We have always been told, following the basic assumption in economics that prices are the result of supply and demand. The higher the demand, the higher the price is and the more the supply, the lower the price. Without challenging this assumption head-on, I can testify that the diamond industry does not follow this basic formula or any adaptation of this assumption anywhere in its entire supply chain.

In general, we have three systems of pricing: the pricing of rough diamonds, the pricing of polished diamonds within the pipeline and the price of the polished diamond for the consumer.

Each system of diamond pricing reflects the needs of the particular market but none follows the supply/demand assumption.

The main problem of the rough mining companies is the enormous long-term investments that involves in developing a mine. Apart from the expensive exploration process, when a diamond mine is found, it takes many years until it becomes fully operative. To make the Venetia mine, one of the largest in South Africa, operative it took ten years for De Beers, the world’s most efficient mining company, to accomplish. Even when the mine is fully operative, it is very expensive to operate. Diamond mines are the world largest earth movers and we measure a yield of a mine by carats (1 carat = 0.2 gram) to 100 tons of gravel.

On average, we need to earth ten times the Wembley or the Shea stadiums to get one 1 CT diamond of the D IF quality.

So as to reduce the risk involved in such a long-term investment, De Beers followed by other producers developed a system that, when applied can indicate clearly the value of the diamonds to be mined. This information is relatively stable as well as the life of the mine. Thus, while the mining companies have to invest vast amounts of money over many years, they are able to predict the level of production and, consequently, their revenues.

The system that De Beers uses is based on a 5000-categories price list. This price list is based mainly on the relative rarity of various diamonds but it takes into consideration the diamond’s shape, quality, difficulty to manufacture and other factors. You can get similar polished diamonds out of different-in-price categories.

The pricing system that the polished-diamond industry uses is complicated as well. On the one hand, it is based on relative rarity – the larger, whiter and cleaner the diamond is, the more expensive it is. The shapes plays a role as well as round diamonds are usually more expensive than other shapes. The other element involved in the pricing system is risk. There is no guarantee that a certain diamond will be sold and people buy diamonds into their stock with the hope that they will be sold eventually. Thus, the price of the diamond that is based on its relative rarity is discounted to reflect the risk of not selling it. When the market suffers from sever illiquidity, the risk of not selling is higher and prices drop. In an active market, the discount becomes smaller and the gap between different quality and rarity categories increases. Unfortunately the diamond industry is far smaller that the market of options and derivatives and the Black-Scholes formula was never applied in the diamond market.

How about you, the consumer? Are any of these considerations concerning you? I doubt it. Is there a fair price for diamonds? I doubt it as well. After all, if you buy a diamond that you cannot enjoy, you just wasted your money.

All you have to check is whether you are happy to spend on your loved one the amount that you are asked for and whether she is going to be happy with what she is going to get. If the answer to both is “yes”, go ahead and enjoy your spending.

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