By August 11, 2006 1 Comments Read More →

Some Honesty in Pricing for Once

U.S. airlines raise fares by up to $10 each way

Here is some rare honesty in the discussion about how prices are set. Normally, an article or company would claim that “due to cost increases” (due to oil, etc.) that the company is “forced” to raise prices for their customers. Bull. Companies raise prices because they can, such as in the case of airlines with strong demand. Companies charge what the market will bear.

This is a central tenet of TPS, that Price is set by the market, so therefore Profit = Price – Cost. You only have direct control over costs, so reducing costs is the path to increased profits (yes, you can increase demand through good product design or marketing, which would increase the price the market will bear).

If your costs go up, you’re not entitled to raise prices to keep profit the same. That’s the old thinking of Price (set by you) = Cost + Desired Profit.

With this latest terror threat, if airline demand is down, they’ll have to lower costs. That’s how markets work. You charge that you can. Toyota’s not the cheapest car out there… because people are willing to pay it, the market values the cars that way.

Some other Lean Blog posts on this same topic can be found here.

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Mark Graban's passion is creating a better, safer, more cost effective healthcare system for patients and better workplaces for all. Mark is a consultant, author, and speaker in the "Lean healthcare" methodology. He is author of the Shingo Award-winning books Lean Hospitals and Healthcare Kaizen, as well as The Executive Guide to Healthcare Kaizen. His most recent project is an eBook titled Practicing Lean that benefits the Louise H. Batz Patient Safety Foundation, where Mark is a board member. Mark is also the VP of Improvement & Innovation Services for the technology company KaiNexus.

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1 Comment on "Some Honesty in Pricing for Once"

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  1. Eric Christiansen says:

    Mark,

    Ever since I saw TPS and the “Profit = Price – Cost” I have had that on my whiteboard staring me in the face everyday.

    But I look at a modified version of “Profit = (Market price * Perceived Value) – cost.”

    See, the market is willing to pay X amount for a car. Now, if the nameplate is GM, they’ll discount the price. If the nameplate is Toyota, they are willing to pay more.

    We have the same thing here at my company — typically when we get to pricing discusions, sales is always saying “Our competition is 10% lower than us” to which we reply “Yes, on price. But when you look at what it will cost the client to use them, we are actually the cheaper solution.”

    And people are willing to pay more for a lower cost solution than a lower priced solution.

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