Very few of us do a good job setting prices. I have seen several companies, large and small, set prices, and it's not nearly as rational and analytic as it should be. And when it is rational and analytic, the process is usually too narrow, ignoring several important issues.
The book has two key values. First, it offers a list of major pricing strategies. Managers often get so used to doing things one way that they don't reconsider whether they are using the right method. Smart Pricing is a guide to strategies that every business should consider.
The second value is that the book occassionally shakes up one's thinking. That's especially true (at least for me) of the chapter on price wars. I have advised clients not to engage in a price war. Raju and Zhang explain why my blanket advice is wrong. There are times when a price war is the right strategy. Certainly there are many more times when it is the wrong strategy, but it's a tool that should be in every manager's toolkit.
Step One for managers with the worry that maybe their pricing strategy is not the best possible: think about it, considering a wider range of options than you have discussed in the past. You should also consider bringing in a consultant (hint, hint) to help broaden your thinking.
When will the next recession hit us? Everyone wants to know, but that’s not really the best question. It is, however, pretty close to very good question.
Approximate transcript (this is what I meant to say, but some of the exact phrases may be different in the video).
When will the next recession hit us? Everyone wants to know, but that’s not really the best question. It is, however, pretty close to very good question.
I’m Dr. Bill Conerly, economic consultant and author of Businomics.
Why is this not a good question? Because I don’t know the answer. Ask me something I can help you with. And I’m not just being flippant. The economics profession is not very good at forecasting recessions ahead of time. I’m proud that the year before the recession, I was telling my clients that the risk of recession was high enough that they should be doing contingency planning. That was when everyone knew the boom would last forever.
There are some forecasters claiming to have predicted the recession. All the ones I’ve heard of, though, were predicting recession every year, good or bad, for decades. They are like the broken clock that’s right twice a day. The doom-and-gloomsters are right once a business cycle.
So what’s the good question? How about: what should I do if I’m running a company and I don’t know when the next recession is coming. I want to be prepared, but I know that if I hunker down too soon, I’ll miss the opportunities of the good years.
I’ll offer an elaboration on some techniques I describe in my book, Businomics. So listen carefully if you want to save yourself $14.95 plus shipping and handling.
You first should evaluate your vulnerability to recession. Looking at how the recent recession affected you will give you a good handle. The key, though, is to be data-driven. Before the recession, I heard plenty of folks say that their business would do better in a downturn. Mostly that’s hogwash. On the Businomics web site, I have a listing of how different industries actually perform in a recession, so be fact-based as much as possible.
After evaluating your own vulnerability to recession, it’s time to develop your customized early warning system. Identify the spending decisions that lead to sales. It’s not as simple as whether you have made a sale, in many cases. The guy who sells shopping bags to Nordstrom. He should not be monitoring only his own sales to Nordstrom. He should be monitoring Nordstrom’s sales, because they won’t cut back on their purchases of bags until they have seen their own sales turn down. I also suggest that you monitor economic factors that drive those purchasing decisions. So if you are dependent on discretionary consumer spending, for example, watch disposable consumer income, consumer confidence, and so forth.
For many businesses, an important part of the early warning system is watching sales representatives reports. If your sales reps are doing a good job of logging potential sales, interest, meetings, and proposals, you should be able to see a downturn coming even before you sales fall off.
So now you have evaluated your own vulnerability to recession, and you have developed an early warning system. It’s time for contingency planning. Start with a single sheet of paper. You don’t want to fill a binder, you only want key ideas. You can take off to the bar or Starbucks of your choice, or better yet, meet with your senior team. Brainstorm on what actions you will take if sales turn down. By visualizing your possible actions, you prepare yourself. It’s even good to set some decision rules. If sales drop by 8 percent from a year ago, we institute a hiring freeze. If sales drop 15 %, we’ll lay off 10 production employees.
When I meet with a management team, I run through a checklist of possible cuts that I’ve developed by working with businesses in a variety of industries. It’s important to begin with a long list of possibilities and then narrow it down.
You’re almost done. You have evaluated your vulnerability to recession, set up an early warning system, and sketched out a contingency plan. Now, manage the business to maintain the flexibility to take action as needed. Here’s a family example of maintaining flexibility, but it applies to business as well. My son told me that he qualified for a free new cell phone. I said “Free?”
He said “Yes, it’s been two years since I got my phone, so now I can get a free one.”
I said, “It’s not free. You have to commit for another two years of cell phone service. You won’t have the flexibility to change providers or cut way back on your service.”
I’m not saying that a free cell phone isn’t a good idea. Sometimes it is. But when you lock your business into a long-term commitment, you give up flexibility. Don’t do that unless you’re getting a really good deal. Think about this with respect to employees versus contractors, real estate leases, debt versus equity, and long-term supply agreements.
Get ready for the next recession by following these four steps: assess your vulnerability to recession, set up an early warning system, sketch out a contingency plan, and maintain your flexibility to implement the plan. You can do it yourself, but if you would be more comfortable with professional help, give me a call. I’m a consultant and I love helping businesses lower their risks and increase their profitability.
The Christmas tree included a great book that got me thinking about the economics of pricing. No, my family did not bless me with an economics text. However, my son Peter gave me a delightful book, The Man Who Loved Books Too Much: The True Story of a Thief, a Detective and a World of Literary Obsession. The title pretty much says what the book is all about, but as I learned about avid book collectors, I started wondering about rare editions of my favorite books.
A wider search for the Wealth of Nations turned up a much more affordable fifth edition, printed in 1789 (rather than 1776 of the first edition) and priced at only $6,500. That may sound like much, but it's actually affordable to many people, if only they made it a priority. The Survey of Consumer Expenditures shows that the middle quintile of households spends an average of $2,106 on entertainment goods and services. That fifth edition Wealth of Nations would require a few years of savings for an average family, but it is within reach if the desire is strong enough. There's also pure entertainment in some of the other categories of consumer spending. My car has heated leather seats, which aren't really a necessity. Similarly, our spending on housing and food includes plenty of luxury purchases mixed in with some necessities. So a middle income family could afford that book if they scrimped and saved across their budget.
I looked at my trusty copy of Wealth of Nations, which I purchased used many years ago for $4.95. It's a nice hardback Modern Library edition. I don't know when it was printed, but the introduction is copyright 1937. Similar volumes are selling on Amazon for about $10, so I've double my money--but over 30 years or so, I would guess. Not a great ROI.
When I want to grab a quote from Smith, though, I don't turn to my bookshelf. Instead I go to the Libary of Economics and Liberty online, which has a searchable copy--for FREE! I can search, then copy and paste a quotation into my word processor. That's far better functionality than a physical book provides.
The Christmas tree also had under it a Kindle. I was able to get a free Kindle version of the Wealth of Nations, so I could take it with me on travels without lugging a heavy volume around.
So, what does The Wealth of Nations cost? Correct answers range from free up to $150,000. That may sound a little "soft" to you mathematical types, but it reflects an important point with significant business implications: different consumers have different desires and motivations associated with the purchase of a seemingly identical good or service. Those different desires and purchases can translate into different price points.
For example, a round a golf is, for some people, primarily a social experience. For others, it is the challenge of a difficult physical activity. For yet others, it is something to occupy oneself on an otherwise boring vacation. One activity, three different purposes. Possibly three different price points. Don't get caught up in the idea that your product has only one value. It's worth differing amounts to different people. Take that into account when devising pricing strategies.
By the way, I have tremendous respect for Hayek but his writing is kind of dense. His best short work, in my opinion, is The Use of Knowledge in Society.
I've been reading some Roman history, stimulated by my recent visit to the Eternal City. (See my video "Economic Lesson from Ancient Rome.") I recently found an interesting passage in Will Durant's classic Caesar and Christ: A History of Roman Civilization and Christianity from the beginnings to A.D. 325, which is Part III of his and Ariel Durant's The Story of Civilization..
The famous “panic” of A.D. 33 illustrates the development and complex interdependence of banks and commerce in the Empire. Augustus had coined and spent money lavishly, on the theory that its increased circulation, low interest rates, and rising prices would stimulate business. They did; but as the process could not go on forever, a reaction set in as early as 10 B.C., when this flush minting ceased. Tiberius rebounded to the opposite theory that the most economical economy is the best. He severely limited the governmental expenditures, sharply restricted new issues of currency, and hoarded 2,700,000,000 sesterces in the Treasury.
The resulting dearth of circulating medium was made worse by the drain of money eastward in exchange for luxuries. Prices fell, interest rates rose, creditors foreclosed on debtors, debtors sued usurers, and money-lending almost ceased. The Senate tried to check the export of capital by requiring a high percentage of every senator’s fortune to be invested in Italian land; senators thereupon called in loans and foreclosed mortgages to raise cash, and the crisis rose. When the senator Publius Spinther notified the bank of Balbus and Ollius that he must withdraw 30,000,000 sesterces to comply with the new law, the firm announced its bankruptcy.
At the same time the failure of an Alexandrian firm, Seuthes and Son due to their loss of three ships laden with costly spices and the collapse of the great dyeing concern of Malchus at Tyre, led to rumors that the Roman banking house of Maximus and Vibo would be broken by their extensive loans to these firms. When its depositors began a “run” on this bank it shut its doors, and later on that day a larger bank, of the Brothers Pettius, also suspended payment. Almost simultaneously came news that great banking establishments had failed in Lyons, Carthage, Corinth, and Byzantium. One after another the banks of Rome closed. Money could be borrowed only at rates far above the legal limit. Tiberius finally met the crisis by suspending the land-investment act and distributing 100,000,000 sesterces to the banks, to be lent without interest for three years on the security of realty. Private lenders were thereby constrained to lower their interest rates, money came out of hiding, and confidence slowly re-turned.
Ireland’s economy was stagnant in the early years of the 20th century. Liberalization of international trade taxes and rules in the 1960s allowed the economy to begin keeping pace with the rest of Europe, but that wasn’t saying much. Government budget deficits in the 1970s and early 1980s were accompanied by European-style anemic growth. The budget deficits were resolved through spending cuts. Then other policy changes made it more difficult for the government to resume deficit finance.
In the late 1970s, tax rates were reduced. Rate reduction followed rate reduction, and the highest personal income tax rate fell from 80 percent in 1975 to 44 percent in 2001. Corporate tax rates were also reduced, from 40 percent in 1996 to 24 percent in 2000, with even lower rates for companies involved in manufacturing or internationally traded services. Tariff rates were reduced further, and the republic received an inflow of aid, which it spent on infrastructure projects.
The result was the “Celtic Tiger,” a name derived from Asia’s Four Tigers that had grown rapidly (Hong Kong, Singapore, South Korea and Taiwan). For 19 years in a row, Ireland’s growth rate exceeded that of Europe.
However, the real estate boom that swept the United States also swept the world, including Ireland. The nation had survived a housing bubble in the late 1990s, but the banking sector, emboldened by the global boom, doubled its assets in just three years, lending to Irish and non-Irish alike. When the global bubble burst, the banks were in a severe crisis. The government feared that institutional providers of funds to the banks would withdraw, leading to a collapse of the banking sector. To prevent such a run, the government guaranteed the senior debt of the banks.
Most personal financial experts advise individuals against co-signing notes for friends and family members. Someone should have told Ireland that the advice is especially valuable to people going heavily into debt themselves. As recession hit the Irish economy, government spending accelerated.
Now the Irish government has tons of its own debt, and its bank bond guarantees total 200 percent of GDP. Other European countries, as well as the International Monetary Fund, are pumping loans into Ireland to stave off a collapse.
The Irish government had resisted outside calls for the bondholders to take a haircut. (The Economist headline read, “Time to send the barber home?”) Allowing private creditors to escape damage seems silly at first, but it has more logic when the creditors had previously received an explicit government guarantee. A haircut for creditors could well be considered a default by the Irish government.
Looking around Europe, many banks in the core (France and Germany) have large holdings of bonds from the periphery (Ireland, Portugal, Spain, Italy and Greece). Some are suggesting an additional round of stress tests for major banks on the Continent. With borrowing difficult for governments, more austerity—and possibly social unrest—are certain to come. Credit will be tight, due to the banking industry’s difficult situation with sovereign debt.
Europe could possibly lapse into recession, especially if one of the weak countries cannot refinance existing notes as they come due. On the positive side, though, the global economy is making progress, which will help both European exports and attitudes. A recession is not certain by any means—I’d still put the odds no higher than 20 percent.
Unfortunately, the American economy is stuck in low gear. Losing Europe to a double dip would stress our own economy, probably to the recession point itself. This is a significant risk, and one that bears some contingency planning by banks and businesses and families in the United States.
We had the housing boom, with millions of risky mortgages made to shaky borrowers. Then we learned our lesson. Banks tightened lending standards. Congress passed financial reform legislation. What's the result? Today 60% of all new mortgages have down payments less than 5% of principal.
At the height of the boom, only 40% of new mortgages had such low down payments. What happened? Private lenders are now regulated, so they have to require more conservative underwriting. But the Federal Housing Administration has ballooned its lending and is planning on even more expansion in the coming years. This information comes from "How the Government is Creating Another Housing Bubble" by Peter Wallison and Edward Pinto of the American Enterprise Institute. (Hat tip to National Center for Policy Analysis's Daily Policy Digest.)
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