Wednesday, October 21, 2020

Who Sets Prices? - You Do, To Some Extent

Prices are not determined by the seller but rather by the marketplace.

Many people are under the misapprehension that prices are determined by retailers and manufacturers.  Nothing could be further from the truth.  A lot of people believe that manufacturers add up the cost of materials. labor. and overhead and add on a "reasonable profit" and this becomes the retail price.  The reality is, the price of goods is determined by the marketplace, and this means sometimes a manufacturer or retailer makes an awful lot of money on a product because people are willing to pay far more for it than it cost to make, or sometimes they actually lose money on a product because what people are willing to pay is less than what it cost to make the product.

For example, if you want to buy a pickup truck or an SUV, the manufacturer is more than happy to sell them to you because they make a lot of money on these - thousands if not tens of thousands of dollars each.  On the other hand if you want to buy a small car, they may actually break even or lose money, which is why in American car manufacturers have stopped selling small cars.

Of course, sometimes manufacturers will sell products at a loss if there are other business reasons for doing so.  For example, in the early days of the Thunderbird, they said that Ford lost money on each car they made.  However, the car had a "halo effect" that drove people to the showroom to look at the car.  Once inside the showroom, they would realize the car was impractical for a family of four and then salesman can then steer them toward the brand new Ford Fairlane.

But in general, unless there is some business case to be made for losing money on a product, most companies eventually stop manufacturing products that cost more to make than the market will pay. 

We have a friend that likes to go shopping, and she regales us with the amount of "savings" she got on something she purchased.  She'll buy something for $3 and crow that it was "70% off the retail price!"  But of course, this "retail price" is just a made-up number, often figured in advance to be discounted heavily later on.   Manufactures and retailers don't set prices, they put prices on things at a price point where they will sell.   And oftentimes, this means different prices for different customers - some paying the "full retail" while others seek out discounts.   But even discounted, often there is a profit to the retailer and manufacturer, just not as big a profit as at regular retail prices.

But of course, you cannot "save money" by buying something on sale, you are only spending money.  And if you are spending money on something you don't really need, because it is "on sale" then you are merely wasting money.   For example, I have two yard carts, one of which I bought online and an identical one a neighbor gave me.  They work well, but the axles rust out, and so I replaced the axle on one of them.   The other day, I was in the store and saw in the "closeout" bin a wheel for these yard carts, marked down from $16 to $3.   Who would buy a yard cart wheel in the first place?   But I thought, "Hey, I already replaced an axle on one of these, and who knows, I might need a wheel someday, and I'll never find one at this price!"   So I wasted $3 on a wheel I likely will never use.

Others are convinced that sellers can dictate prices to the marketplace which is also not true. Mark once listed a house for sale in Holland Hall in Alexandria, Virginia and a neighbor called him to complain that he priced the house too high.  She argued that since the house was priced so high, her property taxes would go up, and that it was unfair of him to sell the house for that price.

But like any good real estate agent, he had researched the market carefully and determined what a good price would be for the property, based on other sales in the area of comparable homes.  In other words, what other buyers were willing to pay.  If you overprice a house, it won't sell regardless of whether you want to sell at that price.  Sellers cannot dictate to the market what prices will be.  And when a house is overpriced and it remains on the market for too long, a real estate agent might end up losing their commission if the seller gets tired and hires a new agent.

A similar thing happened to a friend of ours who was trying to sell their condominium in Florida. The realtor real estate agent over-priced the property, and now she's reduced the price by $100,000.  Regardless of what she and the real estate agent thought the property was worth, the market thought otherwise.  You cannot dictate arbitrary prices to the market.

This is one reason I say to walk away from dreamers or the perpetual "for sale" people who claim they have to get "their price" - as if they are entitled to more than market value by dint of their saying so.

Of course, under the law of agency, the seller dictates the asking sales price. The seller should rely on the advice of a real estate agent and figure out what is a reasonable price to sell the property within a reasonable amount of time. Unfortunately, a lot of people are convinced that sellers do dictate prices and get into a lot of trouble when they go to sell their home.

For example, another friend of ours went to sell their house and they interviewed three real estate agents. They went with the agent that told them they could get the highest price for their house. Months later the house is still in the market with few showings and no offers. And the reason why is real estate agent over-priced the house in order to get the listing. The agent knew that the seller would go with the agent that told them the highest price, and thus just gave her a high number, hoping she would come to her senses later on and reduce the price of the listing and he would get his commission.

As I noted before, over-listing like this is often short-sighted for the seller. Often what happens is the house sits on the market for months and sometimes even years, until the seller gets desperate and then cuts the price dramatically and sells it for less than market value - at which point it's quickly snapped up by a savvy buyer.

You can't dictate to the market what the price of something is. You have to hope there's a buyer willing and able to purchase at the price you want. If not, well, you have little or no choice but to lower your prices.

And of course there is a limit to this. If people demand lower prices on consumer goods to the point where they cost less than the cost of production, eventually each producer will go out of business or choose to stop making that product one by one. At that point, there will be a shortage of that product which will cause people to bid up prices until equilibrium is again established. The system is self-correcting, although there is a lot of hysteresis in it. At some points in the cycle the seller is losing money on each transaction and some points in the cycle and consumer is overpaying. But overall an agreement is reached between buyer and seller as to what is a reasonable price. One party can't dictate to the other any price they choose out of a hat.