By Jim McCarthy Sep 29, 2010 6 comments

The Wisdom of the Soda Seller

Suppose I have a really simple business:  I sell sodas on the beach from a little booth.  (Actually, some days, that would sound kind of appealing.)

My two expenses are the rent that I pay for the booth and the cost of the soda, which I pay to a wholesaler.  And let’s say I pay the wholesaler $.50 per soda and sell it to you for $1.

On the surface, you might say that the price I charge you is related to the cost I have in getting the soda.

Well, it’s not.

Ok, it sorta is, but not really.  The price I charge you is based on one and one thing only and that is the value you place on the soda.  If it’s a super hot day, I could probably charge you $2 for the soda and in the pouring rain, during the winter, it’s probably not worth a $1 to you.  I’m sure everyone’s with me on that.

And what exactly does that have to do with my cost of $.50 per soda?  Not a thing.

Suppose for example that I drove to Sam’s Club to pick up my week’s supply of sodas, which will cost me $.50 apiece and in the process my delivery bike got a flat tire, which I had to fix, and which cost me $15, which translated into $.10 per soda for my order of 150 sodas.  My costs have definitely gone up, but did it have an impact on price?

Maybe.  Because I might try to punish you for my mistakes by raising prices, but it sure doesn’t change the reality of the market, which in this case says that a soda is worth a $1.  If I had a two for one club card discount and my sodas were $.25 apiece, I don’t think customers would expect me to cut my prices to $.50.

Because cost doesn’t have anything to do with price.

EXCEPT…that ultimately if you can’t fit costs to price, you don’t have a business.  So many do it the other way around: run up a bunch of costs and then tabulate what you “need” to charge.  This has an appealing simplicity, but it’s also nuts, when you think about it.  What if your business model, based on that calculation, doesn’t make any sense in the marketplace?

This is not easy (and as I told @aaronmandersen on Twitter yesterday, when he said it’s “harder than it sounds,” I told him that it doesn’t even sound easy to me.) but the point is to put the thing in reverse order: think of a market proposition that you think is going to have a certain amount of value to people and then figure out how best to deliver it given that value.

In other words, instead of buying sodas for $.50 and then saying, “how much do I need to charge to make money?” you should  say, ” I think I can effectively sell soda at the beach on an average summer day for $1 each.  Let’s see what I’d have to do to make that work financially.”

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