Have you ever seen the Edvard Munch painting “The Scream”? If Munch doesn’t ring a bell, recall the scene in the movie “Home Alone” in which Macaulay Culkin shaves for the first time, and then applies after-shave to his raw face: hands slapped over his ears, eyes as big as saucers, he emits a scream that can be heard a block away.
Such was my response to a Harvard Business Review article that recently arrived in my inbox. The article discussed book pricing relative to Amazon’s Kindle, Apple’s iPad, and traditional print books. The author’s position was to keep prices high for ebooks, because “charging what the market will bear creates value not just for companies but for consumers as well”.
I read that statement and screamed. Macaulay has nothing on me.
You see, value is not created by price. Value is a personal issue. Price is determined by the intersection of supply and demand. Value can have an impact on demand, so consequently has some impact on price, but it is a secondary determinate. For example, I love baseball. When I was a kid, I was a big Washington Senators fan. I hold Senators memorabilia in high regard. If I personally value a Topps Camilo Pasqual baseball card at $20, then I would be willing to pay $20 and under for the card. If the intersection of supply and demand places the price of the card at $15, it doesn’t mean that the card’s value is $15, it just means that $15 is a good price for me, since it’s below the value that I personally place on the card.
Antiques dealers rely on a variety of methods to determine the price of their wares; each dealer has his own “default” method of pricing. Some dealers price by “gut feel”, some use price guides that list (last years) average market price; some use online resources; some use a “markup” method. Taken individually, these pricing models have more weaknesses than strengths. Taken together, they provide a good foundation for determining the value of an item – and hence it’s best price. Let’s look at how these three pricing strategies: research, cost (amount paid), and “gut feeling” can combine to establish an item’s best price.
It’s been said that dealers make their money when they buy, not when they sell. A common trap for dealers is to overpay for items to which they attach a high personal value. I see this scenario played out often on the TV show American Pickers. Mike loves his bicycles, Frank loves his oil cans, and sometimes they pay way too much for them. As they drive from town to town sorting through peoples barns, they often buy based on “gut feeling” and research an item only when it’s bought and in their van.
What is the lesson here? Research your purchases before you buy. Cell phone signals are available throughout most of America. In 2011, every dealer should be armed with a Smartphone, a cell phone data account, and subscriptions to several pricing databases. Pricing databases will provide a dealer with the historic points at which supply met demand – the starting point for determining what one should pay for an item (not sell it for).
Dealers who use a “markup” approach to pricing usually have a formula for their markup, 2 times the cost, 3 times the cost, etc. Though this method provides a quick “rule of thumb” for a dealer, it does not tie a dealer’s profitability to the price of his products. A straight markup pricing formula does not allow for changes in expenses, so an uptick in expenses cuts right into a dealer’s profits.
Look at it this way: if I’ve determined that I want to sell an item for at least 3 times my cost, my income statement might look like this:
Sales Revenue $300,000?
Cost of Goods Sold ($100,000)?
Operating Expenses ($140,000)
The following year, expenses go up, but I’m still using the “3 times” as my markup:
Sales Revenue $300,000
Cost of Goods Sold ($100,000)?
Operating Expenses ($165,000)
An 18 percent increase in expenses resulted in a 58 percent decrease in profits. The “3 times” markup did not take into account the upswing in expenses. If I want to maintain the same profit level in year two as in year one, I have to make sure that my price calculation includes both the higher expenses plus the return on investment that I want.
Here’s how to do that: in year two, my operating expenses were equal to 165 percnet of my cost of goods. Also, I want a 20 percent return on investment, just as I had in year one. If I have purchased an antique framistan for $100, here’s how I’d calculate the selling price so that I make the desired profit:
Cost Of Goods.: $100
Operating Expense: = $165
($100 x 1.65 )
Total Investment: $265 ?
on Investment = $53
Selling price: $318
Or, in this example, you can multiply your cost by 3.18 times and be assured profitability. Two concepts are important here: don’t cheat yourself when it comes to your return on investment, and always know what your expenses are as a percentage of your cost of goods. This system is a variation of cost-plus pricing.
The weakness of cost-plus pricing is that it doesn’t take into account market prices. When you calculate price based on what you pay, you could be either under or over the “intersection of supply and demand.” The other weakness is that it doesn’t take into account value. Determining value is where a dealer’s “gut instinct” comes into play.
As in my baseball card analogy above, value is what your customer believes an item is worth to them. If you know your customers and keep good records, you will know “who collects what” and have a record of their purchases. You should also know what criteria your customers use to make buying decisions (value markers). When you buy an item that has special appeal to one of your collectors, don’t price via your standard markup. Determine how much you think your customer would be willing to pay, and price the item accordingly. Price high; you can always come down but you can never go up.
The psychology that drives value pricing also drives auction bidding: items are worth more to some people than they are to others. The people who value an item the most are the ones who bid the highest for the item. Value pricing that is supported by research and cost analysis will bring a dealer the best price on the items in his inventory.
Dealers, take the time to review how much return you expect from your business, and analyze your expenses and your pricing structure. You’ll be glad you did. That is, unless I have already sent you screaming from the room.
Previously published in Antique Trader Magazine