Price

It is not easy to determine a fair price. Fair here means the price I charge is equal to the price I am willing to pay. Usually I know what I want to charge: as high as possible (LOL!), but it is more difficult to imagine the price I am willing to pay. In my current job I have to approve a lot of purchasing, need to know their fair prices fast, and to teach my pricing strategy to staff.

Let me share my pricing strategy. The easiest pricing strategy is by comparison. This strategy works well when comparing two competing price bids.

Allow me to give one example. My teenage son bought $40 shoes at Zara in Calgary. It took him 3 months to outlast the shoes as one sole was torn apart. When I protested him for being not caring enough about his shoes, he replied that my Asics running shoes cost 3.5 times more expensive. What to do? I told him that my Asics shoes lasted for 3+ years, so even though I paid $150 for the shoes, per month I only pay $3.75, while for his shoes $13 per month. Zara shoes ended up 3.5 more expensive than Asics shoes because the latter last a lot longer. We can make the calculation more complicated by applying a constant depreciation rate, but it is clear that the Zara shoes' depreciation rate is ridicuously much higher than Asics'. This means the Asics price is actually cheaper than Zara price.

A more complicated price comparison example is the Equipment Rental Rates published by State of California Business, Transportation and Housing Agency. This list could be converted into a good estimate of a rental price for any country if I at least know the cost-of-living index ratio (using say, the Big Mac index). There are a lot of price information available in North America, but I have to convert this information to a relatively fair Indonesian prices using this approach.

One very important variable in business decision is time. (It's a pity that the time variable is often ignored in most engineering courses, except in applied mechanics and engineering economics.) A good business decision made today may be a bad decision if made 4 months later. One main reason is cash flow. So, Asics price is better than Zara price if the time horizon is > 3 years. Most business decisions need on average a 3-years horizon.

Another pricing strategy is by determining its components. This computation is good for estimating labour cost. What I usually do is to come up with the price for a unit task. For example, if I want to estimate the labour cost of building a warehouse, I would then break down this construction project to a sequence of tasks: from digging the construction site to installing the wall cladding. Each task requires a number of workers and I build the price using estimated labour cost per hour by including efficiency factor based on the number of shifts required per day and the speed of the workers based on the construction site's geometrical information.

I have previously used this component-wise pricing calculation to determine the profit margin of a contractor. I was able to get a good discount, as a result, when this information was communicated nicely. One reason I cannot just brag to the contractor that he takes too much margin above a fair price is that the pricing has to accommodate delays due to unexpected fluctuations like weather, work interruptions, and sickness. This random factor, for a competitive sector, could very well be what makes or breaks a profit margin. If I am willing to assume this random risk, then the price would be lower. It is like paying insurance premium. (That is, if I am entrepreneurial, this "random" margin is a business opportunity.)