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High Quality vs Low-Cost Bargain: The Current Dichotomy (XXI). The Meaning of Low-Cost Bargain

This week is our penultimate one in our saga.  I would like to acknowledge again that we are expecting to end this current epic on March 30th, 2021.  Therefore, we must continue our journey.

Today it is the day for understanding the meaning of low-cost bargain pricing. First, I will explain why I tagged this phrase under low-cost and not low-price.  Let’s recall the definition of price: It is the amount of money charged for a product or service, which is the sum of all the values that customers exchange for the benefits for having or using the product or service. If you wish to revisit the definition of pricing please click here:

As I mentioned 8 weeks ago, the cost based pricing methodology sets prices based on the costs for producing, distributing and selling plus a markup, which usually is shown with what we believe is the fair rate of return (it could be 10% or 30% or 100% or more). This markup are our profits. The minimum profit (mark-up) in theory, is to charge at least our cost of capital or something above our cost of capital.

Tuga Tortuga. Better slowly than destroying ourselves. A handmade aquarelle by Eleonora Escalante. Painted with love on Fabriano 5 paper. Size: 7 inches x 5 inches. Reference picture, Baby Turtle:

When the seller is not the manufacturer. Until today we have explored the case of pricing when it comes to manufacturers that directly sell to consumers. However, that is not always the case. Manufacturers rely on third parties, entities, or individuals who are resellers. When manufacturers sell through resellers, these can be the distributors, the wholesalers, the retailers, the same clients which after using it, decide to sell it second-hand, or a combination of some of these.  Therefore, the final price that each consumer sees, is the resellers’ prices. The manufacturer usually only suggests the final price, but it is the reseller that holds the total empowerment to set its last word, enabling the final price paid by the customer.  See below the basic elements included in cost analysis, when the seller is not the manufacturer.

Determinants of Final Price. Source: Peter Doyle

Given the latter explanation, the final price that is paid by the customer includes all the activities that are listed (probably with the Internet, we must add extra costs related to the digital channel, we include here the marketing and sales using digital internet tools).

Cost-based pricing identifies the profit margin as another component of the costs. When deliberately we utilize cost-based pricing, even though we believe that we are charging a profit margin above fixed costs and variable costs; in reality, we are categorizing the mark-up as another cost. Unbelievably, that is the way in which all strategy and marketing strategy textbooks have been philosophically set up. Consequently, we are ignoring the competitor prices, we are disregarding the value differentials based on the perception by each segment of clients, and we are closing our eyes to sources of differentiation, but only considering the sources of cost advantage from the manufacturing of the product. 

The trap of the low-quality. Ultimately clients who do not have an economic position of at least a global middle-middle class (a mid-middle class family has annual earnings between US$40,000 up to US$80,000 per year) are always trying to save some money. And it is natural embedded to look for convenient quality at the price of a cheapskate. Therefore, if consumers don’t have at least a mid-middle class income and lifestyle, the low-working class that lives in poverty tend to search for thrift low-cost products and services. the result is that the poor class live with pauper conditions of life. Companies producing low-cost offers are serving the unfortunate with miserable mediocre products. A low-cost product or service is designed to keep the underprivileged living with straitened circumstances and things. Is this ethically fair? For example, all this idea of emigrating the traditional education to a digital model is nothing else than to provide a deprived impecunious low-paid education to the needy. That is not the way to solve our global lack of education problems.

A low-cost product or service price is calculated using cost-based pricing. Low-cost products/services are usually trapped in the low-quality standard segment, with fragile market shares, because any new competitors are cannibalizing the profits, and are living on the edge of price-war traps. This applies not only to the products that we buy in cheap Dollar stores, but also applies to every single industry, including education. Let’s see the following example from a Harvard Business School recent MBA graduate.

Harvard Business School, Cambridge, Massachusetts.

Education that is worthy of excellence is expensive. Nothing that is exquisite or tip-top class can be calculated using cost-based pricing. Why? Because we are leaving money on the table. If a Harvard Business School MBA is in a job negotiation setting and uses the cost-based pricing approach, he or she will demonstrate it by leaving money on the table when negotiating with the potential employer. In the current pandemic circumstances, many MBAs that are graduating in May 2021, are probably desperate to be hired, particularly when they do not have other simultaneous job offers from other companies, or have to get in debt to pay Harvard. Given the high pressures of timing, if an HBS Graduate is not confident in his or her own value differentials and focuses on calculating his or her desired salary under a cost-based approach, this individual will miss all the salary available for him or her, in the mediation process.

Per year every single student at Harvard Business School has to be ready to spend around US$111,818 dollars. For a two years program that implies US$223,636 dollars.  On average, the expected average salary for each new graduate MBA from Harvard is around US$140,000 dollars (pre-pandemic data). But each new graduate has to compete with other talented individuals which are also looking for a job. See below a comparison report from The Economist (2018).

Low-cost bargains are usually identified with the following characteristics:

  • Based on cost plus formula. Repeating, the 95% of low-cost bargain products are calculated with cost-based pricing. In other words, using, a cost plus “profit markup”.  I already provided an analysis of the cost drivers during the Saga Strategy Regatta Volvo Ocean Race 2017-2018. Since the 80s (particularly in the decade of 1990s), the era of managing for cost efficiency was installed. The pressure to create shareholder value resulted in an emphasis on cost reduction, and especially through the quest for new sources of cost reduction. Every single manufacturer has embraced the cost advantage dynamic sources of cost efficiency, corporate restructuring and re-design of manufacturing processes for cost reductions. This is the business strategy followed during the last 30 years, and in consequence all the low-cost pricing only reflects the cost based approach.
  • The low-cost bargains exist in every quadrant along the Value Equivalent Line (VEL). These low-cost products/services are not necessarily numerically between zero to ten dollars of ambulant markets or Dollar Stores. The confusion has happened because every single item you can imagine, regardless you wish it or not, is or it is partially built and/or ensemble totally or in components or parts in China or Asia. Since the majority or our entire manufacturing base, for the economy segment, for the medium value and the premium segments is produced there, then the final prices have come to the reduction. In the past, the offer of products was ample in origin and was privileging the local producers. In addition, many traditional resellers such as department stores habitually sold them with value differentials or under top quality brands. By now, China has dominated the world market production of these items. And any item on earth is replicated and sold using average or low quality inputs and industrial methods. The distribution channels of Asian products are numerous. The dollar stores are simply one of the most visible channels, of a convenient retailer format strategy that has expanded numerously everywhere. However, the low-cost bargains abound anywhere. These Asian items are portrayed on racks in between the aisles of the cheap stores, the medium and the high-end department stores. They are sold inside any tech brand that you can pick.  We also can find them in low fixed costs of the kiosk stores, or in between ambulant vendors at the center of our overcrowded capital cities.

Furthermore, the low-cost bargain exists in the premium high segment markets. For example,  we could be in front of two yachts, identical on the outside, of 533-footlong, one of them sold with a price tag of US$ 400 million dollars.  The second ship is listed at US$ 1.5 billion. The difference between the first one and the second ship, named Eclipse is the quality, the inner design, and the attention to details well spent by his owner Roman Abramovich. From the outside, the cheapest first one looks identical to the Eclipse boat, but it lacks all the value differentials in quality inputs, and it also lacks the intruder detection missile system, the two helipads, the luxury details of the guest cabins, the mini-submarine, the armor plating, the bulletproof windows, and an anti-paparazzi shield with sweeping laser beams.

Eclipse Yacht. Photo by Hendrik.
  • Low-cost bargains don’t honor high quality. Low-cost bargains privilege cost reductions. And price wars. The crisis of the high quality artisan products is nothing new. It is the result of the implementation of 30 years of cost-based pricing which is the consequence of cost competitive advantage. When every single industry on earth, decided to accept and apply cost efficiencies, please do not tell us that a low-cost strategy privileges quality. Low cost products and services privilege cost reductions at every single level: with the economies of scale level; at the economies of learning to reduce time and increase efficiency; with the production techniques and processes using automation-robotics and massive sources of technologies; at the product design at low cost to standardized components; when procurement of inputs (raw materials or components) of the cheapest resources; research and development at the service of cost reduction; agile factories for capacity utilization at the service of reducing unit costs, and finally searching always for residual differences in operating and managerial efficiencies…
  • Low-cost bargains are proposals of low or null zero differentials. Every time we see a low-cost bargain, we have to imagine how hard has been for humans to bear it. We have to ask ourselves, if humans or robots/automated machines have manufactured the product. If the company behind such low-cost item is pursuing a sustainable and integral strategy for the employees that work for them. Artisan and high quality processes are highly differentiated. They should charge more, and for people to buy them, they also need to live as middle-class members of a society, not as poor. To elevate the society income means to offer possibilities for the artisans to survive and to continue honoring the privilege of being an artisan.
  • Cost efficiency may no longer be a guarantee of security and profitability in today’s fast changing markets (Robert M. Grant). The only way in which a cost advantage strategy is successful, happens at expenses of the high-quality manufacturers and artisans. It is very hard to reconcile the pursuit of integral strategy innovation, with a holistic approach for the environment and the global humanity priorities, when pursuing cost reduction. There is no room for differentiation at that level of manufacturing. “Adopting a low-price, or low-cost strategy generally implies a market positioning based upon limited features, standardized offerings and a tradeoff between quality-cost”. Even if the world decides to go digital, that move only benefits the cost advantage strategy. Our urgent call to balance our commerce and trade, is not to continue to reducing costs, by implementing the elements of the 4th industrial revolution. That is not that way that we must pursue, but to begin to put our trade again in equilibrium, by elevating our humanity and our income. By understanding that again we must treasure what makes us different and human. To elevate us, means to reconfigure our work and manufacturing, to begin to address our business models in a way that we can make our value chain processes at the service of humans quality of life, and not focusing only for shareholders value through cost reductions. Companies also need to start to provide solutions to our most difficult issues, beyond the concept of charity.  To provide solutions for sustainability of the environment, or increasing the salaries to a minimum of US$2,400 per month (on global average), or caring for any other of your favorite charity causes, money is needed. That money has to come from a differentiation strategy. And our pricing strategy has to go to the rise, to augment. Not to the reduction.

There are more considerations that I will address when it comes to low-cost pricing meaning. For me, low-cost pricing based on cost reduction or cost efficiencies is simply against the good theory of making an integral strategy. It is like selling rubbish things to the poor, to keep them in a poverty lifestyle. It is like admitting that the needy have to get used to inexpensive and petty things. It is like allowing that by selling cheapskates items that are replaced with another cheap one, we will continue making more disposable garbage. It is like going down the drain, instead of elevating our humanity. If the strategic concept is wrong, then pricing is wrong. Because a low-cost price considers the profit margins as another cost. Then this has to be reviewed by theorists and professors at its roots.

See you again this week to cover the theme High Quality vs. Low-Cost Bargain Contradictions.  


Source of theory reference cited in this article

Disclaimer: Illustrations in Watercolor are painted by Eleonora Escalante. Other types of illustrations or videos (which are not mine) are used for educational purposes ONLY. Nevertheless, the majority of the pictures, images, or videos shown on this blog are not mine. I do not own any of the lovely photos or images posted unless otherwise stated.

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