Monday, May 10, 2010

Pricing Perfume

Technology startups are notorious for underpricing their initial products.  I think there are two reasons for this.  First, the people most likely to be interested in their early offerings are often technology enthusiasts, who, for some reason believe that your technology should be free or at least very, very cheap (funny, how this doesn't apply to their salaries!).  But the second and main reason is because most startups don't have a good understanding the value they provide to their customers.  This is not meant to be a glib criticism.  Determining value can be a difficult and arduous process.

Why is understanding value so important?  Because more often than not, price is a function of value not cost.  I repeat:  price is a function of value not cost.

Many times when I say this, especially to engineers, their hackles go up and they stare at me with an indignant "are you insane?" glare.  In fact, that was pretty much my reaction as a newbie engineer fresh out of college.

Shortly thereafter, I found myself walking through the cosmetics section at a Macy's in Allentown, PA when it suddenly hit me.

Perfume.  A large cloud of it.

Turning to the young lady that had just hit me with eau de some fleurs (or should I say odious flowers?), I made a quick comment about "walking through $50 mists..."

"$150," she smiled perkily as she held up a very tiny bottle.

And that's when it really hit me.  "$150?! What a scam!"  I thought.  And being a chemical engineer, I conservatively estimated the component costs:
  • 4 oz of ethyl alcohol, reagent grade ~$  5
  • Fragrances                                     ~$ 10
  • Fancy glass bottle                          ~$   5
  • Box                                               ~$   2
  • Other Manufacture/Shipping           ~$ 30
  • Total                                             ~$ 52
Yes, I know the fragrances are supposed to come from some rare flower that only blooms once every 50 years on some cliff in the Italian Alps, retrievable only by specially trained ravens, but we're talking milligrams here.  And I left out advertising costs because, quite frankly, the only reason the cosmetic industry spends so much on advertising is because they can, not because they need it to reach customers.

So smelling like flowers, I decided to return the favor and took it upon myself to educate the salesgirl.

I'm the one who got the education.

With flawless logic and reasonable facts, I explained how the costs worked.  No impression.  She knew the value of what she was selling.  It was precious, it was rare, and it was "painstakingly formulated to enhance a woman's personal biochemistry!"

Undaunted, I pressed on in the name of truth and drawing on a past summer job experience working for a fragrance and flavor chemist (yes this is a real profession), I explained how most of the fragrances were actually artificially synthesized, how the liquid was mainly ethanol, and how the bottles were made in China.

Her smile faded and the room temperature plummeted as her gaze turned hard.

That's when I realized what it was that the perfume makers were really selling.  If you want to see an industry that understands the link between price and value, the perfume industry is one of the best. And the value is no less real for being intangible.  How do you put a price on making someone feel special?

In this case, it has to be high enough to trigger the "I'm worth it" reaction yet it can't be so high as to be out of reach of the target customer.  (My unscientific market research shows most quality perfumes are priced between $110 to $250 for a 3.4oz bottle.)

And gentleman, lest you be too smug about my example, maybe one of you can explain to me why someone would pay $3700 for a 100ml bottle of Diva vodka vs. $25 for a 750ml bottle of Stolichnaya?

Value is the eye of the customer.  Price accordingly.

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