The Role of Cost in Amazon's Potential Price Increase
BY Ilan Mochari
Amazon is citing increased costs as one reason for its potential price increase. Here's why costs never tell the whole story.
"Shipping costs have gone up a lot; fuel costs have gone up a lot," said Thomas J. Szkutak, Amazon's CFO, during yesterday's announcement that the online retailer was considering a $20 to $40 price increase for its Prime program. The program, which costs $79 a year, gives 25 million subcribers free two-day shipping, premium video streaming, and e-book lending.
Certainly, shipping and fuel costs have gone up. But pricing expert Ron Baker once told me that costs should never be the main driver of price.
What should be? Simply put, it should be a price point at which both seller and customer feel as if they're making a profit. If that sounds simple, it's because it is. The seller needs to make a cozy margin. The buyer needs to feel as if she's getting more than what she paid for.
Customers Don't Care About Your Costs
In Baker's view, no entrepreneur had a better grasp of this concept than Charles Revson, the marketing legend who built the Revlon cosmetics empire. As detailed in Fire and Ice, the unauthorized biography of Revson by Andrew Tobias, Revson refused to base the price of his beauty products solely on their cost.
For example, though other nail polish products sold for 10 cents during the Great Depression, Revson's products were 50 cents. His lipstick sold for one dollar, compared with the 49 cent price of competitors'. Baker writes: "Revson didn't compete on price, since he understood Revlon was selling the chance of turning the right head or [lending] a touch of class."
Had Revson priced his products strictly on a cost-plus-reasonable-margin basis, he would have priced his products in the neighborhood of his competitors'. Instead, he realized that he could charge double or more and still get his customers to perceive that they were getting a great value.
After all: What price can you put on romantic hope?
The Netflix Factor
Only three days ago, Netflix announced that it, too, was considering a price increase. The announcement hinted that Netflix would switch to a three-tiered pricing model. Derek Thompson in The Atlantic believes Netflix's new pricing plan will include "(a) a cheapo discount with inferior access; (b) a 'premium' product that costs more than the current $7.99; and (c) a 'super-premium' product whose higher price will make the premium product seem tolerable."
If Amazon raises the price of Prime by $20 to $40, it will still cost $99 to $119 a year. That amounts to $8.25 to $9.92 a month, rates at which it would still, ostensibly, compete with the lower tiers of the future Netflix rates.
What Amazon and Netflix Are Really Selling
No, it's not an apples-to-apples comparison. The value of Prime, for many customers, remains in the two-day shipping, rather than the streaming and lending. Nevertheless, the monthly cost (still under $10) provides a clue about what both Netflix and Amazon are identifying as a reasonable customer price point.
You could argue, of course, that the programs Amazon and Netflix provide are worth far more to subscribers than $10 a month. In the same way Revson believed he sold romantic hope, rather than lipstick or nail polish, it's arguable that today's entertainment suppliers are selling leisure--something most of us would agree is both priceless and in perilously short supply.
Perhaps, then, this is just the first of many price increases we'll see from Amazon and Netflix, not to mention cable providers and concert promoters and sports franchises. In a work-till-you-drop culture, what price tag can you put on fun?
Meanwhile, it's worth noting that Fire and Ice, the unauthorized biography of Revson written in 1977, is available on Amazon. Regular shipping, for non-Prime customers, is $3.99.