In the past, I've explained how corporate-speak rots your brain and how business clichés destroy your credibility. I've also provided several lists of terms (like weasel words) that you should avoid whilst doing business.

What I haven't written about are business terms that people use incorrectly. This isn't uncommon. I once interviewed a writer for Business Week who thought "net profit" meant profit made by selling things on the Net. Ouch.

Anyway, I recently read an article that mentioned a company that purchased a product at a "discounted cost." Then I read another article yesterday that talked about retailers "raising costs to make more profit."

What the first article meant, of course, was the company purchased the product at a discounted price (not cost) and the retailers were raising prices (not costs) to create additional profit.

Those are just two examples of how people, even executives and journalists who should know better, treat the terms "cost" and "price" as if they are interchangeable. They are not. Price and cost are opposites, not equivalents. 

The price is the amount of money the seller is asking. The cost is whatever the buyer ends up paying. While that monetary value is sometimes identical, that's not necessarily the case. Allow me to explain.

Imagine a supply chain consisting of 1) a manufacturer, 2) a retailer, and 3) a consumer.

The manufacturer sets a price for which it will sell a product to the retailer. If the retailer pays that price, that amount of money is a cost, but only from the retailer's perspective. To the manufacturer, it's still the price.

The retailer now sets a price for which it will sell that product to the consumer. If the retailer's price is greater than the cost (what the retailer paid the manufacturer), the retailer makes a profit.

When the consumer buys the product, they pay the retailer's price, but that money when spent, is a cost, but only from the perspective of the consumer. To the retailer, that amount is still the price.

The distinction between price and cost is important because the difference between price and cost is what creates profit.

To increase sales, you set a price that generates the most money by persuading as many customers as possible to pay the highest price possible.

To reduce expenses, you cut costs, one of which is your cost of goods, which is the cost (to you) of the products that you subsequently sell, at your designated price.

One way to increase sales is to discount your price, which means asking a lower price for your product in the hope of persuading more customers to buy, resulting in an overall increase in the money you receive for selling your product.

One way to reduce costs is to ask your suppliers to discount their price, which reduces your costs. However, it's impossible to discount a cost, because the cost is whatever you end up paying, regardless of whether the price is discounted.

Confusing the terms "price" and "cost" is a recipe for confusion and subsequent bad decisions.

For example, suppose your business plan states that your sales team should "achieve the best possible cost."

Does that mean the salespeople should avoid discounting in order to get as much money as possible from every sale? Or does that mean the salespeople should offer steep discounts so that customers incur the best possible cost (from their perspective)? Those are diametrically opposite strategies, but that's not clear if the term "price" isn't being used precisely.

Similarly, suppose your business plan calls for "aggressive pricing to maximize profit." Does "aggressive" refer to the price you plan to charge so that you'll make more money? Or does "aggressive" refer to the prices you hope your suppliers will charge so that your expenses are as low as possible? Again, those are very different strategies, but that's not clear if the word "price" isn't being used correctly.

The ambiguities and possible confusion disappear when both terms are used correctly.  For example: "Our pricing strategy is to offer discounts to grow our customer base, while keeping profits high by aggressively reducing our costs." No ambiguity there.

Now, all of this might seem a bit petty, because most of the time it's pretty easy to figure out what's meant by "price" and "cost" when they're used in context. It would be a mistake, however, to assume that's always the case.

Consider this: NASA accidentally crashed an expensive space probe smack into the surface of Mars because somebody confused the metric system (kilometers) with the imperial system (miles). Tiny mistakes in terminology can indeed create huge disasters.

Published on: Jun 12, 2018