Kids who spend recess doing their math homework go to college and become accountants. Kids who spend recess selling baseball cards leave school and hire the kids who became accountants. But that means entrepreneurs often lack simple number skills that every business owner needs to know. Here are three math facts that can boost any business.
1. Giving More of a Product for Free Costs Less Than a Discount
Imagine that a hardware store is offering two deals on a liter of paint. The first deal gives away 33 percent more paint for the same price. The second deal offers the liter of paint for 33 percent less money. Which is the better deal for the customer?
If you think they're the same, you're like most of the respondents in marketing studies. You're also wrong.
Let's say that liter of paint costs $20. The customer is paying 2 cents for every milliliter. If they're getting an extra 33 percent free, they're paying $20 for 1,333 milliliters, or 1.5 cents per milliliter. If the customer receives a 33 percent discount, they pay $13.20 for a liter of paint, or 1.3 cents per milliliter.
That's a big difference for the customer, a big difference for the business...and the reason cereal manufacturers promise 25 percent more Cheerios instead of cutting the price.
2. Prices Work Best With Comparisons
In a classic test, psychologist Dan Ariely, showed how smart pricing can affect purchase decisions. He took a subscription offer for The Economist and showed it to 100 MIT students. The magazine was offering a digital-only subscription for $59; a print-only subscription for $125; and a print and digital subscription also for $125.
Sixteen students chose the digital subscription, and 84 chose the print and digital subscription. Not surprisingly, no one chose the print-only subscription that cost the same price as the third option.
So Ariely took out the second option and offered the remaining two choices to another 100 MIT students. This time 68 chose the cheaper option and 32 made the more expensive choice.
That second choice wasn't filling space. It was making the most expensive option look cheap. Add a lower value option next to high margin offer, and even if everyone ignores it, you'll make more profits.
3. Extended Warranties Never Add Up...Except for the Seller
Imagine your business needs a new computer. You decide on the specifications, surf the Web for comparisons, then head to the store to make your purchase. When you reach the checkout desk, the clerk asks if you want to buy an extended warranty. The computer costs $1,000 and comes with a one-year guarantee. A three-year warranty is $180.
It's almost never a good deal. In effect, you're being asked to pay $180 for a repair that hasn't happened yet, and may never happen. And if something does happen to the computer, it's more likely to happen towards the end of its life when it's less valuable anyway.
Think of it this way: $180 represents 18 percent of the computer's value at the time of purchase. After nearly three years, the value of the computer may have fallen by 50 percent. For the warranty to be a good purchase, the cost of repair has to be a third of the cost of the computer. At that stage, replacement would be a better choice.
Extended warranties make sense for sellers, who often take half the premium for themselves, and for the clerks who sell them because they make a commission. But when you're buying for your business, choose good products and skip the warranty.