Reflections In A Cup: Value Judgments
By Stuart Daw
By Stuart Daw
The free market rules. No matter how we try to avoid it, eliminate it,
or bend it to our whims, it is immutable. Governments like to tinker
with it; the results of which are inevitably bad.
The free market rules. No matter how we try to avoid it, eliminate it, or bend it to our whims, it is immutable. Governments like to tinker with it; the results of which are inevitably bad.
But for our purposes here, let’s take a micro view from the perspective of the coffee service or vending operator.
Every consumer of a good or service, perhaps without realizing it, is involved in a search for value. A worker in an office will buy a refreshment item, placing a higher value on that purchase than he does on the money he exchanges for it, or he wouldn’t buy it. And he may survey a range of choices before taking that item that gives him what economists call “the greatest marginal satisfaction.”
But that satisfaction is always tied to the price. For instance, you might prefer a filet mignon to a hamburger at some particular time, but if you can’t afford the filet right now you will have to be satisfied with the hamburger. Thus the market determines that hamburgers will always outsell filets.
The best illustration of this was in the lesson we learned when we were embroiled in the business that is now pretty well passé, that business straight from hell, called honour snacks. Through inflation, the numbers escalated through time, but the percentages prevailed. So let’s take an era when the asking price for snacks from the box was 50 cents. That meant that the average cost of the snacks should be 20 cents, because allowing for a 20 per cent shortage rate (read: theft), the actual selling price would be 40 cents, yielding a 50 per cent gross profit.
But of course the actual cost of each snack item was not the same as the average. A chocolate bar would be much higher than a beef jerky, but we couldn’t price every item separately. So it was our habit to monitor outgoing trays for the total cost of items sold to ensure the expected average. But when we made the same audit of the returned trays, the average snack cost was always less, meaning that the customers were eating the high cost things and turning away from the lower, thus hurting the expected margins.
Why? Obviously the cost averaging approach might have been the proper, and perhaps only, way to control what went out. But the public wasn’t fooled. People simply, maybe in most cases intuitively, chose the better value.
Now, in a hypothetical case, let’s consider a coffee service operator who doesn’t like having to deal with different, actual costs in coffee products. He buys 42-count cases of a blend with every combination of weights from 2.5-ounce down to 1.25. He’s selling all these cases at the same price, so he wants to pay the same price for them too, even though the actual production costs in packaging materials alone may vary by as much as one dollar. After all, he says, the customers all get the same number of bags of the same quality coffee, so they should pay the same price.
He asks the roaster to merely take the average cost price of them all, which turns out to be for the 1.75-ounce case. The supplier agrees, because as long as the ratio of weights remains the same through time, he thinks, “what the heck, it makes no difference to us.”
But a problem arises. For some reason, the customers of the coffee service gradually begin to have a bias toward the 2.5-ounce cases. The coffee service operator goes blithely on, seemingly not affected by all this. But the roaster sees margins dwindling, and demands a general price increase to compensate for the change. Now the operator winds up with lower margins, and is in a tight spot regarding raising his own selling prices.
From the end user’s point of view, he did nothing wrong in preferring the higher weight, more flavourful coffee.
“Why are you charging more when the coffee market hasn’t moved?” he asks.
The operator, now stressed with a problem, has learned a bit late to see the consequence of trying to beat the economics of supply and demand, of customers seeking the best value.
The moral? Be consistent in pricing, reflecting the true relative value for the products that you sell. Then let the customers decide based on their own individual value judgments.
The above is, as mentioned, only a hypothetical example, but it pertains to every case that one can imagine involving the principle of cost averaging.