Value, Price, and Cost

The comments on my guest post over at Derek J Canyon’s blog have gotten interesting in the last day or so.  Not that they weren’t interesting before, mind you.  But in the last day or two, the discussion has shifted away from me (damnit!) and toward ebook pricing.  One guy in particular, who goes by the handle Stitch, espouses the thesis that because ebooks are not created on paper, they have no value.  Because it’s the paper, binding, and the rest that give a book monetary value.  The words have value, but not in a monetary sense.  I won’t recreate the entire discussion here, but I would like to share some thoughts on this topic.  Go to Derek’s place and read the comments first, though.

I disagree with Stitch’s thesis on several levels, and I talked about it on Derek’s blog.  Here, I’d like to talk for a little bit about Value, Price, and Cost, because I think at the root of some of Stitch’s assertions is a misunderstanding of those concepts.  The other thing is he misunderstands what the product really is that publishers are selling.

Cost

The cost of a thing isn’t that hard to figure out or understand.  It comes from many things, but can generally be broken down into three categories: Labor cost, Materials cost, and Overhead.  Computing the first to is easy.  For labor cost, you just keep records of how long everyone worked to produce the product then multiply the hourly wage rate.  In the case of salaried personnel, you can still figure an hourly rate.  Materials cost is even easier.  How much did you pay for the materials you used to produce the product?  Overhead is everything else.  Rent, utilities, web hosting, servers, insurance, etc, etc, etc.  It’s not that hard to get overhead for the business as a whole.  But how do you apply it to individual products?  There are a lot of different ways to do that, some more complicated than others.  One way that’s not so difficult is to compute the total overhead cost in a month, then figure out the total number of hours worked by people in the company each month.  Then you can compute an hourly overhead rate.  Since you know the labor hours to produce the product in question, you can then apply overhead based on those labor hours.

So that’s Cost.  Pretty easy.

Price

Price isn’t so hard either.  You take the cost of the thing and tack on whatever profit margin you need and add it onto the cost.  But how much profit margin is ok?  Businesses will compute a thing called the Weighted Average Cost of Capital (WACC).  The WACC takes into account the cost of getting the cash to do business: interest payments on long and short-term debt, dividend payments to stockholders, things like that.  If the business makes enough so that the return on a project to equal the WACC, then it will break even because the cost of doing business will be balanced with income.  So a lot of the time the business will analyze potential products using WACC or a similar computation.

That works great for products like hammers, where you can assign a distinct unit cost to each one.  But for something like ebooks, where the cost to make additional copies is very low (but not zero), it can become less clear how to do this.  I’ve thought on it, and it seems to me you just need to assume a number of copies sold, then allocate the costs in a per unit basis.  Then when you’ve figured out how much margin you need, adjust the per unit price accordingly.  Of course that’s pretty imprecise.

Which is, I guess, partially why the ebook pricing topic is so contentious.  Because there really isn’t a definitive price that THOU SHALT GO TO.

Value

Value is more tricky.  A lot of people, Stitch included apparently, conflate price and value, but the two are not the same thing.  Value is a relation between how much benefit the customer gets from a product and the price the customer paid for it.  If the benefit is less than the cost, then value would be overall negative and you’d expect the customer wouldn’t buy it.  That said, we all can think of instances where people got ripped off or screwed themselves by paying way too much for something that wasn’t worth the price, can’t we?  Funny thing is, though, many people have a different opinion on whether they got screwed or not.  If they prize a thing above all others, they’ll pay for it.  If a person then happens along who values that thing less, person#2 will think person #1 got screwed when in fact person #1 might still be extremely happy with the purchase, since his assessment of the value (benefits minus costs) of the new thing is different from person #2.  In other words. value can be a relative thing.

But it is a real thing, too.  People assess value all the time, sometimes without realizing it.  Cost-benefit analysis is what value is all about.

Hope that helps.  There’s more to say, but it’s about midnight and I’m fading fast.  More to follow tomorrow, I guess.  🙂

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