Victus Spiritus


Don't discount the value of short term optimization 

13 Jan 2011

Invest in the partnerships, people and technology that will benefit your business and projects in the long run. Plenty of folks will advise you to make commitments to sustainable solutions with long term planning, myself included. Yet there are times when the switching cost is far less than the cost of premature commitment to a suboptimal, although inevitable alternative.

The fine art (science!) of pricing

Pricing is an extreme case where the switching costs are close to minimal. If you want a truly fluid market don't look at local currency, it's value jumps all over, look at prices. A price change can be as simple as a database update, and customers are an unforgiving lot when it comes to mispriced goods.

The price of a product is simply what the market will bear, but discovering the break point of optimal returns is non-trivial*. Based on initial scarcity the price begins at a premium level. Then as cost per unit drops and competition fiercely competes for market share, prices go through a decline, falling to a commoditization level. A particular case worth looking at is how Apple has priced the iPhone and how it stays above the commoditization price floor.

Case study of iPhone pricing

If Apple had never upgraded the hardware or software on the original iPhone released in 2007 it would have quickly fallen to a commoditized price level. The cost per unit would have dropped drastically with technology upgrades, and competitors would have offered more capable phones. A breakthrough product would have been near obsolescence in just a handful of years, in the true spirit of personal computers, yet faster!

But the folks at Apple were driven to design (the hardware is made in China) more capable hardware and software. They iteratively released upgraded phones to match the natural drop in prices so that the latest iPhone always remained in the same region of profit per unit. It's no small feat to create and deliver at the pace of a hot market. One slip up in a release of new cutting edge smart phones, and the Apple mobile market faces being gobbled up by hungry competitors. 

Apple has apparently mastered short term optimization with upgraded product lines across all categories. As long as they continue to do so, they'll protect a healthy margin on their products. The grim reaper of profits (commoditization) is only a product cycle away.

*= Dynamic pricing to optimize profit is optimized by a system level solution. Iterative feedback updates internal market models, which help guide unit price and consistent market (competition) and product line (upgrades within a brand) prices.