Lowering prices is easy. Being able to afford to lower prices is hard. – Jeff Bezos
The Sad Story of Metro Fares in Santiago
The Santiago Metro, in Santiago, the capital of Chile, or more popularly known as “Metro de Santiago” is one of the oldest public transport systems in the Latin American region. It carries around three million people every day. That is a considerable number because it is almost half of the population of Santiago.
Chile has been hailed by the world as a success story because of their lower poverty rates and higher index of living compared to the rest of the countries in Latin America. And the Metro de Santiago is an institution that most Chileans are proud of.
The government operates the Metro de Santiago, and the fares are also fixed by the government. The country is still suffering from inequality because of the dictatorship in the 1970s and 1980s in which town planning took a backseat. The metro was a ticket out of this inequality as it offered a ride away from the badly planned towns and housing societies.
But things took a turn for the worse in the middle of October 2019 when the government decided to raise the prices of the metro tickets by thirty pesos, or $0.04 which was nearly a 4 percent hike. People became unhappy and this price rise led to mass protests on the morning of October 18. That day, the students of Santiago used social media to call for public fare evasion and popularized the hashtag #EvasionMasiva. The protests became worse as people came out in large numbers, which resulted in larger demonstrations and total chaos. Santiago witnessed widespread looting of supermarkets, rioting, and torching of more than twenty metro stations. The right-wing president declared a state of emergency and installed a curfew across Chile for the first time since the end of the cruel dictatorship.[1]
But the saddest part was the loss of thirty lives because of the riots and protests.
The government stepped in by announcing welfare measures that promised to reduce the inequalities. But even after several negotiations, a major reshuffle of the cabinet, and a referendum in favor of a new constitution, the protests did not die down completely till the COVID-19 pandemic broke out. The impact of the price rise was not final. It resulted in the change of power in 2022, and it refuses to die down even today.
This is a classic case of the impact governments and other controlling bodies have on the price of a product, and the power of customers in deciding the final price of the same product. And how worrying things can get if these different stakeholders are not in alignment.
And as organizations, do you know what is even tougher? It is the fact that these factors are external and may not fully be within the power of the organization to control or influence it.
The 5Cs of Pricing, Or the External Factors That Impact Prices
In a previous article, we saw six internal factors that can influence the right pricing – a great pricing strategy, the right technology and tools, a clear definition of the pricing responsibilities, the right incentives that can drive pricing, the right team with the optimum and diverse capabilities, and the presence of the right organization structure. These are within the control of an organization, and organizations like things that are within their control.
But the real world is different, and not quite forgiving. Everyone wants to have a say on the price of the product, but very few have the power to influence it. And most of these may not always be within the control of the organization. And organizations do not really like things that are not within their control.
There are five aspects that are external to an organization and have the power to influence the price of a product – the competition; the customers; the commoditization; the capacity in the market; and the controllers, or in other words the regulators.
Yes, while organizations can influence them, and try to overcome them, their impact cannot be neglected.
Let us look at each factor.
Competition
Jeff Bezos is probably the greatest disruptor in the last three decades. Amazon, and the impetus it gave to the e-commerce industry disrupted the structured and unstructured retail industry.
Through this disruption, Amazon and its ilk became competition to a lot of organizations across the retail value chain, and one of them was the manufacturers themselves. They were forced to choose between the traditional retailers or the e-commerce giants. And they were also exposed to the prospect of being compared with a huge set of competitors, with a lot of them being far cheaper. Yes, there was also the small threat of Amazon and other e-commerce giants promoting their home-grown brands and the brands that they have a stake in. And because of this, the way organizations adopted pricing has changed.
For example, Quality Bicycle Products, an American bicycle manufacturer promoted the concept of minimum advertised pricing that made it hard for online retailers to sell a product with deep discounts. They also gave preferences to local stores to access their products and started giving preferential treatment to the retailers.[2]
But not everyone is lucky and can take a strong stand. For example, Circuit City was a well-known electronics retailer which was one of the leaders in the consumer electronics industry. In the early 2000s, Circuit City faced intense competition from other major electronics retailers.
What did Circuit City do? They were predictable. They decided to lower prices aggressively. However, as their competitors which included Amazon also were well funded and well backed, Circuit City could not hold fort. The price wars eroded the company’s profit margins, as the reduced prices led to lower profitability and reduced revenues. And soon Circuit City was forced to file for bankruptcy.
The level of competition in an industry also decides the extent to which the prices go beyond the true value of a product. In an industry which has zero competition, or in other words, is a monopoly, the prices are higher – organizations have the power to charge more, and the lack of alternatives may render customers helpless.
But in a highly competitive market, organizations will compete on prices to attract customers or to gain market share, and in the process may even undercut the cost of the product or the service. And once the prices touch rock bottom, organizations will be forced to innovate to cut their costs further to maintain their cost leadership or market share. Or in other words, competition drives down prices, and prices drive up innovation, and innovation further drives down the costs. Yes, everything is OK if organizations do not come together and create a cartel.
Competition also leads to price wars, especially in a heavily competitive market. Sadly, very few companies are left standing after heavy price wars, and it is not good for the industry or customers in the long run.
Ultimately, the impact of competition is more far flung than organizations may be able to plan for and can create unwanted situations that may be beyond the control of the organization.
Customer
Ted Williams, who lived in Columbus, Ohio, was a homeless man. Having been honorably discharged from the army, Ted took to drugs and alcohol and was thrown out from his home in the mid-1990s. He was arrested several times for crimes such as theft, drug possession, escape, and robbery.
But life had something better in store for him. Towards the end of 2010, Doral Chenoweth, a videographer for the Columbus Dispatch in Columbus, Ohio, recorded an interview with Williams, and posted the interview on the newspaper’s website on January 3, 2011. Recorded during a period when Williams was homeless, Williams was shown standing next to traffic, holding a cardboard sign with a handwritten advertisement of his voice and a request for donations. In the recording, Chenoweth asked Williams to demonstrate his voice. The video showed a disheveled Williams gratefully receiving a donation and improvising an accomplished radio station promo. The video was reposted to YouTube which led to Ted being offered a lot of jobs, money, clothes, and more importantly, it led to Ted becoming a national sensation. And in a few days, he was dubbed as the man with a golden voice. And soon he became popular, and his life turned around. Today, after several controversies, he is a well-known radio host, and his voice is still popular.[3]
While he may be one of the few lucky ones who got a break and was able to become an overnight sensation and retain the fame over a long period, it is also a great case study from the point of view of pure economics. There was a demand for his voice and for his story, and the customers who included the listeners as well as the media personalities who were willing to make a dime out of his story, were willing to pay for both.
And it was because of both these sets of customers that he became famous and has been able to turn around a new leaf and live a normal life.
But not everyone is lucky. Go to any famous walking streets, and the chances of the street being thronged with street performers will be quite high. Some are great, some are good, and the others – let us just say that they are in it for their passion. A lot of them need the money, and very few do not need the money. Commonly known as buskers, they are part of a city’s life and contribute to its vibe.
But there is one common thing that connects most of these buskers. They are not in control of the price of the service that they are offering. The customers tip them based on how they perceive their performance, and a host of other factors – their moods, the other performers (or competition), the weather (probably), and even the time of the day or the night. The price is often left completely in the hands of the customer.
The buskers are not the odd ones out. There is a digital storefront called Humble Bumble which sells videogames, e-books, and other digital content. Yes, so what is great about that? Well, for a start, they let the customers decide the price. Customers can choose how much they want to pay for a bundle, and they can also choose how much part of their payment goes to charity, the content creators, and Humble Bundle itself. Yes, all hail the customer.
These are extreme examples of the pricing being entirely in the hands of the customer. But to some extent pricing power, in a normal or highly competitive market, is in the hands of the customer. They have the power of choice and may even go to the extent of completely ignoring a brand. Just ask Netflix which suffered the wrath of their customers when they decided to raise the prices of their streaming services in the early 2010s. The share prices dropped, and customers flocked to other streaming providers.
The customer is the king, or the queen. And they have a strong say in deciding the prices. Organizations that forget this may not survive too long.
Commoditization
How do you price salt? It is quite essential, the market is quite competitive, and the customers are not looking for a significant value addition in their product. Yet the price of several salt brands has risen by nearly 40% in the last six years across the world.
You see, salt is a commodity. Pricing a commodity is easy because you really cannot go out of a prescribed range, and yet it is tough because you really cannot innovate with your pricing.
Pricing of commodity products is based on several factors including market competition, market benchmarks, market regulations, and market sentiments. There are several other factors also that decide the price of a commodity like salt, and can influence the price of a commodity, but may not be reflected in the short term. These are factors such as the supply and demand of a product, its production costs, and the fluctuations in costs due to currency volatility.
And hence, the pricing of salt followed a pattern – price within a range, and marketed it by claiming the presence of several exciting ingredients.
The degree of commoditization of a product in a market cannot be controlled by an organization. And many organizations do not prefer to enter a market that is commoditized. Because it takes pricing out of their control.
But all is not lost if your organization is handling a commodity product. Our quintessential salt has gotten new forms as organizations have sought to break the shackles of pricing.
Have you heard about the organization called Salty Jack Salt Co? As part of its offerings, they offer ‘personalized salts’ that can be made for each individual or organization that is based on their requirement. Personalization is apparently a terrific way to break free from the boundaries set by commoditization.
Have you heard about gourmet salt or the Himalayan pink salt? Or the salt with a reduced quantity of sodium that promotes better health? Well, the low sodium version costs 100% more than the normal salt, and the Himalayan salt costs more than 300% of the base version and may even cost ten times the normal version in some cases, even if the production costs may not differ much. It’s all about differentiation, or the apparent perception of differentiation.
Organizations can also focus on innovative packaging and branding to jack up the prices. A better packaging that is expected to increase the shelf-life of salt may warrant a higher price even if most of us store the salt in a different container.
Organizations can also increase the price of commodity products by creating versions of the products that offer the value of being limited and unique. For example, in the case of salt, organizations can focus on the salt that is from a different region or geography or can even highlight a unique origin. The concepts of limited-edition products or collector’s edition products are examples of such a concept as organizations aim to break the shackles of commodity pricing.
The degree of commoditization in a market is not a factor that organizations can control, yet they can take actions to break free from the boundaries set by commoditization.
Capacity of the Market
Let me take you through the fundamentals of Economics 101 before I explain this concept. The foundation of economics is based on the theory of demand and supply which states that the price of a product is based on the demand and supply of a product in a market. If demand goes up, and the supply remains the same, the prices go up. And if supply goes up, and demand remains the same, the prices go down. Look around and you will see a lot of examples that will support this theory.
Even though this is an overly simplistic explanation of the economy, this concept is the fulcrum based on which the markets decide the price of several items most of the time.
Let us consider the example of the price of pumpkins in the U.S. Every year, during September and October, the prices of pumpkins go up in anticipation of Halloween. The price of the excellent quality ones goes up even further than the prices of the not-so-good ones. Most families, keeping up with the good spirit of the times, do not mind spending a bit more than the norm, to get home the ‘Jack-of-lantern’.
But in 2007, the situation was a bit different. Even though every state in the U.S. grows pumpkins, and hence can meet the national demand, the year of 2007 saw a hotter and drier summer than usual. And to make things worse, the worst affected were the four states that were in the top five of pumpkin harvest – New York, Pennsylvania, Ohio, and Illinois. This resulted in a drop in the harvest by more than 30 percent. It led to a hike in the pumpkin prices by around 15 to 20% as Halloween arrived.[4][5]
The retailers who were selling the pumpkins and jack-of-lanterns were not in control of the prices, and neither were the farmers. Yet it affected the prices. Wait, there is more. Because of the increase in prices of the pumpkins, most retailers were either forced to hike up the prices of the Halloween bundles or reduce the price of other items that were an add-on, and without which the customers may have decided to give a pass because of the increased pumpkin prices.
In other words, the more than the usual dry summer of 2007 was like the flutter of the butterfly wings in the movie The Butterfly Effect. And a lot of organizations were impacted, directly or indirectly because of this change in demand and supply.
Some organizations use the concept of demand and supply to their benefit. For example, Xiaomi creates an artificial gap in demand and supply during their flash sales which helps the products selling out faster. Many organizations that work on the concept of ‘limited stock’ available use this strategy to drive up demand at the prices that they decide.
While organizations may not always be able to cross the bridge when it comes to ‘demand and pricing,’ they can certainly be prepared. Hedging their bets, planning for alternatives, and reducing their dependence on a few suppliers are some of the steps that organizations can take to make sure things do not go out of control.
Controllers
The Economist mentions that ‘one of the oldest surviving texts, the Hammurabi code, includes elaborate price and wage controls: 2.5 grains of silver per day for a rowing boat, six for a laborer. At the other end of history, on January 7th Argentina’s government updated its list of precios cuidados (managed prices), setting guidelines for over 300 supermarket products, including lettuce, contraceptives and mate, a traditional tea-like drink.’[6] As the Economist continues, the controllers, or the government in this case, controls the prices for one of the three reasons – redistribute, stabilize, or deflate.
Remember what I told you before – the concept of demand and supply played a part in deciding the price of an item ‘most’ of the times, and the keyword is ‘most.’ Governments control prices. Directly or indirectly.
Price control is common across the world. There is no nation in the world that does not have any form of price control – either short term, or long term. But doors may not be closed for organizations that have products that are under price control.
These organizations can offer value-added services or create versions that may not come under price control. Or they can look at reducing their costs to make sure that they are able to maintain or grow their margins even with price control. They can even look at advocating for policy changes, but do not set your expectations high because the chances may be limited considering that price control may not always be a rational decision. And in the worst case, organizations may decide to move out of the market if it turns out to be unprofitable.
In the end, price controls are a threat, but also an opportunity. An opportunity for organizations to look within, and to look outside. And the best organizations use this to grow further.
So, Is Helplessness the Only Solution?
There are several things that organizations can do to get their pricing right, and most successful organizations do this perfectly well. And yet there are few things that the organizations cannot manage that are beyond their control.
While organizations have limited control over these factors, the successful ones do not sit back and watch the chaos unfold. They do most of the following actions:
- Acknowledge the factor and acknowledge the fact that not everything may be in their control.
- Identify extremities and create a spectrum of possibilities.
- Plan to mitigate extreme situations that may arise.
- Appoint people to be accountable for managing these situations.
- Reduce dependence on one vendor, customer, or market.
- Decide on when they will exit a market and reduce the emotional baggage.
- Act decisively.
Let us realize that not everything can be controlled but let us also understand that it is always better to be prepared. As they say, a bad plan is better than no plan.