Posts Tagged 'Pricing'

November 7, 2008

Tax Policy as Pricing Strategy

One of the big items up for “spin” and a little debate in this Presidential election is the tax policy proposed by each candidate. We’ve heard accusations ranging from tax breaks for wealthy CEOs to socialist welfare where money is taken from the rich CEOs and given to the non-taxpaying poor under the guise of a “tax cut”. The word “fairness” gets thrown around a lot and now Joe the Plumber may get a record deal out of all this.

Absent any fiscal discipline by the government (and I have never seen this from either political party), it’s clear that the government needs more money or else it will run deficit spending until we’re all bankrupt. Therefore, tax policy should be nothing more than a pricing strategy to maximize government revenues. Taxes are essentially the government’s pricing structure for their offerings of goods and services (roads, law enforcement, subsidized student loans, etc.)

The problem is, if cutting a particular tax or tax rate will actually bring more revenue to the government, it will be criticized for whatever group “benefits” from the lower rates, regardless of how much better off the government treasury will be.

Yes, it is possible to bring in more revenue and profit by reducing prices. It is a very, very common practice in the business world and we employ this practice at SoftLayer. Consider this scenario:

You sell a product that cost you $50 to build.

At $100, you can sell 1 unit per month. Here is your revenue and profit calculation:

$100 x 1 sale = $100 revenue – $50 costs = $50 profit

Now, if you cut the price 20% to $80, you can sell 2 units per month. In this case, here is your revenue and profit calculation:

$80 x 2 sales = $160 – $100 total costs for 2 units = $60 profit

So, most people would think that $60 in your pocket is better than $50. By cutting the price, you have made more money.

What if you could sell 3 units if you drop the price to $60? Let’s take a look:

$60 x 3 sales = $180 – $150 total costs for 3 units = $30 profit

Because you only keep $30 profit, in this case the BEST price for your product is $80 because at that price you maximize the profit that you keep.

Likewise there are ways to increase government revenue by cutting tax rates. Let’s say we want to tax more dollars from the rich and give to the poor – fine. The paradox is that the way to get more tax dollars from the rich is to cut their tax rates. Really, I’m not crazy – Congress itself has reported this fact.

Business people know that if you raise your prices, people’s behavior will change and they will buy lower volume of what you sell. Even with must have items like gasoline, as the price rises, people find ways to use less of it, even if using less is inconvenient because you have to get up earlier to carpool.

By the same token, if taxes go up, those who are exposed to those taxes will change their behavior and reduce their exposure to those taxes. As a result, the government can actually collect less money by raising taxes.

Every time we set a price or run a special deal here at SoftLayer, we are well aware of this fundamental law of supply and demand. When we need to move units on a particular item, we will reduce the price.

I only wish our government would apply the same principle when pricing its products and services with tax policy – not because I want to pay less in tax but because I want the government to maximize its profit and avoid burdening our children and grandchildren with unmanageable government debt.

-Gary

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May 29, 2007

The Real Price of Retail

A few days ago Dell made a splash by telling the world they had established a partnership with Wal-Mart to sell their computers and other products throughout Wal-Mart’s 3,000 stores worldwide. This marks an interesting milestone in Dell's corporate existence. Dell has always been acknowledged as an innovative and cutting edge company through their direct sales model which took a layer of distribution (in this case retail) out of the sales process and allowed customers to "have it their way", so to speak.

With the competitiveness in the PC market and Dell’s admission of trailing behind the likes of HP and IBM, the motivation for this transition in their sales channel is clearly predicated on increasing overall volume to boost the market's perception of their thriving company and the goal of being #1 worldwide in the PC market. Obviously, this has sparked a debate on their ability to maintain a differentiated strategy in the branding of "Dell", which has generally been perceived as a higher quality because of their direct channel strategy.

In hearing the news of this new marriage between Dell and Wal-Mart it reminded me of an article that I ran across at fastcompany.com entitled "The man who said no to Wal-Mart" and it hit home with the story of Jim Wier, CEO of Simplicity (owner of Snapper Lawn Mowers) who was at a crux in his company's life cycle where he would have to choose a path that would shape the course of his company going forward. Was he going to choose a path of high volume, low margins products or high quality and sustained margins product sets at levels that his company needed to maintain its proper corporate health? To the surprise of many, including Wal-Mart, Mr. Wier respectfully choose the path that many others had not in the past -- the one without Wal-Mart. Although two unique industries here with technology and durable consumer goods, the thoughts have to be the same in the minds of both management teams. It’s a fascinating article and I would encourage anyone who runs a business that struggles with pricing and volume levels to read.

There is no doubt Dell has been one of the most influential companies of the last 20 years in the technology industry and their management teams, through addition and attrition, have paved the way for tremendous success both financially and technologically over those years. Not many other companies have the ability to coin a phrase such as "Dellionaire". With this shift, I trust the powers that be have thought long and hard regarding the pros and cons of the retail markets, primarily in the retail technology sectors. If volume is what they want, then volume is what they are likely to receive. The real question lies in “at what price?” and which of these two corporate giants has a bigger muscle to flex in the room, Dell or Wal-Mart?

-Sean

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