Rafi Mohammed

Pricing Lessons from New England's Lobster Glut

Posted on August 9th, 2012 (0 Comments)

Reprinted from the Harvard Business Review website.

Summertime in New England means lobster — and this year, there's lots of it. With the abundance of lobsters in Maine this summer, prices that lobster fisherman receive at the docks have sunk to a 40 year low of under $2 a pound. (By comparison, last year dock prices reached $4 a pound.)

With cheap wholesale prices, consumers must be benefiting by paying less for lobster, right? Not necessarily. Yes, prices at Boston grocery stores have dipped to as low as $3.99 per pound. Similarly, a "Cantonese style" twin lobster dinner at a restaurant I frequent in Chinatown has dropped from $24.99 to $19.99. However, at my favorite upscale restaurant, prices have not budged — a lobster roll platter is still close to $30. Similarly, prices for picked lobster (meat removed from the shell) at retail outlets have remained constant too.

So what's going on here? Why are some businesses lowering their lobster prices while others aren't?

This situation illustrates a key pricing concept — value-based pricing — that all companies can learn from.

In my consulting work, I find that most companies set their prices incorrectly by using a "cost-plus" method. This involves simply marking up costs by a fixed margin. For instance, if a product costs $100 to manufacture and a manager wants a 50% gross margin, the cost-plus price would be $150. While easy to implement, the downside is these prices have no correlation to what consumers will actually pay. When you are buying a product, do you evaluate prices with a dictum that they can't be more than 50% of what it costs to manufacture? Most of us don't.

The key to better pricing is to capture the value of your product relative to your customers' next best alternatives. If your product is exactly identical to customers' next best alternatives, your prices have to be the same. Why would customers pay more? However, if your product is better, there is an opportunity to charge a premium over rivals' prices. Conversely, if your product is worse, you have to offer an incentive — a discount — to get customers to buy.

When it comes to lobster, it makes sense for supermarkets to duke it out with rivals with low lobster prices to draw in customers. Similarly, in restaurant-laden Chinatown, most restaurants tape scribbled signs on their windows with their current twin lobster prices. Given the competition, these kinds of restaurants have to lower prices to remain competitive.

In contrast, well-known or upscale restaurants or fishmongers offering picked lobster meat operate in more of what I call a "vacuum pricing environment." They cater to less price sensitive customers, have excellent brand reputations, don't advertise prices in windows to attract patrons, and provide unique — not offered by many rivals — lobster preparations. Because of the unique value they provide, these businesses don't have to lower their lobster dish prices to remain competitive.

All businesses should strive to be in a vacuum pricing environment. Creating unique value — such as picked lobster or gourmet preparations — results in an enviable pricing situation. Companies are insulated from competition, which can lead to higher profits.

So what do you think? Should all businesses selling lobster lower their prices? Does your company use cost-plus pricing? Should companies in a "vacuum pricing environment" lower prices when their costs fall?

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