My Mental Model for Pricing in Labour, Capital and Product Markets
My mental model on prices has evolved through my experience, received knowledge and conversations in the classroom. It has helped me understand different pricing situations and be able to determine if the choice of pricing strategy and consequent pricing decisions are appropriate for a given context.
- Price is the compensation I deserve for helping create, deliver & realise value. It is not a source of value as many people believe. Lower price does not necessarily mean superior value for the buyer.
- Exchange of value for a price also involves an explicit or an implicit risk-sharing arrangement. A person taking higher risk deserves better price – be it the firm, consumer, worker or an investor.
- Negotiated contract must identify & incorporate risk elements and specific compensation for each element as explicitly as possible. If the risk of contract termination is with me, I deserve a probability adjusted compensation for taking that risk.
- In case the contract performance is likely to experience uncertainty, it is appropriate that we define principles that would help determine compensation once uncertainty gets resolved.
- If we struggle to resolve the issues through the objectively determined principles, it is appropriate to use ‘fairness’ as the basis for sharing.
Pricing for Value, given the risk-sharing arrangement, is the only way to build a sustainable market system.
If I exploit the pricing power that I have as result of the value, the receiver attaches to my output, I will, for sure, face competition.
In situations, where my pricing power extends to the market, the regulator will awaken itself one day.
I can use marketing programmes and/or political influence to distort markets, but the consumer and the society will see through my game at some point in time.