Munger Problem: Achieve Higher Physical Volume By Increasing The Price?

Achieve Higher Physical Volume By Increasing The Price?

Question:

Now tell me several instances when, if you want the physical volume to go up, the correct answer is to raise the price?

“You have studied supply and demand curves. You have learned that when you raise the price, ordinarily the volume you can sell goes down, and when you reduce the price, the volume you can sell goes up. Is that right? That’s what you’ve learned?” They all nod yes. And I say, “Now tell me several instances when, if you want the physical volume to go up, the correct answer is to increase the price?” And there’s this long and ghastly pause. And finally, in each of the two business schools in which I’ve tried this, maybe one person in fifty could name one instance. And nobody has yet to come up with the main answer that I like.”

Answer: There are four categories of answers to this problem. A few people get the first category but rarely any of the others.

  1. Luxury goods: Raising the price can improve the products ability as a “show-off “item, i.e., by raising the price the utility of the goods is improved to someone engaging in conspicuous consumption. Further, people will frequently assume that the high price equates to a better product, and this can sometimes lead to increased sales.
  2. Non-luxury goods: same as factor cited above, i.e., the higher the price conveys information assumed to be correct by the consumer, that the higher prices connotes higher value. This can especially apply to industrial goods where high reliability is an important factor.
  3. Raise the price and use the extra revenue in legal ways to make the product work better or to make the sales system work better.
  4. Raise the price and use the extra revenue in illegal or unethical ways to drive sales by the functional equivalent of bribing purchasing agents or in other ways detrimental to the end consumer, i.e., mutual fund commission practices. [This is the answer Charlie likes most, but never gets]

I found the following problem to be fascinating. From my personal thoughts I was able to come up with the answer luxury goods (I have background experience at Luxottica Retail) as well as an answer that was not provided, although it does relate to number 4. The tactic I thought of (among others) is using stimuli that are addictive, nicotine, etc. to create operant conditioning while slowly raising the price as the social proof factor materializes. If the price is relatively inelastic (determined by observing behavior), the additional funds can be used to market/sell additional product, boosting revenue and creating a lollapalooza effect of marketing, price raises, social proofing, operant conditioning, critical mass, etc. The example is also relatable to pharmaceuticals.

This happened in the case of my friend Bill Ballhaus. When he was head of Beckman Instruments it produced some complicated product where if it failed it caused enormous damage to the purchaser. It wasn’t a pump at the bottom of an oil well, but that’s a good mental example. And he realized that the reason this thing was selling so poorly, even though it was better than anybody else’s product, was because it was priced lower. It made people think it was a low quality gizmo. So he raised the price by 20% or so and the volume went way up.

But only one in fifty (2%) can come up with this sole instance in a modern business school – one of the business schools being Stanford, which is hard to get into. And nobody has yet come up with the main answer that I like. Suppose you raise that price, and use the extra money to bribe the other guy’s purchasing agent? (Laughter). Is that going to work? And are there functional equivalents in economics – microeconomics – of raising the price and using the extra sales proceeds to drive sales higher? And of course there are zillion, once you’ve made that mental jump. It’s so simple.

Now let us quickly reexamine the problem with the benefit of hindsight bias and frame the questions in such a manner a physicist or algebraist would.

Invert. Always Invert. – Carl Jacobi

 

When can we lower the price and lose sales volume? How?

  • Products associated with reliability or quality, deterioration of social proof and operant conditioning overtime to competitors.

When can’t we raise the price and increase sales volume?

  • Obviously not everyone would be able to exploit such a pricing process or else the government would step in with price controls. The answer is likely to come from non-regulated or minimal regulated industries.

Of course none of these answers are definite and at best are messy and uncertain.

Why did Max Planck, one of the smartest people who ever lived, give up economics?

“It was too hard. The best solution you can get is messy and uncertain at best.”

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