marginal revenue – DanHerr.com

“Sell to the classes, eat with the masses.
Sell to the masses, eat with the classes.”
– Henry Ford

One recent point in my class on Economics and the Firm looked at how to maximize revenue in a business from the standpoint of an economist. The example has been, “If you increase the price of your product by 10% and you lose less than 10%, you likely aren’t charging enough and haven’t maximized your marginal revenue.” Once you lose the same percentage of your customers as the percentage you increase in your price, you have maximized your revenue. All of this lead to an interesting point in my head demonstrating that Henry Ford, from an economists standpoint, would be dead on to market and sell to the masses.

Economists create some pretty lame terms, but I have to go into one for you here. All that “price elasticity” means is “how much people will react when you change your prices.” If I am selling my Aqua-Globe doodad for $20 each, will no one buy them anymore if I raise the price to $40 each? What about if I just raise it by one dollar, how many people will just say, “The heck with this, I’ll get a friend to come over and water my plants”? To address these questions economists came up with their terms:

“Elastic” – like a rubber band, it can be changed / stretched easily
“Inelastic” or solid stuff, doesn’t like to change

With an inelastic product people won’t really change how much they purchase and with elastic they will. Anyway, enough with economics vocabulary… the point was that you want to build an “inelastic” business so your customers won’t leave when prices change (perhaps by building a connection with them, proving that you are about value more than cheapest price, etc.).

To Henry Ford’s point, if you are selling more of a product (selling to the masses) you will tend move toward the economist’s “inelastic region” and rest on the right side of the maximized revenue point (eat with the classes). I believe Mr. Ford had some great points, and obviously proved his abilities and business values far more than I have, but I would make sure to emphasize that more than simply selling to the masses, you need to provide enough value such that customers keep coming back. I believe Mr. Ford would agree.

I would argue that in focusing upon value, your business will naturally end up in that “inelastic region”. Sure you may be more likely to reach that region by selling large quantities (which are likely at a lower price), but I believe businesses can also get there with a cult-like status. Build a business that provides so much value and genuine emotional connection that it is near impossible to replicate the results: Disney, Grateful Dead, Harley Davidson, Red Bull, Google, or Incline’s T’s Mesquite Rotisserie. Once you’ve built that great business, even if your prices come up, or competitors try to imitate you, you won’t lose many customers. When your business is just barely “inelastic” (whether naturally or economically engineered) an increase in price still increases your revenue and your business is less susceptible to another Great Recession (or decrease in customer income).

Bringing us back to the first example, if I want to operate in this attractive inelastic region, I can’t just maximize my revenue. Once I focus simply on maximizing my revenue, any change in the economy will push me off the hill and down the slope into elasticity where all the customers care about is the cheapest price. No longer are you a value provider, but just another name in the game of the lowest bidder. To that end I say:

Don’t forfeit your values to squeeze every last penny out of your pricing.
Focus on providing Value instead of Value Engineering.
– Me, Today (25-May-2012)

This is all too often what you see companies do just before an Initial Public Offering, trying to puff up their feathers for the potential investors. “Look! Our revenue has grown 100% in the last year! We are booming!” Fail. If you subscribe to this philosopy, please allow me to give you a little lesson Value vs. Growth stock investing (for educational purposes only).

In wrapping this up, economists basically went through all this to show that you should try to have a hook that keeps customers coming back (inelastic) and if you’re interested in making more money, sell to more people. Amazing that it takes all this math and graphs to figure out something that is common sense. Gotta love economists.

Thank you for reading my blog – Daniel S. Herr.
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