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Feb 17Doug Smith

Deconstructing the Price Tag

Feb 17Doug Smith
Marked Down Price Tag

I love a good bargain. But how do I really know I’m getting one? When I walk into a store, there are claims about savings from the “regular price.” But how can I learn how that original price – or the discounted one – were arrived at. A new study, highlighted in a recent issue of the HBS Working Knowledge blog, shows that explaining what it costs to produce a product can potentially increase its sales. Here’s the article:

“When a company sets a price for a product, shoppers typically have no idea what it costs to produce that item. But it turns out that consumers reward efforts to lay out these figures—to deconstruct the price tag.

In fact, new research shows that when a company selling T-shirts, for example, itemizes what it spends on cotton, cutting, sewing, dyeing, finishing, and transporting each shirt, consumers become more attracted to the brand and more likely to purchase.

“By unpacking the costs, you have the opportunity to explain everything you did for the customer in putting that product or service together,” says Bhavya Mohan, a Harvard Business School doctoral student in marketing. “When firms communicate the effort that went into making a good, consumers tend to value the product more.”

Mohan is an author of the paper Lifting the Veil: The Benefits of Cost Transparency, written with HBS assistant professors Ryan W. Buell and Leslie K. John.

INTIMATE DISCLOSURE

Since cost breakdowns are so often tightly guarded secrets, the researchers say that when a firm does share this information, consumers consider it a form of “intimate disclosure”–and people are often more attracted to brands that disclose intimate information.

Shoppers have greater affinity for brands that advertise how much it costs to make a product.

“If we think about our interpersonal relationships, when people share things with us—as long as they don’t overshare—we tend to like them better,” Buell says. “We find it interesting that we’re seeing evidence of the same thing in our relationships with companies.”

To gather data about consumer pricing sentiment, the researchers conducted six lab experiments in which participants answered questions about a simulated website of a fashion retailer selling T-shirts. The research also included a field study of sales figures at a real online retailer, to look at how spelling out a firm’s variable costs of production could affect consumer purchase behavior. The researchers found:

  • When a firm voluntarily discloses its costs, the consumer is more attracted to the brand, which increases willingness to buy. “There’s this lay intuition that when customers find out that a company is making a profit off of them, they might get upset,” John says. “But that’s not necessarily the case.”
  • Consumers enmeshed in private, longstanding relationships with the brand were just as likely as newcomers to respond favorably to cost transparency.
  • Cost transparency benefits weaken as a company’s profit margins grow larger relative to costs. Interestingly, a company that exposes costs still sees a decent level of purchase intent even with a fairly high price markup.
  • “We wanted to understand when cost transparency would be harmful,” Buell says. “With a T-shirt that cost $6.50 to produce, it seemed reasonable to us that cost transparency would be helpful [in motivating buyers] if the price of the shirt was $10. But even at $35, we still saw an advantage to revealing the cost of production, which is interesting because the markup was five times the cost.”
  • Cost transparency fails only when prices become so high that they are way out of whack with the market norm—and when the firm makes it clear that its own markup is much higher than what competitors charge. For instance, if a company charges $30 for a T-shirt, but emphasizes that competitors are charging only $25, that their costs are the same, and that the competitor’s markup is lower, the consumer becomes less attracted to the higher-priced brand and less willing to buy the brand’s products.
  • “It is possible for cost transparency to backfire, but only when a company reveals it is being unfair with customers,” Buell says. “It was shocking to us how heavy-handed we had to be.” John puts it another way: “Cost transparency doesn’t fall apart until we say, ‘Hey guys, we’re ripping you off.'”

MEANWHILE IN THE REAL WORLD

The researchers took the academic experiments into the real world by examining customers interacting with an online retailer. In anticipation of the holiday season, the retailer introduced a $115 leather wallet on its website that came in five colors. In an effort to promote sales after the holiday, the retailer included an infographic graphic on each product pages that presented the cost of leather ($14.68), construction ($38.56), duties ($4.26), and transportation ($1.00), as well as the total cost of $58.50 to produce the product. But the retailer made a fortuitous error, including the costs infographic for only three of the colors—burgundy, black, and gray.

This discrepancy was overlooked for a five-week period, creating a natural experiment that compared how customers reacted to the three wallets that outlined costs versus the two—bone and tan colors—that did not. The researchers found that the introduction of the cost transparency infographic increased daily unit sales on a per-color basis by 44 percent.

NOT ALL COSTS ARE THE SAME

Consumers seem to have varying levels of tolerance for different cost variables. Shoppers seem to appreciate the cost of raw materials, such as cotton, but certain expenses, like the cost of transportation, “seem like a waste of money to people,” John says—even though it is indeed a very real cost for the company.

Yet even if the costs don’t seem allocated in an ideal way from the customer’s point of view, the customer still applauds the company’s willingness to share its production expenses. “Even if it isn’t exactly what the customer might envision, the customer appreciates the act of disclosure,” Mohan says.

It’s unclear whether a company might see these benefits on a sustained basis, particularly if a number of retailers selling similar items all started revealing their costs. Presently, only a few retailers practice cost transparency.

For example, Everlane (www.everlane.com), is a San Francisco-based online retailer that reveals the variable costs of production for each of its products, as well as images and descriptions of the factories where products are made. And Honest By (www.honestby.com), a Belgian retailer, augments cost transparency on its website with detailed supply chain information for each component of each garment, right down to the hang tag. “This was a novel thing to do, and the advantage is probably greatest when it’s perceived as novel,” John says.

The paper also noted certain cost transparency caveats for retailers. A firm may not want to share production costs if the cost structure provides a competitive advantage. In addition, contracts with suppliers may prevent making certain information public. And it just may be that companies don’t have the information readily available—for example, in cases where goods are produced by a variety of manufacturers.

For companies with goods and services that depend on high fixed costs, such as research and development and overhead, simply providing variable costs may not accurately reflect to consumers many of the other expenses incurred. For example, R&D expenditures in the pharmaceutical industry involve more than just the cost of producing one particular drug. Many drugs may have to fail before one succeeds, and that one hit drug ends up subsidizing the other busts.

“It would be a lot trickier for an industry that spends millions or even billions in developing a product to reveal its costs,” Buell says.

RAW HONESTY APPRECIATED

Yet in the retail industry—and perhaps in other industries where customers may take for granted how much effort and money goes into producing a good—many firms may benefit greatly from sharing cost figures. Perhaps it makes the price a company charges seem more fair and justifiable. Or perhaps it’s simply a matter of consumers appreciating a little raw honesty from the corporate world.

“Our evidence suggests you should open yourself up and say, ‘Here I am, warts and all,'” John says. “When you make yourself vulnerable, people like you more.”

Buell hopes the research findings get company executives thinking about finding ways to engage more openly with consumers in general as a potential way of piquing interest—and even boosting sales.

“One of the big takeaways from my perspective is that this opens up the door to companies considering engaging their customers in a more meaningful dialogue. Costs are one of those things historically that we might have thought of as taboo in a dialogue between consumers and companies. It’s interesting to think how revealing something that is usually hidden can change the nature of the relationship. Companies may truly stand to benefit from being more open.”

photo credit: Does “sale” mean lower prices or does it mean “get outta here”? via photopin (license)

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