June 2019 issue
Every year I look forward to the sixth of June, because I get to celebrate National Yo-Yo Day.
What? You don't celebrate that holiday? Maybe you don't enjoy seeing things go up and down.
I get it. I really do. But do you know what's worse than watching a bit of hard plastic on a string go up and down? Seeing your profits go up and down.
It's time to focus on the economics of your business.
Pricing Question from a Reader
Today's question comes from reader T. A.
My partners and I started a small service-based business. As we've continued to specialize, we've been able to raise our rates by quite a bit. How do we know when we've become so specialized that any additional narrowing of focus will hurt our pricing power?
Specialization seems to be a recurring theme when it comes to pricing. It wasn't all that long ago that I tackled the question of too many concurrent specializations. It seems only natural that I'd eventually come back and consider the possibility of too much specialization and its effect on pricing.
As you've learned, and I've often pointed out, there are many advantages to pursuing a course of specialization: fewer competitors, a greater ability to stand out, and, of course, the ability to charge more are some of the most obvious. In fact, one's first steps toward specialization often result in such strong returns on investment that many have come to push specializing as a panacea.
What many fail to realize, however, is that specialization can often prove quite detrimental. One reader discovered this fact as a result of tailoring his services to the needs of a poorly chosen demographic.
Let's consider the case of a hypothetical typist.
Typists are masters of a few dozen keys, representing the twenty-six letters, ten digits, and handful of symbols used in professional writing.
What if a typist decided to specialize? What if, instead of focusing on every possible key combination, he focused only upon one in particular: the key presses necessary to type an uppercase Q.
Though this degree of specialization is clearly absurd, it serves as the basis of an enlightening thought experiment. Why would this specialization prove to be an undesirable overspecialization?
Here are a handful of reasons:
- Search costs - Few hiring managers would ever think to look for a Q-typing-specialist. Whether hiring such an individual would make sense or not, the idea hasn't yet arrived in the public consciousness. From the specialist's point of view, marketing oneself would be particularly difficult as well. How could such a person advertise his services? Could he write a series of articles to cover advanced techniques for typing the letter Q? Could he hold seminars describing how businesses should rethink their Q-typing philosophies? Probably not.
- Hand-off costs - Even though our specialist might be able to type his capital Qs more quickly than most, the benefits accrued as a result of his increased efficiency would be far outweighed by the speed with which work could be transferred.
- Overhead costs - In addition to the costs of transferring work to and from other parties, one must also consider the overhead that those who hired such a typist would be forced to pay. In a business setting, a firm would have to provide office space, payroll services, and managerial oversight. In many cases, these costs would far outweigh the tangible benefits that a business could ever hope to receive from employing him.
- Lack of economies of scale and scope - One of the goals for most businesses, specialized or not, should be to gain significant economies of scale or scope. Specializing in typing the letter Q presents few options for either. I suppose that our typist might be able to purchase a unique keyboard that did not necessitate the pressing of a shift key, but that's about it in terms of scale. As to the economies of scope, one would be hard-pressed to think of any - no matter how implausible.
- Lack of perceived functional benefit - Except when compared to truly incompetent typists, the final work product of a Q-specialist would be identical to that of any other typist. After all, a Q is a Q is a Q - no matter who typed it. Even if this were not the case, even if there was a functional benefit to be had, the lack of perceived benefit prior to a decision to buy would make any promises of potential benefit highly suspect.
- Minimal reduction in risk - Most typists are able to type the capital Q without particular difficulty. Thanks to the ubiquity of backspace and delete keys, even a series of typographical errors can be corrected in mere seconds. As a result, employers would likely receive little benefit from someone who is less likely to mistype the letter Q.
- No barrier to entry - Finally, typing the letter Q isn't all that challenging. In fact, I've done in quite a few times while composing this very newsletter. Nearly anyone can be trained to type the letter Q in a matter of minutes. As such, there is little in the way of barriers to entry for those who promote themselves as Q-specialists. Even if, somehow, this specialization proved lucrative in the short term, once word got out, competitors would immediately flood the market. In a matter of seconds, any benefits derived from this particular specialization would be rendered moot.
Yes, specialization is a powerful tool that can lead to greater profitability and higher degrees of pricing power. That said, it rarely makes sense to take this concept to the extreme. Business owners need to take note: specialization for specialization's sake isn't always the answer.
Questions come from readers like you. If you'd like your questions answered, send them my way.
Pricing in the News
- FanDuel is now charging inactive users $3 per month for not playing - Pricing so high that you can't afford not to use it
- Why are U.S. natural gas prices in Texas below zero? - Gas pricing may have run out of gas
- Charter squeezes more money out of Internet users with new cancellation policy - Can't sell? Charge to cancel!
- Illinois might start charging $1,000 per year to own an electric vehicle: 'It's outrageous' - New potential tax driving electric car owners crazy
- U.S. states accuse Teva, other drugmakers, of price-fixing: lawsuit - Recommended defense: Your honor, drug pricing is broken; we were just trying to fix it.
- Supreme Court ruling could threaten Apple's 30 percent app commission - No one knows what might be in store for the app store
- Pentagon Contractor's 9,400% Profit on Half-Inch Pin Challenged - Shareholders reportedly on pins and needles
- Grifty "information security" companies promised they could decrypt ransomware-locked computers, but they were just quietly paying the ransoms - Will these companies have to pay the price again?
- Police fine pedestrian £90 after he tries to cover his face from facial recognition camera - Citizens forced to decide whether to face cameras or face fines
- Uber, Lyft drivers manipulate fares at Reagan National causing artificial price surges - Drivers are turning the tables so that they don't leave money on them
- Colorado Caps Insulin Co-Pays At $100 For Insured Residents - No efforts were made to sugarcoat the news to drug companies
From the Blog Archives
- Six Ways To Get Fleeced in the Housing Market - Jason and the Argonauts traveled the seas for a fleece, but you can get fleeced in your own backyard
Notable Pricing Quote
"If you think it's expensive to hire a professional to do the job, wait until you hire an amateur." -- Red Adair
Shameless Commercial Plug
Did you know that roughly one in twelve people has a birthday this month? Don't wait until the last minute to try to find the perfect birthday gift.
Show people how much you care and buy your friends, your family members, and even your frenemies a copy of Strategic Pricing: The Novel. It's the birthday gift that everyone is talking about.