October 2019 issue
I just heard a riddle that goes something like this:
Q. Why does the price of balloons keep going up?
Clearly, pricing is no laughing matter.
Pricing is serious business. It's important. And if you don't understand it, you'll be at a significant disadvantage in the business world - both as a buyer and as a seller.
Pricing Question from a Reader
Today's question comes from reader T. J.
I'm creating a startup, and my advisors keep telling me that I can't just be as good as the established players. In order to succeed, I have to deliver something that is fundamentally better. Is this true?
Most economists would say that the solution to all of your problems is specialization. A company that specializes doesn't have to make its products better at everything; it just has to make its products better in a handful of ways.
That said, there's another approach that few dare to mention: rather than producing a good that is better in some ways and worse in others, a company can choose to produce a product that is universally inferior to that which currently dominates the market.
Neither fraud nor deception is required. Firms really can earn significant sums of money selling inferior products.
Welcome to the world of ersatz goods
To understand the concept of ersatz, we'll need to look back to the early twentieth century.
Around the beginning of World War I, Germany found itself in a difficult position. Its leaders had bold strategic plans, yet lacked the troops to put them into action. Its highly-trained and experienced soldiers were being spread far too thin.
This shortage in manpower assured disaster after disaster. Germany's greatest minds came together to come up with a solution. How could the military bolster its troop count as quickly as possible?
The answer lay in what would be called the Ersatz Corps (literal translation: replacement corps). The corps' soldiers didn't meet the same standards as the rest of the military. They weren't as well-trained, or as effective as traditional soldiers, but they weren't intended to be. These new recruits could provide some value to a fighting force that was desperate for assistance.
The German government may not have looked upon its ersatz units with pride or satisfaction, but you had better believe that it was happy that the ersatz corps existed.
The concept of an ersatz product is occasionally discussed in economics. Ersatz goods are items that aren't quite as good as those which they are intended to replace, but, for one reason or another, are used by the market as product substitutes.
Benefits for vendors
The pursuit of an ersatz strategy provides vendors with many benefits:
- Ability to ignore edge cases - A strategy that does not require excellence allows vendors to simplify the design, engineering, and testing tasks. Makers of superior goods work had to ensure that their products succeed in a broad range of conditions. Makers of ersatz goods, on the other hand, have no such concerns. They can focus only on the most basic and common use cases instead.
- Reduced need for consistency - Producers of ersatz goods enjoy a greater ability to substitute inputs and features without fear of customer revolt. While a restaurant known for its Kobe beef might go bankrupt should its supply chain become disrupted, the owner of a hot dog stand could change the ingredients of his hot dogs quite often and with minimal risk.
- Ability to enter new markets - Products of the ersatz persuasion can often be used to enter new markets at times when traditional options are unavailable. Once a beachhead is established, those manufacturers can even become manufacturers of non-ersatz versions as well.
- A built-in excuse - An ersatz good is not intended to meet traditional standards of excellence and value. As a result, accusations of low quality by others will prove less frequent and often fall on deaf ears.
Is every market ripe for an ersatz competitor?
All things being equal, buyers would rather possess a superior product than an ersatz one. For that reason, firms should think carefully before engaging in an ersatz strategy.
Here are a few characteristics of marketplaces that might be most welcoming to an ersatz good:
- Long lead times - When superior goods are produced via lengthy supply chains, customers may be willing to accept an inferior substitute, if it can be delivered more quickly (or with less red tape).
- Scarcity at affordable prices - When products cannot be easily acquired, buyers may be forced to reevaluate their buying criteria. Superior goods that experience swings in availability and affordability will provide ersatz goods with periods of great demand. As some vendors move to fragile just-in-time manufacturing processes to boost manufacturing efficiency, they may be creating opportunities for ersatz entrants.
- A lack of focus upon quality - When quality is given short shrift or is difficult to measure, an ersatz good might not be at much of a disadvantage. This is often true when needs are short-term or infrequent in nature. A person who uses a sailboat a few times a year doesn't necessarily receive any benefit from increased build quality that a full-time sailor would demand.
- Privacy when buying and using - Many buyers don't just purchase goods for what they are but for the signals that they send. A socialite might be willing to buy an off-brand vitamin by mail, but he will likely do whatever is necessary to avoid being seen driving a low-cost automobile.
- Fear of damage, loss, or theft - Many people who own superior goods will also purchase lower quality substitutes. This is not because of a preference for ersatz goods, so much as the fact that owners of superior goods are often concerned with the condition of their most cherished possessions.
- A separation of user and buyer - Many products are bought by one party and used by another. In such cases, the buyer may not be willing to invest the time, effort, or care to ensure that the product being purchased is not an ersatz product. In fact, the buyer may intentionally prefer to purchase inferior goods, even when financial savings are non-existent. Those with power and authority may not want to share access to superior products with those whom they see as beneath them.
Risks of the ersatz approach
Of course, producing ersatz goods is not without risk. Here are but a few risks to watch out for:
- Competition from low-quality vendors - Vendors of superior goods can use their reputation as barriers to entry for competitors. Absent other advantages, competitors may spring up like weeds. For that reason, it is essential to seek out some form of defense. One possibility is the production of ersatz goods that enjoy network effects.
- Competition from high-quality vendors - When vendors do not price, position, and market ersatz products with care, they can be steamrolled by higher-quality offerings.
- Reputational damage - An ersatz good can taint the name of an existing brand or limit the ability of a new brand to rise to greater heights in the future. For this reason, many firms would do well to separate ersatz brands from their mainstream offerings.
- Morale reductions - A solid income stream may be enough for some business owners. Others may wish to take pride in their offerings - a difficult task when products are of low quality by design.
Don't believe the legions of pundits and academics who extol the virtues of quality and excellence. Such thinking has its place. Sometimes, however, striving to produce a better mousetrap is not the right answer.
I have no doubt that you have what it takes to create a middling product or service that is somewhat OK, and unworthy of praise or admiration. All you need to do is believe in yourself a bit - but not too much.
Questions come from readers like you. If you'd like your questions answered, send them my way.
Pricing in the News
- California Approves Statewide Rent Control to Ease Housing Crisis
- Column: When a hospital sling costs 900% more than Amazon's price, something is very wrong
- Lawsuit claims Ontario law forcing gas stations to display cost of federal carbon pricing is illegal
- StarKist to pay $100 million fine in tuna price-fixing case
- Cheese Prices, Do We Have A Problem?
- Get Set for Outcome-Based Pricing
- Drug firms admit to colluding in order to keep prices up
From the Blog Archives
- The Problem with Low, Low Prices - Low prices might cost you more than you think
Notable Pricing Quote
"October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February." -- Mark Twain
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