Ketchup Economists and Pricing

Krugman has a lengthy piece in the Times this weekend about how economists got is so "wrong." Krugman is referring to the current recession. He has a good notion in there, about Ketchup economics. It goes like this: if a one quart bottle of ketchup costs X than a two quart bottle of ketchup should cost 2X. For me, the notion is one of pricing. Krugman talks about this in relationship to how people justified the housing bubble. He attributes this to Larry Summers. I think it is very illustrative of pricing. Competitive pricing is only one piece of value a good or service.

A lot times people make arguments about what price something should be. On the job, as a marketer, pricing is a key responsibility to address. In business school, I took away three ways that pricing actions should be taken:

1. Competitive - This is very simple, "how much are your competitors charging?" But it can also get very complex. In most pricing exercises, especially business to business ones, there is no perfect competitors. Often times there are substitutes that overlap with some of your offer's capabilities.

2. Economic Value - This is pricing an object by the economic value it yields to the recipient. For example, flying from Washington DC to Boston saves 2 hours over driving, nominally. This would mean that the price of that flight should be the price of driving plus the value of your time multiplied by the hours on the plane because of the savings.

3. Cost-based - This is based on the cost it requires the produce, plus some margin. This is typically used in commodities and manufacturing products.

The ketchup economists are using the competitive or market based pricing and not really taking into consideration the economic and intrinsic value of the good. The less those other two legs are taken into account, the more ripe the market is for a pricing correction by a new entrant or in the housing standpoint, a bubble bursting.