When in doubt, price up.

In the absence of other information, price is a powerful signal.

I went to a snack shop today to get some pani-puri. The shop keeper offered me two variants - one made of maida and another made of wheat flour. Now, I knew nothing about the difference between the two (and neither did the shop keeper). But the one made of maida was priced at Rs.10 while that of wheat was priced at Rs.12. I ended up choosing the one made of wheat.

Why? Practically, I'm indifferent to either price. But the costlier wheat variety made me think that it must have something better in it, that made the shop keeper price it higher. So why take a chance with an inferior variety.

The interesting thing is, I have seen this effect in a lot of decision making - particularly where there is limited associated information (other than price) that can help differentiate and decide. Restaurants - same food, but the pricier ones seem always better. Cars - same drive (and particularly if I don't know the specs), the pricier ones are always an envy. Even laundry services - somehow I've figured after a year of experience that the cheap dhobi who comes to my apartment does as good a job as the professional shop that charges 10 times as much - but why do I pay the professional guy so much more?

For one, price is itself a signal of quality. Price is a derivative of value of a product or service - if the seller himself undervalues his offering (and given that he always has more information than the buyer), why should the buyer, in the absence of better know-how, think otherwise?

Secondly, the absence of information creates a perception of risk. In the pani-puri example, why should I take a chance with eating a poorer variant when I could pay marginally better and avoid a health hazard? Or in the dhobi's case, why take a chance with my pricey clothes when I could pay but a small percentage of their cost to prevent the risk?

Third, is a sort of self-fulfilling prophesy effect in intangibles, wherein my belief in the better product/service due its higher price influences my experience, causing me to enjoy it better, which in turn reinforces or fulfils my belief. A costlier hair-cut feels better than a cheaper one (though in practice, there might be no difference at all), because I force myself to believe that there must be a reason for paying more, which influences my enjoyment of the service.

In sum, price acts as a strong signal of the quality of the product or service. So when in doubt, price up.

Leaving money on the table

Pricing perfectly is a science, nay an art.

I just realized how difficult it is to price something well and not leave money on the table when I paid my laundryman. The guy charges the lowest prices per piece I have ever seen anywhere in the country (and by extention anywhere in the world). His prices are atleast one-tenth the prices I would pay if I took it a professional shop thats a 10 min drive from here. And the poor guy ends up borrowing money in advance to tide over his expenses during the month.

Clearly, he could easily raise his prices without losing customers.

Or can he? Now, he is one of the two laundrymen who service the apartment complex where I live. And both of them charge the same rates. If he raises his prices, there is a good chance customers could switch.

So whats his way out?

He has two basic options. One - collude with the other laundryman to raise prices. Or Two - start differentiating, for e.g. offer a premium service at a higher price point and attempt to move customers up.

Again, how much could he raise prices?

Pricing theory says one could raise prices all the way to the point till customers see value, capped by prices of comparable alternatives. In this case, if I were a representative customer, he could raise prices almost 10-fold (assuming he could match the professional service shop) or atleast 2-3 fold at his current service level. I'd imagine that the money he's leaving on the table could solve most of his monetary problems. But does he realize it?

One factor in this is the availability of quality information. A lot of pricing that happens in practice (even in large firms) is through benchmarks. For the laundryman, the only comparable is his competitor. And this makes him leave money on my table.

This underpricing is something I've noticed in a lot of the unorganized labor in the place where I live. And this is quite sad for it feels almost exploitive to be keeping back money from people who are more in need.

Finally, it is interesting to look at professional services available in this town. Quite a opposite to the unorganized, they seem to follow the maxim 'when in doubt, price up'. With scarcity on their side, they rule the roost. To cite the contrast again, I've never seen professional services priced so high anywhere else in India.

Gurgaon is an interesting city.